Vertex Elegy $VTNR

I come to bury Vertex, not to praise it.

Friends, Investors, countrymen, lend me your ears;

I come to bury Vertex, not to praise it.

The mistakes that management does live after them;

The good is oft interred with their bones;

So let it be with Vertex.

“I like people admitting they were complete stupid horses' asses. I know I'll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn” - Charlie Munger

The last time I wrote about Vertex Energy (VTNR), was on August 14th.  The final paragraph of that writeup:

“As a rule of thumb, I don’t invest in companies with imminent dilution.  But in this instance, the hidden asset in the truck ramp, and the aligned incentives of having a founder CEO with 7% ownership in the business make me somewhat confident that dilution will be the bare minimum required to bring VTNR into Q2 of 2025 where their fortunes should improve.  Of course there is always the dreaded widowmaker, the crack spread.  A collapse in the highly cyclical refining margins could put huge pressure on VTNR, and surviving through that downturn with such an upside-down balance sheet would result in massive dilution, or the refinery being handed over to the lenders.  It’s a race against time to see how much balance sheet improvement VTNR can execute before the next major crack spread bear market.”

And of course, crack spreads have collapsed:

Vertex Energy had a deadline from their lenders of September 20th to either sell an asset or refinance their debt, and it looks like they were unable to do either and have initiated Chapter 11 proceedings.  Only in about 10% of Chapter 11 restructurings is there any value left over for the equity holders.  And while the CFO told me that his estimate of the bankruptcy auction of the assets would be around $600 million, more than enough to settle the debt, I don’t have much confidence in the judgement of the CFO.  There are a few layers of mistakes with Vertex Energy, and I want to take a moment to examine them for the purpose of investing better next time.

Management’s original sin was to focus on renewable diesel before traditional refining while their floating rate debt slowly ate away at their liquidity.  The COO at the time, James Rhame, wanted to focus on the traditional refining business before spending the enormous capex to build out the renewable diesel business, but the decision was ultimately the CEO’s.  With rising interest rates, the renewable diesel market crashed, and Vertex found itself in a bit of a squeeze.

My first mistake was to confuse tactics for strategy.  What I liked about Vertex was the scrappy CEO, Benjamin Cowart, who created new verticals by building out the bunker fuel distribution business.  I place a lot of emphasis on incentive alignment, and the founder owned 8% of the business, and ended his stock selling program when the price fell below $8 a share.  But good tactics can’t make up for bad strategy.  

Management compounded their original strategic mistake by failing to act decisively.  Management preferred to dig their way out of their mess by finding a joint venture partner, and if that wasn’t possible, to sell the legacy Louisiana business, and last of all, to refinance their debt and bootstrap their way out of it.  By not acting decisively to either sell the Louisiana business or refinance their debt immediately, when the joint venture process failed, there wasn’t enough time left for their backup plans.  

When I compare the turnaround plans of Vertex Energy with Advance Auto Parts (AAP), the current CEO of AAP did act decisively, immediately initiating all the necessary changes to achieve their goals, not just the hub and spoke distribution system and consolidating the point of sale systems, but also immediately selling the wholesale business.  It might have been possible that streamlining logistics and rationalizing software could have plugged enough leaks that AAP would be on its way to recovery without selling assets into a soft market.  But current CEO Shane O’Kelly is acting decisively from the beginning and not waiting for feedback to trickle in slowly when drastic action needs to be taken.

The third mistake that Vertex’s management made was not locking in some hedges when crack spreads, aka the widowmaker, were in a range that would have guaranteed the profitability to reach their goals.  Between January and May of this year there were a lot of opportunities to create some derivative hedges that would have locked in enough cashflow to get the company to their destination, and management failed to create enough runway to land the plane.  The company was on a glide path to profitability sometime between Q4 2024 and Q2 2025, but management did not take the steps necessary to make sure they could reach that target.  

Those are the three main mistakes that led Vertex Energy to their current situation.  I place a large emphasis on incentive alignment, but maybe I need to place a greater emphasis on management executing and delivering results.  The complete mismanagement of the financial planning to obtain liquidity to reach cash flow breakeven destroyed the company. 

Beyond management’s mistakes, there are my own mistakes as an investor.  The largest of these was position size.  I started my investment in Vertex early on in my journey, when I didn’t appreciate how many opportunities are out there, and I never did the spring cleaning of presuppositions to go back and resize the position.  If Vertex were only 1% of my portfolio, it wouldn’t be pleasant, but it also wouldn’t require so much introspection.  I think I was honest and aware that failure was an option, but I didn’t expect failure as my base case.  

Absent the mistake of position size, there is a viable investment strategy surrounding these high torque companies.  If there are ten companies that are capable of delivering 10x returns in five years, and three of them go bankrupt, two breakeven, two generate a 2x, and three generate a 10x, then the annualized rate of return on an equal weighting is 29.10%.  Not a terrible outcome, but that is not my preferred strategy.  With every position, I do the due diligence to give myself a reasonable understanding of the business in the attempt to prevent those worst case scenarios.

In the past bust of Conn’s, there was a CEO who was a West Point graduate, with a 4.5% ownership of the company, decades of experience in the industry, and he executed a merger that left the company bankrupt within six months.  There was a sudden crash in consumer expenditures, but I was relying on the incentive alignment and basic competence of the individuals involved, and they did not deliver.

Similarly with Vertex, the CEO owned about 8% of the company, and his incentives were aligned perfectly with shareholders.  There was evidence of the CEO delivering entirely new verticals for the business, but at the end of the day, he failed to create a path to reach profitability.  The only explanation I can come up with is total incompetence and failure of the financial planning process between the CFO and the CEO.  Again, relying on incentive alignment and basic competence was not enough to prevent the worst case outcome.

Looking back on my due diligence with Vertex, especially since I flew to Houston in February of this year to meet the CFO and chief of strategy, were there any red flags that I should have spotted but failed to add into my calculation?  Yes, in hindsight, there was.  When I compare the business plan that management shared with me to the business plan that Ernie Garcia III of Carvana (CVNA) had to turn around his company, there was an enormous gap in competency and credibility of the path forward.  While I was primarily looking out for behavior indicative of a swindler, I should have also been on the lookout for incompetence.