Distressed: long ZLOMREX 8.5% 2014

The company can be created for 4 times its "normalized" EBITDA, assuming an entry price of 30 cents on the bonds and using a "normalized" EBITDA assumption of PLN 125MM (60% of its PLN 210MM peak EBITDA in 2008).

Net debt as per the end of September 2009 was at PLN 877MM of which PLN 536MM were the outstanding of the notes. Discounting the notes to 30% together with other debt of PLN 341MM (valued at par) brings the market value adjusted net debt number to PLN 501MM which divided by the normalized EBITDA gives us a creation multiple of 4x.

This compares to an estimated target/full value EV/EBITDA multiple range of something closer to 5.5x - 6.5x depending on how generous the market is. The entry multiple of 4x makes me believe that the bonds do have serious downside protection and upside potential. At par those bonds would be 7x normalized or 4.17x peak EBITDA. This is the super-upside case but over a holding period of 1-2 years the bonds have the potential to more than tripple in price and stay current on the 8.5 % coupon. On the downside (f.i. being off the mark on normalized EBITDA) I would assume to still recover 30 cents in about 18 months. Discounted at 25% bonds would have to trade down to 20 cents.

Zlomrex S.A. (ZLOM) is a distributor and producer of steel and steel
products both in Poland and Central and Eastern Europe with four
divisions: Finished Products including Retail Distribution and
representing 87% of its 2008 revenues and the Scrap as well as the
Semi-Finished Product segment accounting for the rest. The company
employs about 4.000 people and consists of about 50 entities
located both in Poland and abroad.  ZLOM was founded in 1990 by Mr. Przemyslaw
Sztuczkowski who remains its 100% owner. ZLOM is a vertically
integrated business and the largest trader of scrap in Poland and is
among the leading producers and distributors of high grade long steel
products in Poland and owns a large distribution network, predominantly
in Austria and Poland but growing in other CEE countries and the West Balkans.

Source: ZLOM

The company owns three mini-mills in Poland producing around 400k¹ tons of long and flat steel
products annually and was actively engaged in acquisitions in the
production and distribution space from 2006 and 2007. Its domestic
revenues have thereby declined from 80% to roughly 50%.

They acquired a Polish mini-mill in 2006, 'Voest Alpine Stahlhandel'
- a Central European distribution company as well as steel distribution
assets in Poland (Centrostal Gdansk, Centrostal Opole, Centrostal
Gornoslaski and Stalexport) and a Croatian steel mill (Zeljezara Split)
in 2007. 

ZLOM has issued a 8.5% senior secured note maturing in February 2014
in the amount of EUR 170MM which recently have been reduced to EUR
127MM as a result of the company repurchasing notes at distressed
prices. The repurchased notes have been canceled. 

ZLOM's post acquisition debt financing structure remained reliant on
short term debt financing for about 50% of its total debt capital by
the end of 2007, which resulted in serious concerns about its extension
risk intensified in the first quarter of 2008 by the then intensifying
credit crisis and fragile state of the banking system.

Source: IMR World Economic Outlook / October

ZLOM's notes began to weaken in June 07 but started to substantially
trade down to distressed levels after the end of 2007, paired with the
expectation of sharply deteriorating earnings expectations given their
exposure to the cyclical steel markets.

Poland's GDP decline was less protracted compared to other EU
nations (real GDP was positive in Q1 and Q2 2009). However, demand for ZLOM's steel products are driven primarily
by construction and automotive industries, both of which have been
negatively impacted by financing restrictions and a decrease in
consumer and business confidence.

Source: IMF world economic outlook / October

Measured by the Polish Construction Confidence index (EUCOPL) which
started to fall in February 2008 and deteriorated until March 2009 when
it stabilized at the low level, while the Eurozone Construction index
(EUCOEMU) already turned slightly positive since its low in May.

Polish Construction Confidence index:

Source: obvious

Operating earnings collapsed impacted by low demand and falling
steel prices starting in September 2008. The vast majority of ZLOM's
products are sold at spot prices and without the benefit of long term
contracts. ZLOM also faced inventory write offs, especially in Split,
where they held high inventories in 2008, and they where hit by the
negative currency impact on its Euro denominated bond debt by the Zloty
falling versus the Euro.

Source: ZLOM

Management team was communicative and accessible for debt investors
and has demonstrated good transparency and corporate disclosure.

They
also reacted by announcing a halt of its acquisition strategy and
reiterated their commitment to decrease leverage and even under severe
circumstances, they have been able to reduce net-debt from its high
point in Q4 2007 of PLN 1.142MM to PLN 952MM by the End of 2008 and
further to PLN 875MM until end of August 2009.

Distribution business absorbs free cash flow by working capital
requirement during the upswing which is released and results in free
cash flows during the downswing when lower working capital is required
(see also Credit Snapshot for Ryerson, Credit Snapshot for Kloeckner).

The reduction of debt was helped by repurchasing EUR 43MM face
amount or 26% of its notes at distressed levels. The repurchase was
conducted opportunistically by various transactions over a few months
financed by cash available from various sources.

Management indicated that they will continue to seek multiple ways
to reduce ZLOM's debt. However, they did not engage a restructuring
advisor which gives rise to the believe that they see secondary bond
repurchases as their preferred way of restructuring. They said to seek
more minority interest sales and asset sales to the extent they may
deem necessary. They did not exclude an exchange offer as an option but
it would in our view be a more expensive alternative to restructure
from the perspective of the equity owner.

ZLOM's 2007 acquisition of its Croatian steel mill, Zeljezara Split
(Split), resulted in massive integration challenges and significant
losses. Split lost about EUR 13.5MM in 2008 and stopped production in
April 2009. Management stated that they had underestimated cultural
issues. They mentioned that around half of Split's employees took sick
leave during summer time and faced other challenges like a two-month
gas shortage and that they could not gain full operational control over
the plant for half a year due to local legal system difficulties.
Finally they decided to cut the Split related cash drain and announced
in September 2009 that they have agreed to sell 95.9% of Split to Carlson
Private Equity Ltd., a UK based a special situations and turnaround fund that was formed in 2003 which committed to
recapitalize the operation. ZLOM continues to hold a receivables claim
in the EUR 17MM range they hope to recover as a result of the
recapitalisation and its prospects as a going concern.

Croatian local
press reported on October 8th that the Economy Ministry rejected the
transaction October. CFO confirmed shortly thereafter that transaction
is carried out according to the schedule and that Government has no
ability to the deal off. Bank of New York, the notes trustee, is
proceeding with the needed share pledge release.

ZLOM also sold their majority stake of one distribution company in
Austria where they held a 60% stake to its minority shareholders and
thereby recovered EUR 5MM which was close to the distributors share
book value. ZLOM also arranged a small secondary offering in the amount
of EUR 3-4MM which was directed towards Polish pension funds for its
majority owned and

Warsaw listed steel distributor (Cognor). 

Availability under its credit facilities as per the end of August
2009 was stated at PLN 105MM while cash held was at EUR 18MM. Short
term debt extensions remain a concern with PLN 334MM (EUR 78MM) due
within one year. Annual CAPEX is expected to be in the PLN 30-40MM
area, slightly lower than the remaining annual coupon for the 8.5%