Monday, December 19, 2011

OfficeMax: When Debt Isn't Debt

On this site, countless examples have been discussed where company obligations that aren't on the balance sheet must be uncovered and included in order to achieve an accurate valuation. But on rare occasions, the exact opposite takes place: a balance sheet obligation should be removed from consideration in order to derive a more accurate valuation.

Such is the case with OfficeMax (OMX), the office supply distributor. A quick look at OfficeMax's balance sheet shows crippling debt of $1.7 billion, compared to average annual operating cash flow of $185 million in the last four years. But upon closer inspection, it turns out that OfficeMax isn't actually on the hook for most of it!

The excruciating details are available in Note 4 in the firm's latest quarterly filing, but the gist is as follows. From the 10-Q:

"In December 2004, we completed a securitization transaction in which the Company’s ...guarantees [in the amount of $1,470 million] were transferred to wholly-owned bankruptcy remote subsidiaries...and therefore there is no recourse against OfficeMax...However, under current generally accepted accounting principles, we are required to continue to recognize the liability related to the Securitization Notes guaranteed by Lehman until such time as the liability has been extinguished."

Essentially, the company transferred some assets and liabilities to a subsidiary. The assets went bad (they were guaranteed by Lehman Brothers, which is in no position to make good!), but because OfficeMax hasn't guaranteed the liabilities, shareholders aren't on the hook for more than what can be recovered from Lehman.

There are some tax implications, however. This complicated structure allowed the company to defer taxes of $543 million until 2020. But because Lehman's bankruptcy will wrap up sooner than that, half of this amount will have to be paid once the bankruptcy is finalized. However, the company does "expect to reduce the estimated tax payment due by utilizing our available alternative minimum tax credits".

Excluding this non-recourse debt, OfficeMax is only on the hook for $270 million worth of debt plus the taxes it incurs, versus a cash position of $485 million! As a result, OfficeMax may have some value potential.

Stay tuned!

Disclosure: No position


Anonymous said...

Dear Saj

I enjoy reading your articles.
One question regarding the non recoursing debt of OMX: why they are still paying $73 M of interest expense?
Best regards, Javier

Saj Karsan said...

Thanks Javier,

Regarding the OMX debt situation, there are a lot of things that complicate that $73M in interest expense you got from last year's annual report (I assume).

First, interest expensed (on the income statement) is not necessarily paid with can accrue. Second, the company has interest income as well. Third, the company does have some other (recourse).

What I understand to be happening here is that interest income from the timber assets is being used to pay the non-recourse debt. At the same time, the company has other debt that must be funded by free cash flow.