|Shares Out. (in M):||22||P/E||0||0|
|Market Cap (in $M):||165||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
New management has recently disclosed that a run-off of ADES (@ $7.50) has signficant upside (arguably $12/+60%), with nearterm catalysts offering additional upside (arguably $20+/+170%) over the next 12 months. Moreover, there exists a tail upside case from a newly disclosed patent portfolio (which could take valuation to $50/share+). There is strong shareholder representation on the Board of Directors to realize this value (for example, ADES recently announced its pursuit of strategic alternatives). ADES seems obviously cheap, given strong downside protection with multiple upside scenarios. This opportunity exists because ADES has apparently been left for dead, while a new management team has not only recovered the business, but is growing it (to a point where cash flow could be returned to shareholders accretively in 2017). In summary, this investment idea appears to demonstrate a trifecta of: asymmetric positive convexity, multiple catalysts, and strong corporate governance.
To quote management from its August conference call:
“Taking a 25% to 30% discount rate against … contracted dollars, our current market cap approximates this base [Tinuum] business cash flow. Said another way, these assumptions do not price in any value for [anything else] nor additional [monetizations by Tinuum]”
The stock today does not reflect this specific disclosure (nor additional positive disclosures). I believe management's comments are reconcilable, and the conclusion is unequivocally positive. I walk through my investment analysis in detail below. Nevertheless, I strongly encourage you to take a look at the 9/13/16 Rodman & Renshaw presentation & webcast, and read the Q2 earnings call transcript yourself (links provided below), and verify my analysis.
WHY THIS OPPORTUNITY EXISTS
ADES has been in triage mode since 2013, with new management appointed in mid-2015. Till 2016, there have not been SEC filings, audited financials, earnings calls, or qualified IR. Today, the new management team is executing very well, and has given materially positive disclosures to the market. However, these disclosures have not had an audience, and management's delivery has been made in a piece meal fashion that has not drawn attention. In short, because ADES is small, off-the-run, and without sell-side analyst coverage, the market is not aware of/appreciating these positive disclosures.
ADES is a sum-of-the-parts valuation, with 4 main components:
There are 5 different catalysts which can drive material upside over the next 6-12 months:
2016 IS AN INFLECTION YEAR
There is significant difference to pitching ADES today than in past. Importantly, the stock price is much lower (and arguably trades below a run-off of its current business portfolio). As importantly, there have been a litany of materially positive developments over the last 6 months.
Importantly, ADES has new management. This is a new management team that has credibly addressed accounting (historical mistatements), litigation (related to the mistatement) and operating issues (failure to monetize an asset rich company). Fixing the operating issues is a big deal, as ADES has been sitting on a lot of unrealized value the market has seemingly lost faith in. Management has demonstrably started to realize this value, doing things in 1H 2016 that prior management couldn't execute on for years.
As important, new management has improved disclosures. ADES's new financial reporting allows one to separate the segments in a way one could not in past. For example, the 42.5% stake in Tinuum is no longer consolidated with the remaining businesses; additionally, ADES now actively discusses the economics / cash flows from Tinuum in slide presentations (for the first time ever). ADES management is also now answering questions with investors on the first conference calls held in years.
Lastly, ADES will generate positive FCF going forward, the most tangible inflection point. Historical FCF has been consumed to repay debt, build out the business, pay consultants (accounting, litigation etc.), support a bloated cost structure, subsidize losing businesses, etc. Going forward, ADES is rightsized with zero corporate debt. They should be able to generate cash to deploy in shareholder friendly manners (e.g., accretive share repurchases). Harvesting cash flow will become a dramatic u-turn for a company that could not even file financials for a few years. Deploying this cash is likely a 2017 event, but is nevertheless coming.
STOCK HAS NOT RESPONDED TO 2016's POSITIVE DISCLOSURES
Mar 2014: $24 Files NT-10K due to accounting issues
Jan 2015: $17 Auditor resigns
Feb 2015: $16 Trades OTC
Apr 2015: $15 Heath Sampson appointed CEO
Dec 2015: $7 Stock grinds lower on no news into year-end
Sep 2016: $8.50 Stock does not rally on:
Leases new RC facilities (the first in years)
Discloses they have been close to multiple, large RC deals "in recent months"
Discloses insurance companies will underwrite RC tax equity risk
First M-Prove sale & disclosure of larger addressable market than expected
Discusses potential patent portfolio value for first time
Reduces headcount 90%
Announces pursuit strategic alternatives
Files 2015 and 2016 SEC filings (now current)
Settles SEC lawsuits & shareholder lawsuits (for small amounts)
Adds net 2 new shareholder representatives to Board
Re-lists on NASDAQ
$165MM market capitalization (22MM shares at $7.50)
$11MM cash (including restricted cash)
$23MM debt (liabilities related to royalty related litigation)
TINUUM GROUP: LUCRATIVE TAX CREDIT PLAY
This segment consists of stable-to-growing cash flows through 2021 with low operating complexity. This is a tax credit play, whereby ADES owns technology (through its 42.5% stake in Tinuum), that reduces emissions from the burning of coal and generates lucrative tax credits in return. This business is not a coal business and is not levered to coal prices.
ADES is one of four companies that has built facilities that can generate Refined Coal ("RC", a term defined by the IRS). Refined Coal is coal treated with a chemical that helps reduces toxic emissions when burned. The IRS created a tax credit to incent the generation of this cleaner "Refined Coal", which spurred the building of these RC facilities. The window to create these facilities closed in 2011 (no more facilities can/will be built). Also, the RC tax credit expires in 2021, so getting the RC facilities producing refined coal (and thus tax credits) s important, given a finite life to the asset.
ADES built 28 of these RC facilities. ADES owns its RC facilities through a 42.5% stake in Tinuum (a joint venture with a private party and Goldman Sachs). Tinuum has the second most facilities in the market, behind Arthur J. Gallagher at 34 (a $9BN publically listed insurance company).
For every ton of refined coal generated, the IRS gives the operator a tax credit worth ~$7.00/ton. These are called “Section 45” tax credits that offset actual tax liability (not just pre-tax income like a NOL). The operator pays then pays ~$7.00 out in costs ($3.50/ton to operate + $3.50/ton payment to Tinuum). The operator thus has net cash flow of $0 ($7.00 minus $7.00 of cost), but can expense this $7.00 of cost on their own income statement (assuming a 35% tax rate, this is $2.45 of tax benefit).
Thus, Tinuum gets paid $3.50 per ton of refined coal using these facilities. These payments are nearly all FCF. To realize this value, Tinuum needs to find a tax equity investor to actually operate the RC facilities who can use the tax credits (and thus afford to pay Tinuum the maximum fee, net of operating costs). Finding a tax equity investor for a RC facility is called “monetizing” a RC facility (a key term).
UNDERSTANDING THE ECONOMICS IN MORE DETAIL
If you net this all out, their cash flow is $0. They receive $7/ton of tax credits, and expense $7/ton of costs. But this same company gets the tax benefit from expensing the $7/ton of costs. Assuming a 35% tax rate, this is $2.45 of NOLs. The tax equity investor thus earns $2.45/ton for no capex investment. The right tax equity investor has a lot of taxable income to shield (using the $7/ton tax credit, and via expensing the $7/ton of operating cost)
Once monetized, Tinuum receives $3.50/ton. Otherwise, Tinuum would not run the plant (because Tinuum would incur the operating costs). Tinuum only runs monetized plants today, having already accrued tax assets from running some plants for its own account in past years. Lastly, Tinuum has incurred the vast majority of capex for the RC facilities, having built them and installed a majority of them at coal burning power plants.
REFINED COAL TAX CREDITS HAVE BECOME MORE MAINSTREAM IN 2016
ADES recently disclosed that insurers are willing to underwrite the the audit risk of using these tax transactions (source: ADES conference call). Further, multiple, large public companies have disclosed their use of refined coal tax credits, including Arthur J. Gallagher, WW Grainger, DTE Energy, Capital One, & Fidelity Investments. You can talk to investor relations at AJG and GWW about their use of the tax credits (AJG highlights them in on investor decks). GWW invested in RC facilities in mid-2015.
TAX CREDIT LIVES THROUGH 2021
These Section 45 tax credits only last through 2021 (unless extended). The name of the game is getting facilities monetized on a timely basis. There is low risk of the tax credit going away ahead of 2021 through Congressional action, as (i) the tax credit naturally expires, (ii) the tax credit is part of a broader tax bill, and (iii) IRS has already blessed RC tax equity deals in the past.
Tax equity investors invest in the RC facililties using annually renewing contracts. Long-term contracts are not allowed due to IRS rules/regulations that require tax equity investors to take risk in transactions (in order to qualify for using the tax credits). Given the massively positive economics & complexity of structuring, tax equity investors do not much incentive to recut/walk away after setting up a RC transaction.
TINUUM GROUP: EACH RC FACILITY IS WORTH $1/SHARE TO ADES
We can put together a DCF of what a hypothetical RC monetization is worth to ADES, and extrapolate ~$1/share (undiscounted).
A review of investor decks & recent SEC filings shows:
TINUUM GROUP: RUN-OFF IS WORTH $9/SHARE TO ADES
Take the math above and multiply by 13 - which is how many RC facilities that ADES has monetized– you get $9.22/share. I believe – but have not confirmed – this is the rough exercise that backs up management’s comment, “taking a 25% to 30% discount rate against those future contracted dollars, our current market cap approximates this base [refined coal]business cash flow”.
ADES actually provides a future cash flow schedule of what it expects to receive from Tinuum, and I included it below. N(ote: CCS is the old name for Tinuum). You can see $639MM x 42.5% = $272MM, which is $12.36/share (on an undiscounted basis), pretty close to my $13.22 rough calculation above.
The exact value to ADES from its stake in Tinuum will of course be slightly different for many reasons. I have highlighted a few below:
TINUUM GROUP: COULD BE WORTH $20/SHARE TO ADES
Tinuum has 28 facilities, but has only monetized 13. This means it has inventory of 15 RC facilities to monetize (and generate significant incremental cash flow). Below is a sensitivity showing possible upside:
ADES should be able to monetize more facilities. Arthur J. Gallagher, in its own public disclosure, has now monetized 31 of its 34 facilities (91%). If AJG can do it, why not ADES? New management has highlighted multiple reasons for Tinuum’s inability to secure all its leases thus far:
I highlight 5 reasons why ADES should be able to monetize more facilities:
The last 2 points shouldn’t be minimized. ADES’s new management has demonstrably turned the corner: a company that hadn’t previously signed a new RC facility in years -- where a single facility is worth $1/share – has now gotten close to monetizing many “multiple units”.
On the April 2016 call, they disclosed how close they were on one of these transactions:
“We were close, a couple months ago, with a large entity. They went all the way through their due diligence and, in fact, even obtained insurance in the market for this product. But in the 11th hour, it got put to the side burner. And the main reason for that, there's a large strategic issue that's popped up for that company and they put on the side burner. So, it's never done 'til it's done, but again we have numerous of these companies that are in those – that are spending a lot of money, doing a lot of due diligence, have been approved through their historical reputation-type committees. So, we're encouraged about closing a number of these facilities in the next couple months.”
Casually mentioned on the August, Q2 2016 earnings call, was that there was second large transaction they were close to:
“we were very close to closing two different tax equity investors for multiple facilities each over the last couple of months”
So in summary, ADES publicly stated it was very close to two multiple-unit transactions that would have presumably resulted in material upside to current trading levels. Further, ADES has a pipeline of potential customers and competitors are largely sold out. Thus, it seems reasonable that ADES/Tinuum has solved their company-specific issues in monetizing facilities, with momentum to monetize additional facilities.
M-PROVE: MAY BE WORTH $3-11/SHARE (POTENTIALLY A LOT MORE)
ADES is a leader in selling emissions control equipment (“EC Equipment). Apparently, some of the resulting IP has not been previously marketed/monetized. New management has spent time to understand what they have, and it’s pretty exciting (especially when compared against the current market capitalization).
For example, management has started marketing one of these products, M-Prove, for the first time in 2016. M-Prove is basically an iodine-based solution for reducing emissions when coal is burned, and is a better product vs. existing bromine-based additives that currently dominate the market (see 2015 product deck below).
This product is high margin & low capex. ADES also says they have multiple customers in the pipeline. Most importantly, ADES announced its first customer on May 10, 2016, showing genuine traction:
Importantly, ADES recently disclosed at its September 2016 presentation that the market size for M-Prove is really big. They stated it could be 350 potential contracts at $1-3MM revenue each (slide 16). Assuming 50% EBITDA margins, that is a $350MM EBITDA addressable market! This would be a very high multiple business to boot given the margin/recurring revenue profile.
If we assume very little market penetration for what seems like a very marketable product, it is worth $3-11/share to ADES (assuming $10-30MM EBITDA). My assumed multiples may be conservative, as they don’t ascribe growth multiples or M&A upside.
Assuming $50-100MM EBITDA yields staggering upside potential.
M-Prove is an asset of ADES that should have been marketed years ago. New management is now realizing that value in a relatively short period of time (a testament to management, and quality of the product). It remains a show-me story, but incremental M-Prove sales should serve as a positive catalyst for the stock.
PATENT PORTFOLIO: COULD HELP UNLOCK THE $50/SHARE TAIL SCENARIO
This is an item that ADES has only recently been discussing. ADES may have a valuable patent portfolio that many companies may be actively violating.
What we know:
These last three points are significant. Firstly, ADES did not even know what it had till 6 months ago, so this is new disclosure for the investment community. Secondly, the Company that has patents that may cover the use of all halogens (i.e., beyond M-Prove to include the industry dominating Bromine solutions) and other/undisclosed coal burning technologies.
If ADES really has these broad based patents, and they are being illegally violated, ADES may own a jackpot winning lottery ticket. This could manifest in fines, royalties or more adoption of M-Prove (using M-Prove vs. the other halogen products currently dominating the market place). Quantifying the value is difficult (how many tons of coal globally are violating this patent, and what could the patent royalty stream be?). But given the small market capitalization today, the upside could be staggering – and you are getting it for free.
To be clear, others have their own patents and will probably fight ADES’s assertions, and I have not personally researched ADES’s patents (further, ADES has stated on calls they do not want to share too much information publicly at this time). But again, you are getting this valuable option for free.
EVERYTHING ELSE: $0/SHARE
A liquidation of the balance sheet yields -$1/share (taking cash and netting out liabilities). The remaining EC Equipment business is probably not worth much, given it does not cover G&A and has uncertain forward outlook. However, this business is generating $10MM EBITDA annually, and is for sale, so represents some positive value. For simplicity sake, I just assume $0 value across cash, liabilities and the EC Equipment business.
LINKS TO MORE INFORMATION
The author of this posting and related persons or entities ("Author") currently holds a long position in this security. The Author makes no representation that it will continue to hold positions in the securities of the issuer. The Author is likely to buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note, nor suitability of the security for any potential investor. The views expressed in this note are the only the opinion of the Author. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the note.
Please see write-up
|Subject||Re: What am I missing?|
|Entry||10/03/2016 01:32 PM|
Great question, and also part of the pitch (why 2016 is an inflection year). I explain my thoughts below in detail below, but first a quote from Q2 call (I should have included in my write-up):
"The good thing is, we're out of a lot of the challenges that we have and we've really restructured a lot, and we do expect cash to be coming in. So what do we do with that cash? We're going to be evaluating what we do, what's the best thing you do for shareholder value, and that's many things from getting money back to you in some form of a dividend, stock buyback, other investments. Whatever it's going to be, it's going to be a very thoughtful process that us and the Board look at to ensure that we return value back to the shareholders"
Tinuum did not maximize historical cash flow
Tinuum distributions were cannibalized by ADES's other operations
The holding company cash burn got so bad that ADES had to borrow $15TL on 10/22/15 (Q1 10-Q, page 26):
"During the three months ended March 31, 2015 the Company's working capital and cash balances continued to decline, due principally to continued losses. Such losses were driven primarily by poor operating performance related to [EC Equipment]... and continuing expenditures required to fund the re-audit and restatement ("Restatement") of certain of our prior consolidated financial statements, and a significant reduction in the receipt of cash distributions from CCS. This deterioration of working capital directly necessitated the securing of the loan transaction described in Note 12 ("Credit Agreement"). The Company expects that pressure on working capital will continue until such time as all Restatement activities are completed, including resolution of the SEC inquiry and the conclusion of the private litigation, both of which are described in Note 8."
Notably, this TL was repaid entirely on 6/30/16 (see Q2 10-Q and call)
Headwinds Should Now Be Gone