KWG Humboldt Wedag KWG
August 27, 2010 - 5:49pm EST by
2010 2011
Price: 5.05 EPS E0.24 E0.37
Shares Out. (in M): 33 P/E 21.0x 13.6x
Market Cap (in $M): 167 P/FCF 8.3x 5.0x
Net Debt (in $M): -138 EBIT 20 30
TEV ($): 30 TEV/EBIT 1.0x 1.0x

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All numbers in Euros
On March 31, 2010, the industrial business of KHD was spun off into KHD Humboldt Wedag (KWG GR) and  the mining royalty asset was spun off into Terra Nova (TTT). After the first spin off, Terra Nova owned 71% of KWG GR and spun off approximately 20% recently.   Terra Nova currently still owns 49% of KWG GR, but is expected to spin off another 29% in the 3rd quarter and remain a 20% shareholder. 
KHD is one of the leading global cement plant and equipment suppliers. In addition KHD provides services such as designing and engineering, project management and supply, as well as supervision of erection and commission of cement plants and equipment. Customer services such as supply of replacements parts, plant optimization and training of plant personnel complement KHD's services. KHD's core equipment includes a wide range of grinding and pyro-process technologies. KHD's grinding technologies are utilized in raw material, clinker and finished cement grinding and include crushing, grinding and separation equipment, while KHD's pyro-process equipment includes pre-heaters, calciner systems, kilns, burners and clinker coolers. KHD also has developed a range of systems automation products, including process control systems and equipment optimization products. Manufacturing is almost entirely outsourced to contract manufacturers who produce the equipment to KHD's specifications. 

Products and services are either provided directly to the operator of a cement plant, or in a consortium that includes equipment specialists in particular in the complementary fields of materials transport, blending, storage and packing or as an equipment supplier as part of an overall turn-key project. 

The company can provide either single equipment, a package of equipment or offer 'full-line' equipment supply sufficient for a complete cement plant equipment line. The latter offering would include equipment from other specialized suppliers and usually KHD would take supervisory and technological responsibility for the entire cement plant process. 

KHD's strategic approach to the market is to be the leading supplier of innovative, environmentally friendly and energy efficient technologies focused on reduced operating and maintenance costs.

The company has its headquarters in Cologne, Germany and functionally operates worldwide via four Customer Service Centres in India; the Americas; Europe, the Middle East and Africa (EMEA) and Russia/CIS. KHD also has operations in Asia Pacific, China and Australia. The KHD Group has more than 700 employees worldwide. 
KWG GR is a 150 year old engineering firm with 780 employees, with at least 40 customers with a minimum order size of $1 million, and 300 plus suppliers.  The brand, Humboldt-Wedag, is a very well known brand among cement producers, their customers.  Sample customers are Cemex, Holcim, Eagle.  The cement producer market is considered mature, with the  top 10 cement producers making up 50% of market share. The company's sustainable unfair advantages are: its 400 patents, its intellectual property, the technical know-how and collective experience of the employees. They do not own manufacturing sites as most everything is outsourced. Hence, their capex needs are minimal.  90% of their revenues come from their cement producing customers. 10% come from their mining customers who use their grinding products. 
The company just published the first half financials for 2010 and gives us a clear picture of the business for the first time since its spin-off.  The company has no debt, and cash of 238 million euros.  About 100 million euro of cash is earmarked for use for future customer contracts (think of it as deposits for deferred revenues).  The market cap is 167 million euros.  For the first half, they did 10 million of EBITDA. Their sales for the first half of 2010 is 115 million, which is a depressed number.  Their backlog is around 314 million, which averages 12 to 18 months to complete. The backlog gives good visibility.  I estimate 2011 sales to be around 300 million euros. 
The cash flow cycle of this business works like this: KWG GR gets 10 to 20% down payment upon beginning of the contract.  Up to 70 to 80% is paid upon certain milestones.  The last 10% comes after performance tests.  All payments are secured by LCs, hence they can go to the bank and get the money.  Collection on A/R is not a problem.
While they have 139 million of excess cash, management prefers to be conservative now.  First, you do not get credit from Bank if you do not have enough cash in your balance sheet.  The issue of dividend/buybacks/options for employees will most likely come up in the next board meeting but nothing guaranteed, of course. 
The outlook is mixed.  Western Europe still looks pessimistic.  But India and developing countries are growing gangbusters.  They are over 100% utilized in their India headquarters. They just got a big contract in Brazil which will boost their Americas utilization rate.  India's government is building roads, highways and currently accounts for 1/3 of revenues. They see this growing to at least 50% over time. 
70 to 80% of the Cost of Goods sold is steel.  There has been a lot of pricing pressure right now on their products because of the low economic activity.  If demand for cement goes up - e.g. cement prices or cement volume goes up, demand for KWG GR's services go up. Gross margins for KWG GR stay in the 15 to 16% range. 
The merits of investment are all there. The only negative is that management does not own enough shares. However, discussions for options may be brought up in the next board meeting.  This fact of management downplaying the value so they can get good option strike prices, coupled with potential shorting by arbitrageurs in the parent TTT and the child KWG GR, may be the reasons the stock has been low and the story is not out in the public. But this is all speculation on my part.  By the way, the parent TTT is issuing rights at 6.60 per share which may be causing more arbitrage selling pressure. 
Taking the cash value at face value, the company trades at negative EV.  In reality, 100 million Euro are customer deposits.  So the true EV is 30 million Euros.  If the company does about 300 million Euro in sales with Ebitda of about 30 million.  This company is trading at 1 times EBITDA.  Capex is minimal (Basically, more pc's and computers for their employees) as this is a know-how business.  This valuation seems dirt cheap for a 150 year old history, well known brand name, 400 patents, presence in many parts of the world with a great exposure to India.  So EBITDA less capex approximates EBITDA. 
I easily will be will to put 8 times EBITDA multiple and add back the 138 million euro net cash position , this company's fair value is 11.40 a share, or an EV of 378 million Euro. 


Financials for the first year after spin-off become clearer.
Management starts meeting investors over time. 
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