Description

Hill International is predominantly a global construction project management firm run by a father-son duo, Irv and David Richter, who together own around 30% of the company. Hill has a great reputation in the industry and is the only pure US-based project management firm. Contractors like URS, Aecom, and Jacobs also have project management divisions, but Hill only does project management, which minimizes potential conflicts of interest. Hill has worked on many high-profile projects since its founding 30+ years ago by Irv Richter. Irv Richter, the current CEO, will shortly become Chairman of the company. His son David will replace him as CEO of the company (for a long time now, David has de facto run day-to-day operations).

1. What does Hill do?

If, for example, Comcast wants to build new headquarters, it can either hire architects and contractors and oversee the project itself (and they have no experience doing this) or hire a project management firm like Hill to oversee the project on its behalf. As a project manager, Hill works on behalf of a developer/owner to supervise its projects. It makes a lot of sense for a developer/owner to use a firm like Hill given that the price a project management firm charges is small compared to the total cost of the project (2 to 3%), but the downside protection is large (avoiding cost overruns and delays). As an example, Hill was in fact the project manager for the new Comcast tower in Philadelphia, Philadelphia’s tallest skyscraper. Other high profile projects include the famous Palm Jumeirah in Dubai, a renovation of the US Supreme Court, and the Abu Dhabi international airport – see Hill’s website for more examples. Hill also has a small construction claim business. After projects end, there are often unresolved claims and sometime litigation. Hill will be hired by one of the parties or their legal advisors to assist with an evaluation of the claims. In 2013, the claim business represented around 20% of revenue. 

2. Why do we like the company? 

1. High barriers to entry – reputation and experience for particular projects matter a lot. For example, if an owner/government wants to build an airport, they will pick a project management firm that has managed a number of airports. That makes it difficult for new entrants to get into the business.
2. Pricing is not the most important factor in the selection process of a project manager given the fact that its fees are small compared to the total cost of the project.
3. High revenue visibility from long-term contracts/backlog.
4. Agency model (low risk) versus contractor model (higher risk) – unlike the typical E&C (engineering and construction) firm that has fixed-price projects and therefore can lose money if there are delays on a project, Hill charges a multiplier of its costs to the clients and therefore doesn’t incur any of that risk.
5. Capex is very low (although a lot of money is tied up in working capital)
6. High ROIC
7. Operational leverage – revenue growth should lead to faster bottom-line growth

3. Financial characteristics

Revenue has grown at a 14% CAGR since 2011, growing from $399 million in 2011 to $512 million in 2013. The company is guiding revenue between $575 and $600 million for 2014. Given the large backlog, HIL has good visibility into 2014. We have modeled the mid-point of this guidance so $587.5 million in 2014. We are assuming $620 million for 2015. Given the operating leverage, EBITDA margins have steadily gone higher. EBITDA was $39.6 million in 2013 and we are modeling $50 million in 2014 and $58 million in 2015. The company is pretty diversified by region (biggest driver is the Middle East at 42.8% of revenue and North America 23.7%), by client type (biggest drivers are private sector 48.2% and foreign government 35.3%), and by project type (biggest drivers are buildings 51% and transportation 31%). Backlog has grown at a CAGR of 13.4% over the last 4 years reaching $1,027 million at the end of 2013.

4. Valuation

At $5.60 per share, the market cap is around $225 million and the EV is around $320 million. The stock is therefore trading at 6.4x 2014 EBITDA and 5.5x 2015 EBITDA.

Peers are trading at 9.8x 2014 EBITDA and 8.8x 2015 EBITDA – see table below.

In 9 months, we expect the market to start valuing the company based on 2015 numbers. Here is a table with different assumptions that highlight HIL potential per share value and potential upside (80% at the midpoint of $9.80 per share):

Assuming the company can refinance its debt (see below for more details) and generate 2015 EBITDA of $55 million, we would expect free cash flow maintenance of around $33 million (capex of $4 million and taxes of $7 million). At 10x, this would translate to a $8.40 share price. At 11x, this would translate to a $9.19 share price. At 12x, this would translate to a $10.03 share price. 

10. Why is the stock mispriced?

We think there are three reasons why the stock is mispriced:

1. Most analysts don’t use an appropriate peer group.

Most analysts/investors use either consulting firms (like FTI, Navigant, Huron) or E&C firms (like URS, Emcor, Aecom, Jacobs) as peer groups. We don’t believe that either of these groups are good peer groups. Consulting firms have lower organic growth than HIL. E&C firms also have lower organic growth than HIL and also a very different risk profile than HIL. These peers tend to trade in the 5-7x EBITDA range. We think that the relevant peer group is the one introduced in the above table as these firms are focused on construction project management.

1. Libyan receivables

In February 2011, due to the political situation there, HIL suspended its operations in Libya. At that time, Libya owed $60 million to HIL. Over the last few months, HIL has been paid $9.2 million of this amount by Libya, leaving a receivable outstanding of $50.8 million. Moreover, Hill is currently negotiating with Libya and is hopeful to receive the remaining amount in 2014. At the same time, Hill is also in active discussions with Libya over several new contracts that could see HIL return to Libya in 2014. We don’t think the market is ascribing any value to this receivable. In our valuation, we have assumed that HIL gets another $30 million. We know that other companies in Hill’s situation have resumed work in Libya and have been paid a significant amount of their Libyan receivables.

1. Leverage

Due in large part to the Libya receivable situation, HIL broke its debt covenants in 2012 and had to refinance at very high interest rate. As you can see on the company’s income statement, interest expense is more than $20 million. We expect HIL to refinance its debt in 2014 and that should be a major catalyst for the stock. The upside of this situation is that the company has been very focused on operations (cost cutting, utilization rate …). The term loan is $100 million, there is $39 million drawn from the credit line and some other smaller items, so we assumed gross debt at $150 million and $55 million in cash.

11. Catalyst

Over the next 12-18 months, we expect that Hill will get a significant amount of its receivables from Libya, will refinance its existing debt, and will further deleverage as a result of FCF generation and EBITDA growth. This should rerate the stock.

12. Risk/Negatives 

1. Middle East – company is levered to the fortune of the Middle East and a slowdown there would be negative for the company.
2. Company is not getting sold anytime soon, which is too bad, as it would fetch a very high price given the quality of the business and the scarcity of the asset.
3. Management team is too focused on acquisitions. They aren’t doing any now (or nothing big) because they don’t have the cash and their stock is too low in their view so they don’t have the currency. But as soon as they delever and the stock is meaningfully higher, I would expect them to be more aggressive on this front. I wish they would be more focused on closing the profitability gap with their peers and achieve their 10% EBIT margin goals.
4. The Richters are regularly selling some of their shares although we don’t believe it is for reasons related to the outlook of the business or its valuation and the amounts are small compared to their total holdings. 

Catalyst