MASTEC INC MTZ
May 19, 2016 - 4:19pm EST by
eventdrivenequity
2016 2017
Price: 21.40 EPS 1.53 2.22
Shares Out. (in M): 82 P/E 14x 9.6x
Market Cap (in $M): 1,760 P/FCF 15x 14x
Net Debt (in $M): 1,008 EBIT 276 367
TEV ($): 2,768 TEV/EBIT 10x 7.5x

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  • Pipeline
  • Wireless
  • infrastructural asset
  • Mexico

Description

INVESTMENT SUMMARY

MTZ offers 60%+ upside over the next 12-18 months in asset-light E&C and Services company as multiple secular tailwinds take hold.  Tightening capacity in NA long-haul pipeline construction, the reacceleration of AT&T capex and DTV adoption, and growth in gigabit fiber installations will drive revenue and margin upside for the next 3+ years.  Free upside optionality in Mexican (and Cuban) infrastructure build-out catalysts and margin recovery in Transmission segment offer incremental earnings levers on top of robust fundamental trends in the base businesses.  Legacy operational and reporting issues (multiple guide-downs in 2014 and a delayed 10-K filing in 2015) are still weighing on sentiment, despite a 75% move off the February lows.  $34 base case PT (53% upside) with bull-case to $43 (100% upside) on our above-street 2017 EBITDA at mid-cycle multiples (6-7x EBITDA).

 

BUSINESS DESCRIPTION AND HISTORY

  • NA infrastructure services and construction company, diversified in telecom, pipeline construction, electrical transmission and power generation.  Family-owned business (insiders own ~21%) with 80 year legacy and dominant NA presence with 14,000 employees in 380 locations.
  • Long-standing contractual relationships with core customers AT&T/DirecTV (in telecom) and Energy Transfer (in O&G) support MTZ’s project backlog, while variable cost-structure and asset-light business model (capex 2-2.5% sales) allows company to quickly downsize in a downturn.
  • NA E&C is a fragmented industry with significant scale component (largest jobs awarded to the largest players).  MTZ holds Top 3 position across NA Specialty Contractors, with closest public comps in Quanta Services (PWR, with whom MTZ competes in both oil/gas and electrical transmission), and Dycom (DY, with whom MTZ competes in wireline).
  • While smaller project work is highly-competitive, the entry barriers to winning large projects are significant – customers typically value incumbents (long-term customer relationships and a track record), and access to capital is critical due to the material initial cost and working capital requirements to ramp up / prepare for a project.  Pricing is a factor in winning bids but rarely the dominant driver; project quality and execution within a specified time frame / budget remains crucial.
  • Notably, given that the permitting and regulatory compliance aspects of pipeline construction represent almost as much (if not more) of total project costs as the E&C work, pipeline customers have almost zero incentive to award work to anyone other than the most experienced contractor, even if a potential new entrant would be considerably less expensive.  The financial, legal and regulatory implications of a potential construction-related issue either during the build or later far outweigh any cost-savings from using a less-proven operator.
  • Segment Descriptions
    • Communications (47% of 2015 revenue) – largest wireless infrastructure contractor in the US (primarily building and servicing wireless towers), offering both project management and self-perform construction services across a broad geographic territory.  Also offers wireline services (primarily installing and servicing metro-scale broadband fiber for GOOGL and CenturyLink) and DirecTV install & customer fulfillment services through an exclusive MSA with AT&T.  Secular growth of mobile data trends and residential demand for gigabit fiber and DTV offerings suggest sustained tailwinds for the segment.
    • Oil & Gas (35% revs) – balanced portfolio of gathering line, mid-stream, long-haul interstate pipeline and related facilities services for oil, gas and gas liquids.  Record 4Q15 backlog (~$2 billion) in the O&G segment supported by expectations for resurgence in US long haul pipeline project activity in 2016 and 2017+ along with continued development of Mexican O&G infrastructure.  MTZ holds incumbency advantage in the massive forthcoming Mexican pipeline infrastructure build-out opportunity ($10B+ in projects to support the doubling of Nat Gas demand from new electric generation capacity) through its current JV with Carlos Slim on the current Waha pipeline build-out (to help transport natural gas from TX into Mexico).
    • Transmission segment & Power Generation segment (9% of revs each) – beyond pipelines, MTZ’s E&C capabilities extend into high capacity powerlines/towers, small power plants, wind farms and solar farms.  The Company’s recent experience in its Transmission (powerlines/towers) segment has been particularly disappointing – see below for further commentary.  The good news is things can only get better on this front, and if for some reason improvement doesn’t happen organically, MTZ will exit the business entirely.  We view this segment as free upside optionality from here.
  • 2014-2015 Operational & Reporting Challenges (why this opportunity exists) – MTZ coming off nightmare years in 2014/15 when project delays and a (now resolved) accounting issue hit the business just as their largest customer (AT&T) slashed annual capex by 15% to focus on completing its merger with DirecTV.  This confluence of events led to a series of guide-downs in 2014 and a delay in the 2015 10-K filing (along with an SEC audit investigation); during this time, many lost faith in management and capitulation selling ensued – the stock fell from $45 in early 2014 to $16 at the end of 2015.  With expectations reset, MTZ has become a “show-me” story and we think the stock is set up well to exceed overly-conservative street estimates, as sentiment remains low (current 10.5% short interest).
  • Management – MTZ has a long operating history, originally founded in 1929 under the name Burnup & Sims, but changed to MasTec in 1994 as Jorge Mas Canosa (the late father of current CEO Jose Mas) led a reverse acquisition.  Jorge was a leader in the anti-Castro movement in Miami and went on to serve as an adviser on Cuban affairs to Presidents Reagan, Bush Sr. and Bill Clinton.  The Mas family’s deep political connections have helped MTZ win work in Mexico and will likely help them as Cuba builds out its infrastructure.  Current CEO, Jose Mas, took over in 2007 and began to diversify the business into O&G, electrical transmission, and power generation, which now comprise 50%+ of revenue.  The Mas family retains material ownership in the company, with a combined 21% stake, and were active open market buyers of MTZ stock in 2015.

 

THESIS OVERVIEW

1. Oil & Gas backlog is largest in firm’s history (having just doubled sequentially into year-end 2015), and management guidance suggests this project backlog will be completed AND replaced within the next 6 to 9 months.

  • Oil and gas backlog up 158% y/y in 4Q15, 122% y/y in 1Q16 to $1.8B on primarily natural gas transport projects
  • CEO guided to full backlog conversion by year-end 2016, with further guidance for 2016 year-end backlog to exceed current levels, implying MTZ expects for orders to continue to grow by 100%+ in 2H16
  • Verbal commits and awards / negotiations suggest that 2017 could be bigger than 2016.  CEO comments on recent 1Q16 conference call (May 6) suggested the company may substantially upgrade its backlog quality with some longer term commitments in 2H16: “…virtually all of our current backlog in this (O&G) segment will be completed in 2016.  And we expect backlog at year-end to exceed current levels…I continue to be surprised by the level of visibility in this segment for years to come. We are in great shape relative to backlog in 2016. We believe 2017 is going to be even better based on verbal commitments and awards, and we are in negotiations and dialogue on projects that will be built all the way out into 2019-2020.”
  • Dakota Access Pipeline project (ETE-backed $3.7bn, 1,168-mile 30-inch diameter pipeline that will connect the Bakken/Three Forks production areas to gathering terminus in Patoka, Illinois) that accounts for roughly half of current O&G backlog was just granted permit approval in Iowa and is slated to begin construction in as early as this month.  This pipe will transport 450k-570k+ bbl/d (~50% of Bakken daily crude production) and is a major priority for ETE, who wants the entire pipeline construction project completed by year-end 2016.  Our view is this project will act as significant utilization vacuum for the entire long-haul pipeline construction industry, lifting margins for all players in 2H16 / 1H17

2.  Oil & Gas EBITDA margins show potential for 200-300bps lift from 2015 as projects ramp and utilization improves across the industry.

  • Variant view on MTZ is primarily driven by +200-300 bps upside to street-implied O&G margins for 2H16-2017
  • Street inclination to remain conservative on margins (given recent commodity price collapse and excess capacity in 2015) creates the opportunity – street estimates baking in 11-12% margins for 2016-2017 in a segment that did 17%+ margins at prior peak (2Q13) with 20% less revenue ($1B in 2H13 revenue vs $1.2B est 2H16 revenue).
  • MTZ is already earning mid-teens EBITDA margins on nearly all of their NA projects.  O&G NA margin strength is currently being masked by a single failed Western Canadian project that is 85% complete and was a ($13m) drag on EBITDA in 1Q16.  Our assumption is that the Canada loss was negative mid-single-digit EBITDA margin in the quarter, implying that non-Canada revenues were ~$220-230m and non-Canada EBITDA was $33m (a 14.3% - 15% margin in non-Canada O&G).  This project will soon be in the rearview mirror.
  • MTZ CEO Jose Mas provides further color from the 1Q16 call: “…While we don't expect a significant improvement in revenues in Canada over the coming quarters, we expect them to be EBITDA positive for the balance of the year. Excluding Canadian results, our Oil and Gas business experienced revenue growth of 35% and EBITDA margins in the mid-teens. We expect oil and gas revenues to dramatically ramp over the coming quarters and our current guidance assumes no further project awards in 2016.”
  • While market intuition and sentiment connects O&G pipeline demand to underlying commodity prices, the data doesn’t support this notion (which is a critical part of our variant view).  The biggest risks are regulatory (project permitting) related.
  • Estimates could prove conservative if the regulatory political environment becomes more favorable (e.g. U.S. approval of the Keystone XL pipeline) and capacity tightens more quickly than expected, with the potential for further margin ramp into 2018.

3. Multiple tailwinds driving Communications business: 1) capex cycle improving for both wireless and wireline network infrastructure and 2) AT&T pushing faster DirecTV sub growth. Both offer additional organic growth opportunities to drive further margin expansion.

  • MTZ’s communications segment is comprised of multiple separate businesses: wireless, wireline/fiber, and DirecTV/install-to-home. While the headline customer concentration figure (AT&T 39% of revenue in 1Q16) appears intimidating, it is misleading. AT&T’s wireless/wireline segment is 20% of MTZ revenue and the balance (19%) is DirecTV.  Not only do the two segments operate under separate budgets (thus reducing risk to MTZ) but MTZ’s DirecTV contract is long-term and fixed through October of 2018. Most importantly, we think MTZ’s communications business as a whole is benefitting from a host of secular tailwinds: demand for faster wireless/fiber networks, faster data speed to support the cloud-based storage transition, and the streaming of higher-bandwidth content to consumers.
  • Wireless (~50% of communications revenue): MTZ continues to benefit from broad secular trend of greater data usage across the country. Communications infrastructure is a scale business that requires high service level and expertise, which gives MTZ an advantaged position versus smaller competitors as the company builds relationships with customers and strengthens its strong incumbency position. The business suffered in 2014/15 when AT&T cut capex to focus on the DTV acquisition, but AT&T’s capex guidance returned to growth in 2016: up $700m yoy (+17.5%) in 1Q16 with full-year 2016 capex guide of +14% yoy and an outlook for +LSD growth in 2017.
  • DirecTV/Install-to-home (~30% of revs): MTZ is the largest third-party contractor in the country (~30% share) for DirecTV and is benefitting from a large increase in installation and support services. Recent DirecTV installs have been accelerating as AT&T actively pushes offering – in 1Q16 MTZ reported a 25% yoy increase in install-to-home (DirecTV) revenue, as net subs increased by 328k (53% sequential lift from 214K adds in 4Q15), reflecting AT&T’s active process to port customers from U-Verse to DirecTV services.  Large maintenance / upgrade business in addition to new installs (over 60% of MTZ’s DirecTV truck rolls relate to maintenance / upgrades) run under a long-term MSA provide a more stable revenue stream under a growing installed base.
  • Wireline/fiber (~20% of revs): MTZ is also supporting the rapid demand growth for gigabit internet installation, with wireline revenues up 31% yoy in 1Q16. These contract wins have traditionally gone to competitor Dycom (DY) but MTZ recently has been benefitting from both new contract wins in existing markets and new market launches (growing TAM).  Major gigabit rollouts by Google, AT&T, and CenturyLink have been announced and we believe the “pie” is growing fast enough for DY, MTZ and other private comps to all benefit.

4. Free upside options in a multi-year infrastructure build-out in Mexico (O&G and Communications) and margin recovery in money-losing Transmission segment.

Mexican Infrastructure

  • $10B in O&G pipeline opportunities thru 2018 (2,500 miles of pipe) as Mexican Nat Gas demand is projected to double by 2028
  • MTZ currently operating in Mexico today (natural gas pipeline infrastructure services) and is uniquely positioned as a Hispanic-owned business that has already won significant contracts thru JV with Carlos Slim / ETE for a Texas to Mexico pipeline currently under construction.
  • KKR, BlackRock, First Reserve and Sempra all have recently funded Mexican energy infrastructure projects, underscoring the significant runway for project growth over the next 3-5 years.
  • Moreover, MTZ’s well established relationship with both Carlos Slim and AT&T (along with its Spanish speaking management team) position it well to eventually provide its communications related services in Mexico on a large scale.

Electrical Transmission (ET) Segment

  • While at one point the ET segment (comp to PWR) was a very attractive business for MTZ, it has been a massive headache over the past 2 years.  Not only did it become the subject of a long, drawn-out audit investigation which distracted management and resulted in a delayed 10K filing (ultimately resolved with insignificant cost recognition shifts between quarters), but it also ran into a period of market wide delays for large scale transmission projects (also acutely experienced by PWR).  These delays were primarily related to project permitting delays, and the long term secular trend of needed upgrades to US and Canadian power transmission infrastructure remains intact.
  • For context, ET segment alone accounted for an ($80m) drag on EBITDA (TTM) and a ($26m) drag to 1Q16 EBITDA
  • The majority of MTZ’s ET project cost overruns related to improper geological survey work done by 3rd party subcontractor; MTZ expects some monetary reconciliation from this geological sub in 2016 and the company has a goal of break-even EBITDA margins in ET thru year-end 2016.
  • Adjusting for ET EBITDA losses improves the stocks’ forward EV/EBITDA valuation by nearly 0.5x

Cuba Infrastructure

  • MTZ is managed (and significantly owned) by the Mas family, Cuban Americans based in Florida with high level political ties to both Democrats and Republicans. 
  • To the extent that the Cuban economy is further liberalized and US-Cuban economic relations are normalized, MTZ appears to be well positioned to play a significant role in any large scale Cuban infrastructure modernization efforts in Communications or Energy.

5. Company is run by multi-generational owner / operators with material equity holdings; large open-market insider buys within the last year suggest even more confidence in the business trajectory in 2016+.

  • MTZ has been family-owned for generations and the Mas family controls 21% of the stock; former CEO and current Chairman Jorge Mas owns 10.5m shares (13% of float / $230m worth) and Jose Mas, his son and current CEO, owns 4.9m (6% of float / $107m worth).
  • As the stock sold off in August with the market, many senior executives including Jorge, Jose, the CFO, head of IR, and other insiders personally bought a total of $13m worth of stock (notably, the MTZ also bought back $100 million of stock during 1H15).
  • These incremental financial commitments reinforce our confidence that this is still early innings for the MTZ story after a disappointing 2014/15 

 

SUMMARY OF VARIANT VIEWS

  • Investor and sell-side anchoring to legacy issues, with significant bias towards conservatism around O&G backlog conversion and margins.  We believe there is 200-300 bps of upside to O&G margins on tighter capacity utilization driven by recent long-haul project awards.
  • MTZ remains a largely ignored / unloved company (due legacy operational issues + 10-K delay overhang + lack of clear sub-sector fit due to end-market mix (energy & telecom) + no bulge bracket coverage), which creates opportunity for material upside surprise.
  • Misperception around commodity leverage in O&G (many believe O&G segment needs higher energy prices in order to grow revenues), whereas cheap natural gas is actually a boon for MTZ’s pipeline business, as it drives new construction to serve the rapidly growing demand from markets such as Mexico and New England.
  • Misplaced fears around customer concentration (T and ETE are ~35% and ~18% of MTZ revenues, respectively).  MTZ broad offering in telecom (wireless, wireline/fiber and DTV) suggests T exposure should be split among 3 distinct and unrelated entities, as services provided to each “customer” are negotiated and contracted independently and the associated services are provided by distinct divisions of MTZ.  On the energy side, customer concentration risk is much less important than project risk.
  • Materially-negative EBITDA drag from recovering ET segment (-$80m TTM basis) still being capitalized in valuation multiples, which remain at a discount to peer DY on both an EV/EBITDA and P/E basis (MTZ = 7x fwd EBITDA / 16x EPS vs DY at 8x/19x) despite MTZ optionality on O&G, Communications and Transmission segments.
  • Longer-tail free options on Mexican and Cuban infrastructure build-out.

 

VALUATION AND TARGET PRICE

BASE = $34 stock (59% upside) $565m in FY17 EBITDA at a 6.3x multiple.  Key assumptions: Communications revenue and EBITDA of $2.25B / $286m (12.7% margin). Oil and gas revenue and EBITDA of $2.28B / $302m (13.2% margin). Net debt of $725m (1.3x levered), FCF of $188m (FCF generation will remain depressed for the near future as MTZ requires heavy working capital investment to prepare for oil/gas ramp)

BULL = $43 stock (96% upside) $615m in FY17 EBITDA at a 7.0x multiple.  Key assumptions: Communications revenue and EBITDA of $2.35B / $307m (13.1% margin). Oil and gas revenue and EBITDA of $2.31B / $314m (13.6% margin).

BEAR = $19 stock (14% downside)  $425m in FY17 EBITDA at a 5.5x multiple.  Key assumptions: Communications revenue and EBITDA of $2.13B / $251m (11.8% margin). Oil and gas revenue and EBITDA of $1.85B / $214m (11.5% margin).

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

2H16 operational beats, backlog growth and guidance raises into 2017

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