KHD Humboldt Wedag KHD
December 15, 2008 - 10:58am EST by
2008 2009
Price: 9.70 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 295 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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KHD Humboldt is a world leader in supplying proprietary technologies, equipment, and engineering/design services for the cement, coal and minerals processing industries. Founded in 1856, KHD’s primary business involves designing and supplying equipment for plants that produce and/or process cement (~86% of revenues) and minerals (~14% of revenues) such as coal, base and precious metals. Unlike traditional engineering and construction companies, KHD does not construct cement or mineral processing facilities for its customers, choosing instead to focus on engineering and specialized equipment procurement. Consequently, KHD’s “asset-light” operating model translates into high returns on invested capital with minimal capital expenditure requirements. Global cement consumption (ex-China) has grown at a CAGR of approximately 6.1% since 2003, well above the historical average 2.5%-3.0%, primarily triggered by urbanization and the associated infrastructure spending boom within faster growing emerging economies like Asia, Russia, Eastern Europe and the Middle East, which collectively account for 92% of KHD’s current backlog of $1.07B. As could be expected, the global credit crunch and precipitous fall in commodity prices has negatively impacted planned capacity expansions and greenfield project schedules for cement and mineral processing facilities in 2009 (and possibly longer), and consumption growth is expected to revert back to historical averages. KHD is certainly not immune to the aforementioned headwinds facing their industry, as evidenced by the Company’s recent commentary in their 3Q08 earnings released on 11/12/08. Despite posting strong year over year growth in revenues (+9.4%), operating income (+44.0%) and backlog (+39.9%), KHD indicated that some of their customers have been negatively impacted by the shortage of credit and moderating demand trends, and some customers had approached the Company to discuss renegotiating or canceling existing contracts in their backlog. After an initial review of the economic crisis impacts on its order backlog, KHD announced on 12/8/08 that of their $1.068B backlog as of 9/30/08, officially canceled orders by their customers amounted to $50.8M and orders officially postponed by more than one year amounted to $18.0M. The Company also stated that another $164.2M of contract value could be at risk, meaning the Company had received verbal indications from customers that contract variations or cancellations are a possibility. Assuming all contracts mentioned above are cancelled, KHD’s remaining backlog would stand at $835M and account for 1.3 years worth of revenue visibility. At our depressed assumption of 10% EBIT margins going forward, that would amount to $83.5M, or $2.74/share in EBIT. After the violent sell-off that occurred over the ensuing month following their 3Q08 earnings release, the stock currently trades for $9.70/share. For that $9.70/share, you are getting the following :

·              $5.95/share in net cash

·              $1.40/share in preferred stock of former parent Mass Financial (ticker: MFCAF)

o             book value is $2.80/share, we haircut by 50% given underlying liquidity.

·              $3.28/share in royalty interest of iron ore deposit

o             Management had reportedly received offers for the royalty interest for twice that value. Based on TTM income b/f tax, the royalty interest is trading for approximately 1x carrying value, despite having a minimum of 10 years remaining mine life. Our estimate is based on a blended average of our DCF and multiple based approaches.  Management simply collects a check every quarter from the mine operators, which include Dofasco, Stelco, and Cliffs Natural Resources. Royalty expires in 2055.

The summation of the Company’s existing net cash & cash equivalents portfolio, their interest in the preferred stock of MFCAF, and our heavily depressed valuation assumption of the royalty interest amount to $10.63/share, a 10% premium to the Company’s current stock price which gives no value to their core engineering and equipment procurement business. KHD structures its contracts to maintain positive cash flow throughout the life of a project by requiring a down payment of 10-20% of the total project cost, along with subsequent payment milestones throughout the remaining project life. Coupled with the Company’s royalty interest in the iron ore mine, the business is entirely self-funding and cash flow positive, which has enabled them to build a large surplus cash balance. Consequently, even under the most bearish assumptions for future order intake and backlog cancellations, KHD should continue to generate positive cash flow ($2.74/share in EBIT from cement/mineral processing operations alone over next 1.3 years based on Management’s update of existing backlog). KHD’s commanding market presence (~20% global market share), premier reputation, and incredibly well capitalized balance sheet will enable the Company to efficiently adapt to the challenges that lie ahead. At its current valuation the market is implying that KHD will cease to exist as a going-concern, creating an opportunity to acquire shares in the Company at roughly the value of their non-core assets, effectively receiving a cash-generative operating model for free. More importantly, given the current state of existing infrastructure in several of KHD’s target markets that will eventually come to bid as credit markets stabilize and economic conditions improve, we believe the Company’s longer-term growth prospects remain relatively bright. 



market recognition of non-core net asset value
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