|Shares Out. (in M):||25||P/E||0||0|
|Market Cap (in $M):||20||P/FCF||0||0|
|Net Debt (in $M):||215||EBIT||0||0|
Please note that this idea is likely only appropriate for a personal trading account given the liquidity.
On February 26, Essex’s stock price plunged 44%, from $1.35 to $0.75 per share. The stock now has an enterprise value of roughly $235M but a market cap of $20M, essentially implying a pending bankruptcy. However, our analysis suggests that the shares are worth around $2 in a very conservative liquidation scenario, although we think liquidation is unlikely. Ultimately the stock could be worth upwards of $5 in an acquisition or in a business turnaround/recovery scenario, as discussed below. In short, Essex shares priced at $0.75 represent one of the more dramatic asymmetric risk/return opportunities we have ever seen. As one of our industry contacts put it, “I’m just a sales guy but it seems obvious to me that someone could come in here and make a boatload of money just selling off the equipment.”
Description Of Situation
Founded in 1960, Essex Rental is a crane rental company based in Illinois. The Company put out a press release on February 26, postponing Essex’s earnings call due to an accounting issue that potentially forces revolver debt reclassification from long-term to short-term. The press release implies that the lender is accelerating revolver repayment – an event that would suggest a bankruptcy given Essex’s current lackluster financials. The stock dropped 44% upon this announcement. Then on March 17, the Company issued an 8K and a NT-10K filing indicating that they will restate their 2013-2014 quarterly and annual financials, reclassifying the revolver as short-term debt. The 8K also indicates that the Company has requested a temporary waiver from its lenders since this reclassification issue trips a covenant, and that they expect that the waiver will be granted. The market does not appear to believe this and the stock continues to be priced as if a pending bankruptcy is on the horizon.
After some research, we believe that:
a) this restatement is related to an accounting technicality
b) lenders are highly unlikely to force bankruptcy
c) liquidation value in a hypothetical bankruptcy is at least $2/share today
d) there is active industry consolidation and a sale of the company could fetch Orderly Liquidation Value (“OLV”), which is around $5/share today
e) the financial performance of the company should eventually reflect strengthening fundamentals, particularly if broader support develops for infrastructure spending. This may take time, but could result in a stock price even higher than $5 per share
We discuss three possible outcomes below: a liquidation, a sale, and a continuing recovery for the Company.
OUTCOME 1: LIQUIDATION
Essex Holdings operates in two separate units called Essex Crane and Coast Crane. The Company tracks the financials separately and there is no cross-collateralization of debt between the two units. Historically, while Essex Crane and Coast Crane were tracked separately internally, the public filing financials consolidated the units for reporting purposes. We believe that, as part of this accounting restatement, the Company will report revenue and profit for Essex Crane and Coast Crane separately. Selected details of their estimated separate financials are in the appendix.
Appraised Liquidation Value
Because ABL loans are primarily dependent on the strength of collateral, lenders typically require frequent appraisals. In Essex’s case, the Company gets an appraisal from a firm called JJ Kane every six months. JJ Kane does appraisal work for both Wells Fargo and GE Capital, the two leads on the Essex loans. The particular appraiser used has been doing crane appraisals since the late 1970s and has an excellent reputation in this close-knit industry. This appraiser issues at least two appraisals: OLV and net OLV (“NOLV”). OLV is an estimate of the value of the assets if liquidated over 9 months in a combination of private sales, sealed bids, and public auctions. This number is publicly disclosed by Essex. See page 6 of the 8k filed on December 3, 2014. This $347M OLV for September 2014 implies a liquidation value leftover to the equity, after repayment of debt, of $5.27 per share.
However, lenders base their revolver borrowing base and internal estimates off of NOLV. NOLV is the OLV, less fees, expenses, and repair/refurbishment to liquidate. This estimate is not disclosed to the public but we have heard from both an appraiser and a lender that the discount from OLV to NOLV is roughly 8-12%. We have used 10% throughout our write-up. NOLV is the best proxy for the real proceeds to the equityholders in a liquidation, since there are a fair amount of expenses involved with the liquidation process – this 10% estimate implies about $35M of liquidation expenses. Therefore NOLV leftover to the equity, after all liquidation costs and debt repayment, is roughly $3.86 per share.
Our More Conservative Liquidation Estimate
After discussions with several informed parties, we believe that, in an absolute worst case scenario, an even more conservative estimate of liquidation value results in a value of at least $2/share. We discussed the composition and valuation of the assets of the company with numerous people including appraisers, sales execs involved in the purchase and sale of all types of cranes, and others. Our calls indicate that OLV represents roughly fair value for most of Essex’s cranes in the event of liquidation and that there is an active liquidation market for each category of assets, with one major exception. By far, the biggest valuation question mark we uncovered for the Essex fleet relates to the 124 Manitowoc traditional crawler cranes held at Essex Crane, valued at an OLV of roughly $76M.
Traditional crawler cranes are being replaced by hydraulic cranes. The two types of cranes serve the same functions, but hydraulic cranes have more automated operations, air conditioning, and several other features that make them more desirable. There are markets where traditional crawler cranes still serve a purpose; primarily in emerging markets and locations near water, where corrosion is an issue for the electronics in a hydraulic crane. However, in general, there is much less demand for traditional crawler cranes today vs. historically. Essex’s traditional crawler crane fleet is also old – sometimes dating back to the 1970s and 1980s. Crane technology has not changed much and these older cranes are considered technically very safe, but renters still prefer to use newer cranes that are more convenient and mitigate risk further. These preferences are visible in reported utilization numbers, which hover around 30% for the traditional crawlers and 70% for newer hydraulic crawlers. On the plus side, Manitowoc today charges around $2.5M for a new hydraulic crane with the same lifting capability as the traditional crawler crane sold decades ago for $500K. As a result, purchases for this kind of lifting capability are generally made in the used market and so used traditional crawler cranes have held their value remarkably well. A crane industry expert estimated that a Manitowoc 4100 crane purchased 35 years ago for $500K will still easily fetch $250-$300K in today’s resale market, with some even selling in the $500-$600K range (i.e. above the original purchase price) if they are in great condition.
Assuming sales over 9 months (the time period underlying OLV), people in the industry we spoke with gave varying estimates of today’s value for used traditional crawlers, ranging from $0.35 on the OLV dollar ($215K per crane) to full value ($613K per crane). All estimates below are indicated as cents on the OLV dollar. The actual data points we have are:
1) Essex has sold ~$40M of equipment from 2012 to date, at 109% of OLV. Management has indicated that a large portion of this equipment was traditional crawler cranes.
2) Conversations with an appraiser who estimated that a 15% discount to OLV was appropriate. He indicated that because he believes that only 50 traditional crawler cranes trade hands annually in the US, bringing 124 to market would result in a 15% sale price discount to recent pricing, or $0.85 on the OLV dollar ($520K per crane).
3) Conversations with an industry expert who suggested full OLV if given enough time but that “you’d be lucky” to get $0.50 on the OLV dollar ($306K per crane) if only given one year. He has been in the crane industry for 30 years and said there is no precedent for a flood of 124 cranes coming to market at once – it is nonsensical and would never be done. Multiple folks we spoke with confirmed the point that there is no precedent for this type of liquidation event.
4) Conversations with a longtime industry veteran that is considered a leading expert in traditional crawler crane sales, who indicated OLV ($613K per crane) is far too high for a true liquidation scenario. He pegged the likely value per machine in liquidation at roughly $250-$300K per crane. This contact was familiar with Essex’s fleet and suggested it is more heavily weighted towards the more valuable Manitowoc 4100 model, which can still sell for $500-$600K, and that his estimate might be a little low. Even using his lowest estimate, $250K per crane represents $0.41 on the OLV dollar.
5) Similarly, according to an industry executive we spoke with, Essex has about 15 traditional crawler cranes in the market right now with an average list price of around $300K.
6) Management off-handedly mentioned that Ritchie Brothers would give them $0.40-$0.50 on the OLV dollar in public auctions held over three years for traditional crawler cranes. This is considered the very worst way to realize value. In addition, Ritchie Brothers charges an additional 8-15% fee resulting in roughly $0.35 realized on the OLV dollar or $215K per crane.
Our analysis uses the lowest value – $0.35 on the OLV dollar – to calculate NOLV for traditional crawler cranes. This equals $27M of NOLV. We then applied the 10% NOLV discount to the remaining equipment OLV. This implies total NOLV of $270M / 24.8M TSO = $2.18 per share, after repaying debt.
The following sensitivity table shows Essex liquidation values for various traditional crawler crane discounts (Y axis) and OLV to NOLV discounts (X axis). If we assign literally zero value to the 124 traditional crawler cranes, and assume the maximum 12% OLV to NOLV discount on the rest of the equipment, we still have roughly $0.89 per share of value.
Why We Think Liquidation Won’t Happen
We believe that liquidation will not happen because the restatement is tied to an accounting technicality and it is highly unlikely that any lender forecloses in this type of situation.
The press release issued on February 26 highlights the FASB issue that resulted in this reclassification of Essex debt from long-term to short-term. An ABL lender explained to us that Essex’s debt is subject to a lockbox and the principal can be subjectively called (subjective acceleration), enabling Wells Fargo or GE Capital to almost immediately force repayment of the Essex and Crane revolvers by taking control of associated lockboxes and by using account funds for repayment, even though these revolvers are not contractually due until October 2016 (Essex Crane) and March 2017 (Coast Crane). Both of these types of revolvers have lockboxes. Typically, debt is classified as short-term if there is a lockbox in place, regardless even of the subjective acceleration clause. We were told that the debt is “more often than not” classified as short-term when a lockbox is in place. A subjective acceleration clause makes it even more likely that debt would be classified as short-term to be consistent with industry standards. Per Essex management, the partner at Grant Thornton who has headed the Essex audit was switched out this year (GT requires a switch every few years). The new partner requested this re-classification from long-term to short-term and in light of current industry standards it was not regarded as significant. The Company does have to restate financials, and has requested lender waivers because financials are temporarily out-of-compliance, but neither struck our contact as particularly worrisome. Also, as the Company notes in the 8k, they believe that the lender waivers will be obtained.
It is our understanding that a lender rarely exercises a subjective acceleration feature of an asset-based loan. This is generally considered a last resort type of measure. It is also very uncommon for ABL lenders to foreclose on “yellow iron” loans. According to our calls, in the vast majority of cases, the bank will refinance the loan or find a solution other than liquidation in order to accommodate the construction cycle. This is particularly true when the loan is syndicated out, as are Essex’s loans. One lender alone does not want to pursue the liquidation of a large number of cranes and a group of 4-5 lenders with different standards makes this that much more difficult. Experienced ABL lenders are also well aware that the crane rental market is cyclical and that earnings can be erratic – a key reason why ABL facilities are common in this space. Earnings cyclicality in these businesses precludes qualifying for a cheaper, cash-flow based facility, so the collateral becomes the main priority when underwriting this loan. Even if a company struggles with covenant compliance, strong collateral generally softens the blow in an ABL facility, particularly when the longer-term future is predicted to be better. Although Essex is suffering more than most given its traditional crawler crane exposure, our calls suggest that there is industry agreement that things will get better. Manitowec’s recent earnings commentary highlights that the short-term recovery remains uncertain, but that the company sees a higher growth, multi-year recovery on the horizon, driven by increasing demand for infrastructure and energy.
OUTCOME 2: SALE
We have spent far less time evaluating this scenario. However, there are many current and past private equity players in the space (Clearlake, Platinum, Odyssey, Prophet Equity, First Reserve, Bain and several others). In fact, Essex was originally purchased from private equity firm Kirtland Capital Partners and Coast was purchased out of bankruptcy from Audax. There are also several potential strategic acquirers, both private and PE-backed, including 3-5 national players in the industry (All-Crane, Bigge, Maxim, AmQuip), dozens of somewhat sizable regional players, and even more small mom-and-pop or niche operators in this industry.
We have been told that acquisitions have historically been done at OLV or at a premium to OLV in bad times and at 6-9x multiples of EBITDA in good times. Unfortunately, most companies in this space are private, so it is rare that transaction terms are disclosed. Numerous folks that we spoke with thought that Essex would likely fetch at least its OLV ($5.27) in a sale. It is also worth noting that an activist who filed a 13-D on February 18 seems to be pushing for the business to be sold.
OUTCOME 3: RECOVERY
Given our comfort with Essex’s liquidation value, we have also spent less time evaluating the recovery scenario. Essex’s results have been improving generally since 2011. Going-forward, we are estimating continued improvement in utilization, leverage on the SG&A line-item, and continued asset sales. We are by no means an expert on this business or the near-term trajectory – we have focused most of our due diligence efforts on simply validating liquidation values and thus have done very little work on our forecasting accuracy. As a sense-check though, our numbers are in-line with guidance for 2014 ($18-$22M EBITDA) and directionally in-line with consensus for 2015 ($23M EBITDA). The Company is covered by CJS Securities and, until December, was also covered by Oppenheimer.
We also note that management was changed in November 2013, which has resulted in a more customer-centric approach and may result in Essex gaining share.
We have heard from multiple sources that the crane rental industry generally targets a 15-25% ROIC across the cycle. Using OLV as a proxy for invested capital implies at least $52M of EBITDA annually. At a 7x multiple, this implies $6/share value, net of debt. This seems far-fetched at the moment, but it is worth noting that incremental revenue in this business has very high incremental margins. In 2008, Essex reported $47M of EBITDA and Coast reported $23M of EBITDA, for a total of $70M of EBITDA at 30%+ EBITDA margins during the peak of the cycle. Additionally, the Company traded at an average of $5.20/share during 2011. Lastly, there is a serious need for infrastructure improvements in the US, which would dramatically increase the need (and prices) for crawler cranes – infrastructure is one of the primary uses for these cranes. We point people to John Oliver’s great video from March 2 on the topic: https://www.youtube.com/watch?v=Wpzvaqypav8
- Asset values may be even less than the $0.35 on the OLV dollar for traditional crawlers and $0.90 on the OLV dollar for other equipment that we use in our liquidation valuation.
- Falling oil prices may lower crane rental demand in the near-term.
- Strengthening US dollar may reduce emerging market demand for traditional crawler cranes.
- A liquidation, in the event that one occurs, is inherently risky for equity holders and takes a long period of time to resolve. Our analysis is likely an oversimplification of what might actually occur and therefore, possibly overstates the value that equity holders might receive.
- The Company has traded at less than $1 for a few weeks and could face delisting if this continues for a much longer period of time.
In order to better understand the debt situation, we took a look at the loan documents related to each of these segments. We laid-out a few of the key pieces of data related to the debt below. Note that we have made rough estimates for profitability from management comments. However, the language in the 8K from March 17 suggests that the Company will begin to break-out the segment data separately.
Based on a review of loan documents and conversations with current and former management, we believe that Essex Crane has roughly $8M of LTM EBITDA, $152M of debt and $253M of asset OLV. Assets consist of 124 traditional crawler cranes valued at an OLV of $76M and roughly 105 hydraulic crawler cranes worth $177M of OLV. Essex’s debt composition includes a $122M revolver outstanding with Wells Fargo, at a 3.9% interest rate due May 2016, and a $30M term loan outstanding at an 11.5% interest rate due May 2019. The debt agreement was amended and re-syndicated in May 2014. The loans have been led by Wells Fargo since 2004 and the current syndicate includes PNC, Alostar Bank, Kayne Anderson Capital, 1492 Capital, and Medley Capital. The current revolver borrowing base reflects 75% of the existing equipment and some working capital. Key covenants are a fixed charge coverage ratio of 1-1.1x, maximum capex of $2M, and a minimum excess availability on the revolver of 10%. The segment has breached the FCC ratio covenants on this loan a handful of times, including in September 2014, so it is not comfortably covering its fixed charges, but it appears to be vaccilating between covering and not covering. The loan agreement was amended in October 2014 to exclude severance costs and to reduce the September FCC ratio slightly, so the segment is now in compliance.
We believe that Coast Crane has roughly $10M of LTM EBITDA, $59M of debt and $84M of asset OLV. Coast Crane assets consist of OLV of: $40M for 100 rough terrain cranes, $14M for 85 boom trucks, $4M for 35 self-erecting tower cranes, and $26M for 65 city tower/other cranes. Coast Crane has a $22M revolver outstanding with GE Capital at a 5.4% interest rate due March 2017 and a $37M term loan outstanding at a 5.3% interest rate due March 2017. The debt agreement was amended and re-syndicated out in March 2013. The loan has been led by GE Capital since 2010 and the current syndicate includes Wells Fargo, PNC, and Capital One. The revolver borrowing base gives credit for some working capital as well as 95% for new equipment and 85% for existing equipment. Key covenants are a fixed charge coverage ratio of 1-1.2x and minimum EBITDA of roughly $8M on a TTM basis over time. The segment has breached the FCC ratio covenants on this loan a handful of times, including as recently as May 2014, but Coast is in compliance as of September 2014.
- Reporting of restated financials by March 31 (per NT-10K filing stated goal)
- Better segment data in restated financials provides clearer visibility into performance
- Foreclosure risk becomes smaller
- Activist investor involvement
- Continued industry improvement and potential highway bill