|Shares Out. (in M):||26||P/E||11.7||0|
|Market Cap (in $M):||64||P/FCF||0||0|
|Net Debt (in $M):||7||EBIT||0||0|
(apologies in advance for some formatting issues i can't seem to fix) Two years ago we wrote up Arotech (“ARTX” or the “Company”) as a short. Much has changed at the company, the stock is down significantly and we now believe it to be an interesting long opportunity.
The Company has three businesses: 1) Training & Simulations - interactive simulation for military, law enforcement and commercial markets; 2) Power Systems - power systems and batteries for the military, commercial and medical markets; and 3) Iron Flow – a pre revenue battery for grid storage. The company’s website actually does a good job describing the business and has some pictures that are very helpful in describing these complicated products.
However, we believe the value of the company’s largest assets is masked by (what some consider to be large) corporate overhead and losses at Iron Flow.
Furthermore, we feel investors may not be fully appreciating all the positive changes that have occurred at the company. Specifically, some investors have been concerned that Management and the Board of Directors were not acting in the best interests of shareholders. However, perhaps as a result of shareholder activism, there have been significant changes at the Board which we expect will create/unlock significant shareholder value.
WHAT HAS CHANGED AT THE BOARD:
1) 1) The Company’s largest shareholder, Ephraim Fields, who owns ~9%, launched a proxy fight threatening to replace 3 directors including the Chairman and CEO (2 different people).
2) 2) A settlement was recently announced that will avoid this proxy fight.
3) 3) Last February Jon Kutler invested in the company and became the second largest shareholder (~6%) and a Board Member. His firm, Admiralty Partners ( http://www.admiraltypartners.com/ ) is a private equity firm that has had significant success investing in the aerospace and defense field.
4) 4) (Pro forma for the upcoming shareholder meeting) 3 longstanding Board Directors have stepped off the Board. Importantly, one of these Directors is the Company’s Chairman, Bob Ehrlich.
5) 5) (Pro forma for the upcoming shareholder meeting) four new directors have joined what will be an 8 person Board. These four individuals include:
a. A representative of Ephraim Fields
b. Jon Kutler
c. Rear Admiral James Quinn, who spent 30 years in the miliarty and 10 years at Northrop Grumman (http://ir.arotech.com/press-releases/detail/1732/arotech-executive-chairman-robert-s-ehrlich-decides-not-to)
d. Carol Battershell who currently works at the Dept of Energy and has significant experience in the energy industry, both in private and public sectors.
e. (Note Directors a & b: clearly are incentivized to create shareholder value).
WHAT HAS CHANGED AT THE COMPANY:
1) In April 2014 (before the changes listed above happened), the company acquired UEC (and merged it into the Power division) for approximately $35 million. This acquisition has not turned out well for the company to date and the company’s stock price is down significantly since the acquisition.
2) 2) After a difficult 2015, especially for the Power division which had non-recurring plant move charges and experienced a significant slowdown in UEC’s business, ARTX’s business and outlook is better for 2016. In addition we believe ARTX (and other industry comps) will benefit from increased defense spending.
3) 3) Bob Ehrlich, 78 years old, resigned as CEO and will resign as Chairman in May.
The below is pro forma for the sale of 1.5mm shares to Kutler/Admiralty at $1.99 in February, 2016. Note: since we started this write up earlier this week, the stock ran up a fair amount, perhaps because of some favorable internet stories about Iron Flow which this heavily retail oriented investor base likes. Anyway, this is a volatile stock so forgive us for not updating the valuation.
Stock Price: $2.45
Shares : 26.2
Equity Cap: 64.2
VALUATION ( based on mid point of company guidance)
EV/ 2016E Revenue 0.7x ($106 mm)
EV/ 2016E Adj. EBITDA 8.9x ($8 mm)
P/2016E Adj EPS 11.7x (21c …$40 mm NOL minimizes cash taxes)
Note: the above guidance include corporate overhead (which some believe to be high relative to total profitability) and $1.1mm net expenses for the pre-revenue Iron Flow.
HOW CAN THE BOARD / ACTIVISTS CREATE SHAREHOLDER VALUE
1) Sell Training or Power divisions as there are few synergies between the divisions and logical buyers for both divisions
2) Sell the entire company – Should a company this small be public?
3) Reduce corporate overhead
4) Improve profitability of business units
5) Monetize Iron Flow, a pre revenue business ARTX will spend $1.1 (net) on in 2016. Considering the company pays little cash taxes, this represents a large “hit” to EPS
6) Optimize balance sheet: net debt/2016 ebitda is 0.8x
7) Selectively pursue accretive acquisitions
Our estimates of 2015 Adjusted EBITDA by segment are below.
Segment $MM Note
Training $9.9 Is this worth more that ARTX’s entire EV?
Power $0.9 $42mm of revenue but profit hurt by plant move, etc.
Iron Flow $(0.5) Pre revenue project with revenue unlikely in foreseeable future.
Corporate $(5.1) Approximately equal to total Adjusted EBITDA.
We believe the above table helps illustrate our belief that the ARTX’s overall valuation is being masked by expenses for Corporate Overhead and Iron Flow.
1) Emphasis on creating shareholder value from new large shareholders and reconstituted Board of Directors.
2) Improved results after poor 2015.
|Entry||04/12/2016 10:10 AM|
All the new board members have to to make this work is strip away some of the layers of bloated SG&A and related part dealings. The battery business should be sold, and industry multiples indicate that 1x sales could be achievable.
$85m current EV
($50m for battery business)
= $35m for defense/simulator business.
This business is worth 9-11x EBITDA or $90-$110m