|Shares Out. (in M):||23||P/E||0||0|
|Market Cap (in $M):||270||P/FCF||0||0|
|Net Debt (in $M):||110||EBIT||0||0|
|Borrow Cost:||Available 0-15% cost|
Cadiz has been identified many times as a short by various idea sites and short newsletters, including two short pieces on VIC in 2012 and 2014. Three years later the stock trades at a higher price despite annual dilution and cash burn. The reason is Trump’s victory, which dramatically improved the company’s prospects for its water transport project. That said, there are still hurdles to the project’s approval, combined with a relatively full valuation even if the project goes ahead. As such the stock still looks like a good short at its current $12.10 bid. In addition, there are relatively inexpensive puts available.
Cadiz proposes to provide several California municipalities with up to 50,000 acre-feet of water annually, piped from Cadiz owned land in the Mojave desert. Roughly a fifth of the water would go to the Santa Margarita Water District. That district’s agency reviewed and approved the project’s environmental status, despite being more than 200 miles from San Bernardino county, where the water resides. San Bernardino could have asserted its position as the municipality best positioned to assess environmental impacts, but then county supervisor Brad Mitzelfelt chose to forego that action. Mitzelfelt soon after received a substantial contribution from Cadiz in his unsuccessful California congressional campaign.
At its heart, the Cadiz project pits California municipalities against the state government. The local municipalities represent small affluent communities and like the idea of secondary water supplies. The state of California, led by California Senator Dianne Feinstein and various state legislators, is concerned with the longer term environmental impact of siphoning large amounts of water from the Mojave desert. The proposed 50,000 annual acre feet of water represents less than 0.1% of California’s annual water supply, making it very much a ‘special interests’ issue. Given how small the Cadiz project is in the relative scheme of California’s water management, it is remarkable how much time, energy, and state and federal legislative attention it has garnered.
I have linked at the bottom of this note to a succinct history of the project as well as some recent commentary. For the purposes of this thesis it’s helpful to understand a few key points:
1) To move water from Cadiz’ reservoir to CA municipalities requires the water to travel over Federal lands, which would require a Federal environmental review. An unbiased environmental review would take more time, and based on widely circulated environmental research might well conclude that Cadiz’ planned water extraction would dry out critical desert aquifers. To bypass this review, in 2008 Cadiz entered a lease agreement with the Arizona & California Railroad company. The company’s goal was to exempt its project from Federal review based on right of way exemptions issued to railroads. However legislation related to railroad ROW specifies that qualifying projects serve a railroad purpose, which does not include selling water to third parties. Cadiz argued its water could be used to extinguish railroad fires. The California branch of BLM ruled against this argument.
2) Cadiz appealed that ruling , but appeared headed for failure prior to the 2016 election. The Trump administration breathed new life into the project, issuing a directive the BLM that widened the meaning of a ‘railroad use’. The administration also indicated that on appeal the project would be reviewed by the BLM’s Washington office. Further, David Bernhardt was confirmed in July as deputy secretary of the Interior. Bernhardt was previously co-chair with Cadiz’ CEO Scott Slater at the law firm Brownstein Hyatt Farber Schreck.
3) Those developments greatly increased the probability the company would receive an exemption from federal review. In response, state assemblywoman Laura Friedman, D-Glendale, moved a bill out of committee that would require state environmental review of projects that involved large water pumping in the desert. The bill was specifically designed to require a state review of the Cadiz project, a point confirmed by Friedman herself.
4) It is not easy to pass legislation in California, however both houses of the state legislature are heavily democratic, and for many legislators it’s not clear that there is much reason to oppose the legislation. Friedman passed the bill as a member of the water committee by changing the language of a pre-existing water conservation bill to specifically target Cadiz. Having passed Friedman’s NRW committee the bill has been referred to the senate appropriations committee for a vote on August 21st. If it passes the appropriations committee it would then be scheduled for a vote before the full Senate. If approved by the Senate it would move back to the assembly for a full vote. If passed there it would go to the governor for signing. Progress of the bill can be monitored here: https://leginfo.legislature.ca.gov/faces/billStatusClient.xhtml?bill_id=201720180AB1000
5) Based on the makeup of the senate appropriations committee, the bill has a reasonable chance of approval. The committee has five democrats and two republicans. Committee chair Ricardo Lara and Senator Scott Wiener both have pro-environment, pro conservation platforms, and are likely ‘yes’ votes. The two committee republicans, Patricia Bates and Jim Nielsen, are likely ‘no’ votes given precincts (Bates represents some receivers of Cadiz water) and past voting. To move the legislation forward, two of the remaining three democrats would need to vote in favor. Jerry Hill represents Silicon Valley and strikes me as a likely ‘yes’ based on his constituency while Jim Beall representing San Jose also has a liberal record, although it’s focused on housing. The final democrat, Steven Bradford, is a less reliable vote given he received past support from supporters of the project. So Jim Beall may end up being the swing vote here.
6) It is worth noting that much of the mainstream press coverage of the project has been negative – for example this LA times op-ed http://www.latimes.com/opinion/op-ed/la-oe-brooks-cadiz-project-water-mojave-desert-20170521-story.html.
7) Even if this particular legislative challenge fails, Cadiz is not out of the woods. The company still needs a favorable BLM ruling, and various parties in California could look for other ways to delay or stop the project.
8) A further possible obstacle is water quality. Cadiz’ project would require it to pipe its water into facilities managed by California’s Metropolitan Water District (MWD), which would represent the last mile distribution to the receiving municipalities. Cadiz’ water has higher than permitted levels of the carcinogen hexavalent chromium (chromium 6), and will have to reach agreement with the MWD regarding treatment of the water to reach satisfactory purity.
Taken as a whole, the project’s odds of success have improved but are far from certain. If one thinks the state legislative challenge has a 20% chance of success, and that failing that there is another 5% chance the state finds some further way of impeding the project’s progress, and that failing that there is at least a 5% chance the BLM denies the company’s appeal, and failing that the company still needs to reach consensus with the MWD on water treatment, I’d argue the project still has less than a 70% chance of approval. I believe the current share price reflects a much higher probability of success.
Prior to the 2016 election, CDZI’s shares were priced at $7, roughly 40% below today’s price, and many close followers of the company viewed that as generous. The company has not shown the ability to generate profits as a going concern, and currently has $130 million of debt, in addition to a $275 million market cap for a current EV of $400 million. I think sub $7 is realistic price target on a significant new setback. If investors become convinced the project is completely untenable, I think the stock is a zero, given the current debt load.
The next question is what would CDZI be worth in the event the project proceeds – I think not much more than it trades for today. Assuming the high end of the company’s estimates for volume and price of 50,000 acre feet sold for $1,000 per year, implies $50 million of annual revenue. The company currently has roughly $10 million of annual G&A, and incremental costs associated with pumping water have not been identified, but I think conservatively would have to run north of $5 million a year. In that scenario, the company could plausibly generate $35 million in annual EBITDA.
To get to that point the company would have to finance the construction of pumping and more significantly, water treatment, and has obtained $240 million of contingent construction financing from Apollo for the project. While I suspect the company would supplement that funding with equity, conservatively assuming that funding represents the total project cost it lifts the pro-forma EV to $700 million, or 20x projected EBITDA. That would be on the very high end of infrastructure multiples for a project that would remain controversial, and for volumes that could decline over time if the company does indeed deplete its aquifers more quickly than it estimates. The main upside would be if the company charges much higher than advertised delivery prices for its water. However this will be a tough proposition, given falling prices for recycled water (see first linked article above).
Given those numbers and with the stock currently trading above $12, I think a straight short is attractive. The risk reward on the puts also looks interesting, although getting the timing right is important. There is a clear event on August 21 (senate vote) which could be a catalyst. Various puts may makes sense, for example the September 10 puts trade for $0.10 - $0.15, which could provide an outside payoff if the legislative process appears to be working against the company.
For a good synopsis of the Cadiz story: http://sbcsentinel.com/2017/07/assembly-bill-would-stop-cadiz-inc-s-mojave-h2o-to-orange-county-plan/
Actual Friedman bill: https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180AB1000
Friedman bill in press: http://www.sbsun.com/environment-and-nature/20170706/bill-would-curb-massive-cadiz-desert-water-project
Progression of Friedman bill, negative BLM ruling on appeal, impasse with MWD, declining recyled water prices, setbacks on project construction.
|Entry||08/15/2017 09:48 AM|
One clarification on note, bill committee hearing is August 21st, and I am assuming a vote on same day following hearing - I'll update outcome -
|Subject||disagree on this one|
|Entry||08/17/2017 04:37 PM|
I have certainly been short some of these perennial "free beer tomorrow" companies but I don't agree on this one. I generally agree that it is somewhat more likely than not that this project proceeds but that it is possible the State of California and/or Feinstein finds a way to block it. But at a high level, I think you left out a couple of important things, like the fact this project has already passed a California Environmental Quality Act (CEQA) review including appeals, and that if Phase I of the project proceeds they will pretty quickly start on a Phase II that could send the stock much higher. Also, I think the Chrom 6 thing is non issue.
I believe the true potential downside of the short is significantly higher than “around where it’s trading”. Phase 2, or the storage portion of the project, is likely worth at least double Phase 1, which is the only portion you use to value the company. Phase 2 is also much less controversial and would likely proceed if the pipeline is constructed. This could potentially put total value around $40 per share or more.
Lastly there is updated information of the Chrom 6 issue. The state has recently went back to 50 ppb from 10 ppb, which is well above the 11-13 ppb in the Cadiz water.
See a summary of CEQA here:
Recent Chrom 6 ruling:
|Subject||Re: disagree on this one|
|Entry||08/18/2017 04:03 PM|
Thanks - on phase 2, a million acre feet at $1500/acre foot reservation cost certainly sounds impressive - has the company provided any real detail on timing, cost, etc? I looked for it on their website and 10-K and didn't see anything substantive. I believe the original CEQA contemplated phase 2 beginning in 50 years after phase 1 - did that change at some point?
if there's a viable case on phase 2, I don't know that it really changes the case on the puts, given the whole thing is predicated on phase 1 moving forward. That said, the put pricing was better with the stock around 12.20 than it is a week later with the stock 8% lower, particularly as the hearing is monday.
|Subject||Re: Re: disagree on this one|
|Entry||08/22/2017 05:19 PM|
Hearing was postponed to the 28th given a full agenda yesterday. The hearings are webcast on ca tv. Having now watched a day of these this appears likely to be put into a 'suspense' file like most bills before the appropriations committee. That leaves it pending vote until committee votes on all suspense file bills. There is no set date for that - its typically around the budget date, which is May - would they wait that long given its now late august? Not sure, goes beyond my understanding of ca political process - yellowhouse do you know on this?
|Subject||Re: Re: Re: Re: disagree on this one|
|Entry||08/28/2017 03:17 PM|
So not surprisingly, the project was sent to the 'suspense' file, which is kind of a catch all for bills before the CA appropriations committee that they don't want to put to an immediate vote. Link to hearing http://calchannel.granicus.com/MediaPlayer.php?view_id=7&clip_id=4932 (not sure how long that link/video remains current)
I don't think there is a date set for all the suspense files to be reviewed - in general it is around May budget time. If that's the case, I'd say it's not a great development for CDZI, as it just creates another 8 months of uncertainty while they burn through another $8 million of cash and accrue more PIK debt (matures Dec 2019). Maybe there will be an earlier hearing - I will keep an eye out.
Regarding SpecialK's comment on the Federal review being less stringent than the CEQA, if that's the case, why go to such lengths to avoid that review?
Regarding phase 2, I think Yellowhouse asks an important question - 'who is the customer for water storage and what would they pay'? $1,500/acre foot strikes me as very very optimistic, given falling costs of recyled and desalinated water. CDZI occasionally describes the collection as being put in place for 'wet' years - so would water collection only occur in years where there was no phase 1 delivery, so the revenue streams are offsetting and the same pipeline would be used? Or would they build a second pipeline? Maybe the company really has a detailed plan in place for phase 2, but if so they are keeping it close to the vest.
|Subject||Re: Re: Re: Re: Re: disagree on this one|
|Entry||09/01/2017 01:15 PM|
So CDZI shares are down 17% today and I have no idea why - my first guess would be a reasonably well circulated short report that hasn't gotten picked up by seeking alpha or some other source. Or maybe there's a leak that they're issuing more equity - I think they have to do this soon, so it would make sense.
In any case, my experience with this name is that it's best to trade around the position, both straight short and with options. The puts I mentioned are now up in a range of 100% to 400%, so I would say take some gains on those. I still think the company is a likely zero over a few years, but would wait for a bounce to reestablish puts or short.
|Subject||Re: good timing|
|Entry||09/01/2017 01:26 PM|
Ah, thanks -
|Subject||Re: Re: good timing|
|Entry||09/01/2017 05:32 PM|
news articles indicate the appropriations committee will vote on AB 1000 in coming days - both governor Brown and LT gov have sent letters in support. As I described in note, high likelihood this gets approved by appropriations committee - then would have to watch timing of floor vote. If it passes both chambers Brown will clearly sign which would likely send stock to or below 52 wk low. It may be tough for most CA dems to vote against bill in this climate (pun intended).
|Subject||Re: Re: Re: good timing|
|Entry||09/02/2017 12:09 PM|
Appropriations committee reviewed bill Friday and did not move out of the suspense file, rather held under submission - here's the CA senate definition of that status:
HELD UNDER SUBMISSION—An action taken by a committee when a bill is heard in committee and there is an indication that the author and the committee members want to work on or discuss the bill further, but there is no motion for the bill to progress out of committee. This does not preclude the bill from being set for another hearing.
Whether this really means the bill is finished and will go into suspense file purgatory I'm not sure, but that seems to be the market interpretation with the stock bid at 12.65 after hours. Certainly a lot better for the CDZI team than if the bill had moved out of committee, although the bill is still out there.
|Subject||Re: Author Exit Recommendation|
|Entry||01/12/2018 10:52 AM|
I should have formally closed this on the trade down after Gov Brown's letter (I suggested something along these lines in a message at the time but was lazy/dumb). The odds this eventually gets built are higher than at any time I can think of, a more recent lawsuit appears likely to be defeated, and the company has gotten BLM approval. As far as the MWD, MWD's board is 38 agency members, so presumably if an agreement were required to pass a vote CDZI would need 20 votes (I haven't independently confirmed this). The board members represent the various districts, and CDZI has already secured a number of district arrangements, so I don't think it's such a stretch they will eventually get there - even districts that don't care about CDZI may not want to be too rigid, as they need the ability to source water from time to time from third parties. Yes, lots of the MWD board doesn't like CDZI, but at the end of the day if some of the agencies want the water and the financing is no longer such a risk I'm not sure its enough organize a majority. This is pure speculation on my part, others may have more direct contact with MWD and may have a more nuanced view.
The project economics continue to look dicey to me. Current EV is roughly $450 million, and with roughly $300 in estimated build/operating cash use, you are at PF EV of over $700 mil by launch date, and probably closer to $800 million. Even at $2,000 per acre foot, well above the current contract rates, that implies a multiple of 8x revenue, and likely a teens multiple on EBITDA. That said, I think the bull case will be that over time $/acre foot can go substantially higher, based on longer term water shortages. Plus the potential for phase 2, storage, which strikes me as make believe or at best an offset in rainy years, but they'll put it out there.
There are still risks on MWD and financing, but the case is clearly weaker, and the timing uncertain. In a world where LFIN has a $3.6 billion market cap, this no longer strikes me as especially compelling.