Arc Group Worldwide arcw
December 29, 2017 - 6:17pm EST by
googie974
2017 2018
Price: 2.10 EPS 0 0
Shares Out. (in M): 18 P/E 0 0
Market Cap (in $M): 38 P/FCF 0 0
Net Debt (in $M): 47 EBIT 0 0
TEV ($): 85 TEV/EBIT 0 0

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Description

Arc Group Worldwide is nearing the completion of restructuring actions intended to correct

operational problems, reduce debt by selling assets that are not essential to their strategy to

disrupt metal parts manufacturing, and raise capital for further investment in that core

strategy. That strategy utilizes legacy powdered metal expertise from their metal injection

molding business to enable 3D printing of metal parts. The company is leveraging this

proprietary knowledge to provide metal part rapid-prototyping services synergistic to their

production metals manufacturing business for OEMs.  At the same time they are also offering

stand-alone 3D printing services of proprietary alloys they’ve developed for production of

demanding medical, dental, and aerospace parts. The controlling shareholder and several

prominent investors are backstopping a $10 million rights offering to shareholders priced at a

10% discount to the trading price on the yet to be defined rights record date (but not less than

$2 a share).  This rights offering may offer an attractive entry price, either by purchasing shares

prior to the record date and oversubscribing in the offering, or by purchasing shares during the

offering where arbitrage selling by rights holders will likely pressure the stock price.

 

Arc Group Worldwide was formed from a series of acquisitions from 2012 to 2014 of metal

parts manufacturing companies. The intent of the controlling shareholder, $3 billion in assets

hedge fund Quadrant Management, was to create a disruptive force in the metal parts

manufacturing industry by offering a highly automated, digital, and holistic supplier that could

offer everything OEMs needed. This included rapid prototyping of metal parts through 3-D

metal printing, and then production manufacturing via the variety of methods used by the

acquired companies. Currently, many large companies have their own procurement personnel

that work with numerous companies to get their metal parts manufactured, one company to

rapid-prototype, another to make machining tools, another to stamp production parts, another

to metal-injection mold, another for the plastic-injection molded housing etc…. Arc Group

offers all of that in house while accepting three dimensional models over the web and

employing software to make prototypes and production parts in a highly automated manner.

Over time, Arc Group’s holistic offering is intended to take business from the many specialized

mom and pop machining providers.

 

Important to being a soul source provider is to be able to offer rapid-prototyping of metal parts.

While expensive, 3D printing allows the creation of a prototype metal part in a day. With rapid-

prototyping, engineers can iterate on designs and get the design right and their products ready

for market quickly. Rapid-prototyping is being increasingly adopted by many companies as an

essential part of the product development process. Metal injection molding (MIM) injects a

mixture of powdered metal and a carrier polymer into molds to form the part. The polymer is

then burned off and the powdered metal particles fused together by heating to form the final

part. It takes time to make the mold and develop the injection process so MIM is generally not

a rapid-prototyping method. However, Arc Group’s core metal injection molding business, the

leading MIM company in the United States, was a pioneer in developing unique expertise in the

powdered metallurgy that MIM requires. While anyone can buy a 3D printer, successful

printing of metal parts requires the ability to print parts from metal powder to precise

dimensions resulting in high-strength parts. Cracks in the metal from the printing process are a

big problem that limits what alloys can be successfully printed. Medical or Aerospace

applications often require the ability to 3D print using titanium or high strength aluminum

powder. Arc Group has made significant investment in further development of their legacy

metal powder expertise for 3D printing and considers this materials expertise a competitive

advantage with high barriers to entry.

 

3D printing capability is important to Arc’s traditional metal manufacturing business as a rapid

proto-typing method for their customer’s product development. However, it is also important

to Arc Group as a production method for high value medical and aerospace parts, some of

which cannot be manufactured in any other way. Arc can print from metal powder high

strength, high temperature ferrous alloys, stainless steel, cobalt, titanium, high strength

aluminum, and other materials for specialized and challenging applications. While operational

problems with the traditional businesses were destroying Arc Groups financials and stock price

the last three years, 3D printing has continued to progress. Revenues in the most recent

quarter tripled over the prior year to $930K and are expected to double in 2018 compared to

2017. With the 2017 expansion of 3D printing facilities, further 3D printing investment being

considered by the board of directors, and their growing revenue from 3D printed parts, Arc

Group’s higher margin 3D printing division may eventually rival in value all of their legacy

businesses combined.

 

BACKGROUND AND HISTORY

Everest Hill, the 48% owner of Arc Group, also owns Quadrant.  Quadrant is a $3 billion in assets

hedge fund started by 68 year old Alan Quasha (the current COB of Arc Group) in 1978. 

Quadrant also owns Vanterra Capital, which is a private equity firm bringing total assets to

around $4 or $5 billion.  Eli Davidai is a 62 year old managing director of Quadrant since 1992. 

Prior to that he worked as CEO of Quadrant Amroq Beverages bringing Pepsi products to

Bucharest Romania and then served as Chairman of Quadrant Beverages bringing Pepsi

products to Bulgaria.  Davidai became the Arc General Manager of Operations at the request of

COB Alan Quasha earlier this year. 

 

The principals at Quadrant (Quasha and Davidai) are believers in technology disruption.  Davidai

at age 62 just finished a program at Harvard Business School and a training class at Berkeley's

Singularity University.  Davidai discusses technology disruption in this youtube video

(https://www.youtube.com/watch?v=G3SGJHJHyzE) where he states “I must tell you... if you

don't find the value proposition , something to differentiate you from another business... close it. Leave

it.  Don't waste your time"!   Arc Group is Quasha’s and Davidai’s attempt at disrupting metal

parts manufacturing.  Their idea was to assemble all the metal manufacturing technologies

under one house and become the one source supplier to big manufacturing companies.  An

important part of their strategy is the development of 3D printing capabilities. 3D printing is

beginning to significantly change metal parts development through rapid proto-typing as well

as serving as a production solution for high-value parts. They built the business by multiple

acquisitions.  Quadrant already owned QMT which included Flowmet LLC (a pioneer in metal

injection molding in Florida), Tekna Seal, General Flange & Forge, and Tubefit.  They sold it to

ARC Group (Arc Wireless at the time, a mostly failed company) in 2012 for $31.4 million in

ARCW stock in a reverse acquisition and Quadrant's people took control.  About the same time,

Arc Group bought AFT for $43 million.  AFT was another MIM company with factories in

Colorado and Hungary.  Coupled with Flowmet, Arc Group became the leading MIM provider in

the United States.  Just a year or so later in December, 2013 3D printing expert Todd Grimm

joins the board and Arc Group forms a new 3D Materials Technology Division. To broaden their

metal-related manufacturing capabilities, they acquired Advanced Tooling Concepts, a plastic

injection molding company, in April, 2014 for $24 million cash and Thixoforming, a specialist in

injection of magnesium Alloys that was next to their Colorado factory for an undisclosed sum. 

To round out their metal capabilities, they acquired Kecy corporation, a metal stamping

company, in June, 2014 for $26 million in cash.  Total purchase price for these acquisitions is

$124.4 million not including Thixoforming. At the time they noted the proforma financials for

2013 was $120 million in revenue with $24 million in ebitda, a 20% ebitda margin. Their core

business of metal injection molding is relatively new with earliest significant production around

year 2000. MIM has grown rapidly since and the technology is forecast to continue to grow as

more traditionally-made parts are switched to this lower-cost method.

 

To run all these acquired business, Quadrant hired a pair of investment bankers.  Jason

Young, an economics major at UCLA, worked for Merrill Lynch Investment Banking Group from

2000 to 2005 before joining Quadrant as managing director in 2005.  He co-founded Vanterra

Capital while at Quadrant before accepting the CEO job at Arc Group in August 2013.  Drew

Kelley, another UCLA grad who also worked for Merrill Lynch at the same time as Young, joined

ARC group as CFO two months after Young took the CEO job.  There's no engineering or

operations background with either of these guys and it didn't take long before operations are a

mess.  Young noted that the culture was centered around engineering and believed that

needed to change.  He endeavored to create a culture centered around sales.  And indeed by

2015 the sales were rising but the margins were down.  The sales force apparently was selling

more services but the engineers couldn’t make the parts at a profit, or in some cases couldn’t

make the parts at all.  This resulted in losses leading to a restructuring.

 

On March 31, 2016 Alan Quasha takes the COB job from Young and begins a strategic review. 

Changes become evident early in 2017, including elimination of unprofitable contracts, a 15%

reduction in the labor force to reflect the reduced work, policy changes on accounts payable

and receivables to reduce working capital, and price increases to reflect their high value

offering and restore margins.  Further reductions come later in 2017.  Assets not core to their

business model of being a sole-source maker of small metal parts by whatever manufacturing

method is best go on the block.  In Sept 2016, the sale of Tekna Seal for $10.5 million is

disclosed and their legacy wireless business is sold for an immaterial amount.  General Flange &

Forge is sold for $3 million around Sept 18, 2017.  The manufacturing operation in Mexico for

more labor-intense work that was opened in February 2016 is closed in July 2017. In 2016,

Quasha had brought in Eli Davidai, a 62 year old managing director of Quadrant with extensive

operations experience, to correct operational problems at some of the facilities. In May, 2017

Davidai becomes Arc General Manager of Operations. In June 2017, Young was out as CEO and

out of Quadrant as well. He’s currently running some type of investment fund in New York.

Drew Kelley who had served as CFO became the interim CEO.

 

BUSINESS STATUS

While damage has been done by the operational problems, the company does not believe their

ability to grow with their core strategy is impaired. Comments from interim CEO (formerly the

CFO) Drew Kelley in the 4Q conference call in September are immediately below.

 

"At the same time let me reiterate. These recent initiatives do not jeopardize the company’s ability

to grow. Rather we are better-positioned both internally and externally to drive customer

satisfaction, bottom-line results and shareholder value. In particular we remain bullish on the 

company’s sales pipeline. As we discussed in the press release, ARC recently received customer

approvals on 166 new customer products with many parts already in full production. Included in

these launches are several holistic solutions for our customers in the medical and defense sectors.

These complete solutions use a multitude of our complementary technologies including metal 3D

printing, MIM and plastic injection molding to garner a larger share of the previously untapped

business opportunities. Similarly our metal 3D printing business continues to grow rapidly. With

the addition of four new machines, ARC now operates 15 metal printers. We are especially

excited about our recently-opened new 30,000-square- foot dedicated 3D facility which provides

us with the ability to add up to 40 additional machines. The new facility does not simply improve

our scale, but includes several dramatic improvements to our key capabilities in 3D printing

including designated areas for defense production, controlled environments for medical implants

and in-house heat treatment and machining. As a result we expect 3D revenues to continue to

grow at its recent pace as we are forecasting 3D revenues to double in the current Fiscal 2018

year".

 

And in response to a question Drew Kelley responds:

 

"So that really is why we’re very excited about the new facility and again I don’t want to suggest that the

MIM solution and the 3D solution are standalone. They are very much symbiotic and they offer our

customers a unique holistic solution. What we are increasingly seeing is large multinational OEMs

approaching us and looking not simply for a dedicated MIM production facility but one that can provide

MIM with plastic over molding with metal 3D printing, etc. And for that we see our ability to not only

grow our wallet share with our existing customers but for us to again exploit or otherwise develop new

markets and new sizable markets in both the 3D and the greater additive space".

 

VALUATION

The stock trades at an enterprise value/sales ratio of about 1 despite an expected return to 20%

ebitda margins, that’s a valuation of 5 times ebitda if those margins are achieved. There’s

expected growth in their MIM businesses with the intended capture of mom and pop

machining business through their rapid prototyping and holistic production manufacturing

strategy. While the business has been a loss-maker the last few quarters, management

believes they haven’t loss their profitable strategic customers and the restructuring hasn’t

impaired their ability to grow with their disruptive strategy. I won’t pretend the traditional

manufacturing operations are a great business, but 5 times ebitda is quite reasonable if they

return to 20% ebitda margins.

 

That leaves their emerging but still low-revenue investment in 3D printing for free. Far more

successful and better managed rapid-prototyping company Proto-labs (ticker PRLB) trades at 8

times sales. Protolabs does mostly rapid prototyping by a variety of methods including 3D

printing for many different industries.  Interestingly, they seem to be moving to a more

comprehensive business model including production capabilities to create a more holistic

offering (similar to Arc Group). Arc Group is trying to do rapid proto-typing similar to proto-labs

but specifically for the small metal parts industry. From their 10Q

 

"Accelerating Speed-to- Market.  The traditional prototype-to- production process is often subject to lengthy

bottlenecks and is characterized by inefficient price quoting delays, time-consuming tooling procedures, and

outdated production methodologies.  To differentiate itself from competitors, ARC focuses on reducing

inefficiencies in the development cycle by offering the seamless integration of a wide-variety of proprietary

technologies in order to dramatically reduce the time and cost associated with new product

development.  Specifically, the Company has developed rapid and instant online quoting solutions, rapid prototype

solutions, short-run production services, in-house rapid and advanced conformal tooling, and rapid full production

capabilities".

 

"Metal 3D Printing.  We offer a variety of 3D printing solutions, with an emphasis on metal 3D printing.  In general,

given promising signs of growth and related barriers to entry, we believe the metal 3D printing sector is one of the

more attractive segments of the overall additive manufacturing industry.  Furthermore, metal 3D printing, while a

complex technology still in its early stages, shares several fundamental similarities with our MIM business, thereby

helping to accelerate our research and development.  Separately, our metal 3D printing capabilities enable ARC to

offer a variety of new services, including rapid prototyping, rapid tooling and short-run production, helping our

customers improve their product speed-to- market.  Given our established customer base, diverse metallurgy

background, and scalable injection molding capabilities, we believe we are well-positioned in the industrial metal

3D printing market".

 

This rapid-protoyping and 3D printing aspect of their business is potentially valuable and

the reason to speculate in a heavily-levered and recently unsuccessful company like Arc Group.

In particular, printing plastic is easy but printing metal parts is very challenging. Among the

many challenges, metal printing is troubled by micro-cracks that form as the powdered metal

bonds together under heat and then cools. These micro-cracks cause fatigue failure as they

gradually enlarge under cyclic loading over time. Only a few metal alloys that are not

proprietary to someone have been successfully 3D printed. Not just anyone can start printing

metal parts. Arc Group claims competitive advantage with high barriers to entry from their

legacy metal powder expertise and their printable metal alloy development the last five years.

They are currently in production with high value aerospace and medical parts and they have

recently expanded facilities and are pondering additional investment. I can’t put a number on

it, but there is potentially more value in their expanding 3D printing business and rapid

prototyping capabilities than all their traditional metal manufacturing businesses combined.

This will be especially true if the rapid-prototyping capabilities take traditional production

business away from mom and pop machining shops as intended.

 

 RIGHTS OFFERING BACKSTOP INVESTORS

Quasha and Davidai are senior members of a $3 billion hedge fund. They are spending a great

deal of effort fixing operations for this $20 million investment that they own through Everest

Hill Group. Everest Hill will backstop the entire $10 million offering after three other backstop

investors who each currently own <1% of Arc Group. Kurt Butenhoff who was a “heavy hitter”

at Bear Stearns and VP at Salomon Brothers now manages his fund Ward Capital. He personally

will backstop $250K of the rights offering. Butenhoff was at Bear Stearns at the same time as

ARC interim CEO and former CFO Drew Kelley. Weintraub Capital Management, a San Francisco

based long-short hedge fund with a terrific track record before returning investors money to

become Jerry Weintraub’s family office, will backstop $1 million. I can’t find any ties between

Weintraub and Arc Group other than participation in this rights offering. Another $250K

backstopper is Zori Investment Limited for which a google search yields nothing.

 

The participation of backstoppers probably indicates that they are bullish. However, many

rights offerings are done to prop up a bad investment and Everest Hill may be backstopping

because nobody else will. The recent history of Arc Group is not pretty with losses, goodwill

impairments, and debt covenant renegotiations. Is Everest Hill participating because they like

the prospects following the restructuring or because they must put in more money to protect

their existing investment? Comments on the 4 th quarter conference call in September from

interim CEO Drew Kelley appear bullish.

 

"Finally I note that during today’s ARC board meeting I was informed that various ARC board members

and other senior management personnel intend to purchase ARC shares in the public market when

permissible and in compliance with the company’s share purchase window policy. I appreciate

everyone’s time on the call and I’ll now pause for questions".

 

There’s been no insider buying since that call in September. However, it is likely insiders knew in

September or shortly thereafter that a rights offering was coming as the S-1 was filed on Dec 8th and it

takes time to prepare.  I would expect there will be insider participation in the rights offering and that

the backstoppers, including Everest Hill, are participating because of a positive outlook. Finally, I’ll note

that Matthew Drapkin of Northern Right Management is a 5% shareholder declared in April 2017. In the

latest 13F he reduced his position by about 20% however. Stifel Nicoulas declared a 5% position on Nov

3rd , 2017 as well, but I know of no ties to Arc management.

 

RISKS

1. This is quite leveraged and recent operating history is poor

2. Motive of already wealthy Davidai and Quasha could be to have something interesting to talk about, 3D printing,

instead of making money

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Completion of restructuring and return to profitability

Incipient growth of 3D metal printing business

    sort by    

    Description

    Arc Group Worldwide is nearing the completion of restructuring actions intended to correct

    operational problems, reduce debt by selling assets that are not essential to their strategy to

    disrupt metal parts manufacturing, and raise capital for further investment in that core

    strategy. That strategy utilizes legacy powdered metal expertise from their metal injection

    molding business to enable 3D printing of metal parts. The company is leveraging this

    proprietary knowledge to provide metal part rapid-prototyping services synergistic to their

    production metals manufacturing business for OEMs.  At the same time they are also offering

    stand-alone 3D printing services of proprietary alloys they’ve developed for production of

    demanding medical, dental, and aerospace parts. The controlling shareholder and several

    prominent investors are backstopping a $10 million rights offering to shareholders priced at a

    10% discount to the trading price on the yet to be defined rights record date (but not less than

    $2 a share).  This rights offering may offer an attractive entry price, either by purchasing shares

    prior to the record date and oversubscribing in the offering, or by purchasing shares during the

    offering where arbitrage selling by rights holders will likely pressure the stock price.

     

    Arc Group Worldwide was formed from a series of acquisitions from 2012 to 2014 of metal

    parts manufacturing companies. The intent of the controlling shareholder, $3 billion in assets

    hedge fund Quadrant Management, was to create a disruptive force in the metal parts

    manufacturing industry by offering a highly automated, digital, and holistic supplier that could

    offer everything OEMs needed. This included rapid prototyping of metal parts through 3-D

    metal printing, and then production manufacturing via the variety of methods used by the

    acquired companies. Currently, many large companies have their own procurement personnel

    that work with numerous companies to get their metal parts manufactured, one company to

    rapid-prototype, another to make machining tools, another to stamp production parts, another

    to metal-injection mold, another for the plastic-injection molded housing etc…. Arc Group

    offers all of that in house while accepting three dimensional models over the web and

    employing software to make prototypes and production parts in a highly automated manner.

    Over time, Arc Group’s holistic offering is intended to take business from the many specialized

    mom and pop machining providers.

     

    Important to being a soul source provider is to be able to offer rapid-prototyping of metal parts.

    While expensive, 3D printing allows the creation of a prototype metal part in a day. With rapid-

    prototyping, engineers can iterate on designs and get the design right and their products ready

    for market quickly. Rapid-prototyping is being increasingly adopted by many companies as an

    essential part of the product development process. Metal injection molding (MIM) injects a

    mixture of powdered metal and a carrier polymer into molds to form the part. The polymer is

    then burned off and the powdered metal particles fused together by heating to form the final

    part. It takes time to make the mold and develop the injection process so MIM is generally not

    a rapid-prototyping method. However, Arc Group’s core metal injection molding business, the

    leading MIM company in the United States, was a pioneer in developing unique expertise in the

    powdered metallurgy that MIM requires. While anyone can buy a 3D printer, successful

    printing of metal parts requires the ability to print parts from metal powder to precise

    dimensions resulting in high-strength parts. Cracks in the metal from the printing process are a

    big problem that limits what alloys can be successfully printed. Medical or Aerospace

    applications often require the ability to 3D print using titanium or high strength aluminum

    powder. Arc Group has made significant investment in further development of their legacy

    metal powder expertise for 3D printing and considers this materials expertise a competitive

    advantage with high barriers to entry.

     

    3D printing capability is important to Arc’s traditional metal manufacturing business as a rapid

    proto-typing method for their customer’s product development. However, it is also important

    to Arc Group as a production method for high value medical and aerospace parts, some of

    which cannot be manufactured in any other way. Arc can print from metal powder high

    strength, high temperature ferrous alloys, stainless steel, cobalt, titanium, high strength

    aluminum, and other materials for specialized and challenging applications. While operational

    problems with the traditional businesses were destroying Arc Groups financials and stock price

    the last three years, 3D printing has continued to progress. Revenues in the most recent

    quarter tripled over the prior year to $930K and are expected to double in 2018 compared to

    2017. With the 2017 expansion of 3D printing facilities, further 3D printing investment being

    considered by the board of directors, and their growing revenue from 3D printed parts, Arc

    Group’s higher margin 3D printing division may eventually rival in value all of their legacy

    businesses combined.

     

    BACKGROUND AND HISTORY

    Everest Hill, the 48% owner of Arc Group, also owns Quadrant.  Quadrant is a $3 billion in assets

    hedge fund started by 68 year old Alan Quasha (the current COB of Arc Group) in 1978. 

    Quadrant also owns Vanterra Capital, which is a private equity firm bringing total assets to

    around $4 or $5 billion.  Eli Davidai is a 62 year old managing director of Quadrant since 1992. 

    Prior to that he worked as CEO of Quadrant Amroq Beverages bringing Pepsi products to

    Bucharest Romania and then served as Chairman of Quadrant Beverages bringing Pepsi

    products to Bulgaria.  Davidai became the Arc General Manager of Operations at the request of

    COB Alan Quasha earlier this year. 

     

    The principals at Quadrant (Quasha and Davidai) are believers in technology disruption.  Davidai

    at age 62 just finished a program at Harvard Business School and a training class at Berkeley's

    Singularity University.  Davidai discusses technology disruption in this youtube video

    (https://www.youtube.com/watch?v=G3SGJHJHyzE) where he states “I must tell you... if you

    don't find the value proposition , something to differentiate you from another business... close it. Leave

    it.  Don't waste your time"!   Arc Group is Quasha’s and Davidai’s attempt at disrupting metal

    parts manufacturing.  Their idea was to assemble all the metal manufacturing technologies

    under one house and become the one source supplier to big manufacturing companies.  An

    important part of their strategy is the development of 3D printing capabilities. 3D printing is

    beginning to significantly change metal parts development through rapid proto-typing as well

    as serving as a production solution for high-value parts. They built the business by multiple

    acquisitions.  Quadrant already owned QMT which included Flowmet LLC (a pioneer in metal

    injection molding in Florida), Tekna Seal, General Flange & Forge, and Tubefit.  They sold it to

    ARC Group (Arc Wireless at the time, a mostly failed company) in 2012 for $31.4 million in

    ARCW stock in a reverse acquisition and Quadrant's people took control.  About the same time,

    Arc Group bought AFT for $43 million.  AFT was another MIM company with factories in

    Colorado and Hungary.  Coupled with Flowmet, Arc Group became the leading MIM provider in

    the United States.  Just a year or so later in December, 2013 3D printing expert Todd Grimm

    joins the board and Arc Group forms a new 3D Materials Technology Division. To broaden their

    metal-related manufacturing capabilities, they acquired Advanced Tooling Concepts, a plastic

    injection molding company, in April, 2014 for $24 million cash and Thixoforming, a specialist in

    injection of magnesium Alloys that was next to their Colorado factory for an undisclosed sum. 

    To round out their metal capabilities, they acquired Kecy corporation, a metal stamping

    company, in June, 2014 for $26 million in cash.  Total purchase price for these acquisitions is

    $124.4 million not including Thixoforming. At the time they noted the proforma financials for

    2013 was $120 million in revenue with $24 million in ebitda, a 20% ebitda margin. Their core

    business of metal injection molding is relatively new with earliest significant production around

    year 2000. MIM has grown rapidly since and the technology is forecast to continue to grow as

    more traditionally-made parts are switched to this lower-cost method.

     

    To run all these acquired business, Quadrant hired a pair of investment bankers.  Jason

    Young, an economics major at UCLA, worked for Merrill Lynch Investment Banking Group from

    2000 to 2005 before joining Quadrant as managing director in 2005.  He co-founded Vanterra

    Capital while at Quadrant before accepting the CEO job at Arc Group in August 2013.  Drew

    Kelley, another UCLA grad who also worked for Merrill Lynch at the same time as Young, joined

    ARC group as CFO two months after Young took the CEO job.  There's no engineering or

    operations background with either of these guys and it didn't take long before operations are a

    mess.  Young noted that the culture was centered around engineering and believed that

    needed to change.  He endeavored to create a culture centered around sales.  And indeed by

    2015 the sales were rising but the margins were down.  The sales force apparently was selling

    more services but the engineers couldn’t make the parts at a profit, or in some cases couldn’t

    make the parts at all.  This resulted in losses leading to a restructuring.

     

    On March 31, 2016 Alan Quasha takes the COB job from Young and begins a strategic review. 

    Changes become evident early in 2017, including elimination of unprofitable contracts, a 15%

    reduction in the labor force to reflect the reduced work, policy changes on accounts payable

    and receivables to reduce working capital, and price increases to reflect their high value

    offering and restore margins.  Further reductions come later in 2017.  Assets not core to their

    business model of being a sole-source maker of small metal parts by whatever manufacturing

    method is best go on the block.  In Sept 2016, the sale of Tekna Seal for $10.5 million is

    disclosed and their legacy wireless business is sold for an immaterial amount.  General Flange &

    Forge is sold for $3 million around Sept 18, 2017.  The manufacturing operation in Mexico for

    more labor-intense work that was opened in February 2016 is closed in July 2017. In 2016,

    Quasha had brought in Eli Davidai, a 62 year old managing director of Quadrant with extensive

    operations experience, to correct operational problems at some of the facilities. In May, 2017

    Davidai becomes Arc General Manager of Operations. In June 2017, Young was out as CEO and

    out of Quadrant as well. He’s currently running some type of investment fund in New York.

    Drew Kelley who had served as CFO became the interim CEO.

     

    BUSINESS STATUS

    While damage has been done by the operational problems, the company does not believe their

    ability to grow with their core strategy is impaired. Comments from interim CEO (formerly the

    CFO) Drew Kelley in the 4Q conference call in September are immediately below.

     

    "At the same time let me reiterate. These recent initiatives do not jeopardize the company’s ability

    to grow. Rather we are better-positioned both internally and externally to drive customer

    satisfaction, bottom-line results and shareholder value. In particular we remain bullish on the 

    company’s sales pipeline. As we discussed in the press release, ARC recently received customer

    approvals on 166 new customer products with many parts already in full production. Included in

    these launches are several holistic solutions for our customers in the medical and defense sectors.

    These complete solutions use a multitude of our complementary technologies including metal 3D

    printing, MIM and plastic injection molding to garner a larger share of the previously untapped

    business opportunities. Similarly our metal 3D printing business continues to grow rapidly. With

    the addition of four new machines, ARC now operates 15 metal printers. We are especially

    excited about our recently-opened new 30,000-square- foot dedicated 3D facility which provides

    us with the ability to add up to 40 additional machines. The new facility does not simply improve

    our scale, but includes several dramatic improvements to our key capabilities in 3D printing

    including designated areas for defense production, controlled environments for medical implants

    and in-house heat treatment and machining. As a result we expect 3D revenues to continue to

    grow at its recent pace as we are forecasting 3D revenues to double in the current Fiscal 2018

    year".

     

    And in response to a question Drew Kelley responds:

     

    "So that really is why we’re very excited about the new facility and again I don’t want to suggest that the

    MIM solution and the 3D solution are standalone. They are very much symbiotic and they offer our

    customers a unique holistic solution. What we are increasingly seeing is large multinational OEMs

    approaching us and looking not simply for a dedicated MIM production facility but one that can provide

    MIM with plastic over molding with metal 3D printing, etc. And for that we see our ability to not only

    grow our wallet share with our existing customers but for us to again exploit or otherwise develop new

    markets and new sizable markets in both the 3D and the greater additive space".

     

    VALUATION

    The stock trades at an enterprise value/sales ratio of about 1 despite an expected return to 20%

    ebitda margins, that’s a valuation of 5 times ebitda if those margins are achieved. There’s

    expected growth in their MIM businesses with the intended capture of mom and pop

    machining business through their rapid prototyping and holistic production manufacturing

    strategy. While the business has been a loss-maker the last few quarters, management

    believes they haven’t loss their profitable strategic customers and the restructuring hasn’t

    impaired their ability to grow with their disruptive strategy. I won’t pretend the traditional

    manufacturing operations are a great business, but 5 times ebitda is quite reasonable if they

    return to 20% ebitda margins.

     

    That leaves their emerging but still low-revenue investment in 3D printing for free. Far more

    successful and better managed rapid-prototyping company Proto-labs (ticker PRLB) trades at 8

    times sales. Protolabs does mostly rapid prototyping by a variety of methods including 3D

    printing for many different industries.  Interestingly, they seem to be moving to a more

    comprehensive business model including production capabilities to create a more holistic

    offering (similar to Arc Group). Arc Group is trying to do rapid proto-typing similar to proto-labs

    but specifically for the small metal parts industry. From their 10Q

     

    "Accelerating Speed-to- Market.  The traditional prototype-to- production process is often subject to lengthy

    bottlenecks and is characterized by inefficient price quoting delays, time-consuming tooling procedures, and

    outdated production methodologies.  To differentiate itself from competitors, ARC focuses on reducing

    inefficiencies in the development cycle by offering the seamless integration of a wide-variety of proprietary

    technologies in order to dramatically reduce the time and cost associated with new product

    development.  Specifically, the Company has developed rapid and instant online quoting solutions, rapid prototype

    solutions, short-run production services, in-house rapid and advanced conformal tooling, and rapid full production

    capabilities".

     

    "Metal 3D Printing.  We offer a variety of 3D printing solutions, with an emphasis on metal 3D printing.  In general,

    given promising signs of growth and related barriers to entry, we believe the metal 3D printing sector is one of the

    more attractive segments of the overall additive manufacturing industry.  Furthermore, metal 3D printing, while a

    complex technology still in its early stages, shares several fundamental similarities with our MIM business, thereby

    helping to accelerate our research and development.  Separately, our metal 3D printing capabilities enable ARC to

    offer a variety of new services, including rapid prototyping, rapid tooling and short-run production, helping our

    customers improve their product speed-to- market.  Given our established customer base, diverse metallurgy

    background, and scalable injection molding capabilities, we believe we are well-positioned in the industrial metal

    3D printing market".

     

    This rapid-protoyping and 3D printing aspect of their business is potentially valuable and

    the reason to speculate in a heavily-levered and recently unsuccessful company like Arc Group.

    In particular, printing plastic is easy but printing metal parts is very challenging. Among the

    many challenges, metal printing is troubled by micro-cracks that form as the powdered metal

    bonds together under heat and then cools. These micro-cracks cause fatigue failure as they

    gradually enlarge under cyclic loading over time. Only a few metal alloys that are not

    proprietary to someone have been successfully 3D printed. Not just anyone can start printing

    metal parts. Arc Group claims competitive advantage with high barriers to entry from their

    legacy metal powder expertise and their printable metal alloy development the last five years.

    They are currently in production with high value aerospace and medical parts and they have

    recently expanded facilities and are pondering additional investment. I can’t put a number on

    it, but there is potentially more value in their expanding 3D printing business and rapid

    prototyping capabilities than all their traditional metal manufacturing businesses combined.

    This will be especially true if the rapid-prototyping capabilities take traditional production

    business away from mom and pop machining shops as intended.

     

     RIGHTS OFFERING BACKSTOP INVESTORS

    Quasha and Davidai are senior members of a $3 billion hedge fund. They are spending a great

    deal of effort fixing operations for this $20 million investment that they own through Everest

    Hill Group. Everest Hill will backstop the entire $10 million offering after three other backstop

    investors who each currently own <1% of Arc Group. Kurt Butenhoff who was a “heavy hitter”

    at Bear Stearns and VP at Salomon Brothers now manages his fund Ward Capital. He personally

    will backstop $250K of the rights offering. Butenhoff was at Bear Stearns at the same time as

    ARC interim CEO and former CFO Drew Kelley. Weintraub Capital Management, a San Francisco

    based long-short hedge fund with a terrific track record before returning investors money to

    become Jerry Weintraub’s family office, will backstop $1 million. I can’t find any ties between

    Weintraub and Arc Group other than participation in this rights offering. Another $250K

    backstopper is Zori Investment Limited for which a google search yields nothing.

     

    The participation of backstoppers probably indicates that they are bullish. However, many

    rights offerings are done to prop up a bad investment and Everest Hill may be backstopping

    because nobody else will. The recent history of Arc Group is not pretty with losses, goodwill

    impairments, and debt covenant renegotiations. Is Everest Hill participating because they like

    the prospects following the restructuring or because they must put in more money to protect

    their existing investment? Comments on the 4 th quarter conference call in September from

    interim CEO Drew Kelley appear bullish.

     

    "Finally I note that during today’s ARC board meeting I was informed that various ARC board members

    and other senior management personnel intend to purchase ARC shares in the public market when

    permissible and in compliance with the company’s share purchase window policy. I appreciate

    everyone’s time on the call and I’ll now pause for questions".

     

    There’s been no insider buying since that call in September. However, it is likely insiders knew in

    September or shortly thereafter that a rights offering was coming as the S-1 was filed on Dec 8th and it

    takes time to prepare.  I would expect there will be insider participation in the rights offering and that

    the backstoppers, including Everest Hill, are participating because of a positive outlook. Finally, I’ll note

    that Matthew Drapkin of Northern Right Management is a 5% shareholder declared in April 2017. In the

    latest 13F he reduced his position by about 20% however. Stifel Nicoulas declared a 5% position on Nov

    3rd , 2017 as well, but I know of no ties to Arc management.

     

    RISKS

    1. This is quite leveraged and recent operating history is poor

    2. Motive of already wealthy Davidai and Quasha could be to have something interesting to talk about, 3D printing,

    instead of making money

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Completion of restructuring and return to profitability

    Incipient growth of 3D metal printing business

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