Description

My previous write up gave an overview of the TH thesis and this write-up explains why I’m reinitating and have bought back my position.

The recent developments over the past few weeks have made me more optimistic on the probabilities of a successful renewal at similar economics on a known timeline.

• Unaccompanied children volumes are surging
• The government is explicit in its ICF bed goal and has offered a definitive timeline for the final awards related to the IDIQ process
• TH’s potential for winning multiple bids within this IDIQ process has increased
• TH has potential to win bids outside of this IDIQ process
• Recent evidence suggests the current Pecos $200m guaranteed revenue is fair

At the core, the bearish view is that TH is a marginal swing capacity bed provider to highly volatile demand (UC volumes). Given the research, I believe the demand is actually inelastic (government needs insurance and total capacity of 20k beds [9-10k state licensed beds + 10k ICF beds]) regardless of the true “end demand” (UC volumes). This inelastic demand is significantly above current supply.

UC Volumes:

• Unaccompanied children volumes are surging again. This is likely due to a potential reversal in asylum rules for migrants. https://www.washingtonpost.com/nation/2023/07/25/asylum-ruling-biden-migrants/ For context, in the past, many families travelled to the border and let their kids go first across the border. Unaccompanied children have a higher probability of making their way through the asylum seeking process. However, the Title 42 expiration was combined with new Biden administration rules on illegal crossings that increased the penalties. From our research, we believe many families decided against letting their kids cross as they tested out the new online asylum process associated with the new rules. As an aside, the new rules on illegal crossing also dropped total border apprehension (adults, families etc.) 40% from May to June.
  • A continued surge will increase time pressure on having permanent ICFs ready this year
  • The fact that children volumes increase 50% in a month goes to show that the government needs to be prepared at a moment’s notice. Not being able to house children is no longer an option given the past debacles.

The government is clear in its ICF bed goal and has offered a definitive timeline for IDIQs

• The government said last week that the three IDIQ-related ICF facility awards will be awarded starting in late August. This is the first time I’ve seen a clear indication of 1) this is going to happen 2) this is going to happen soon
• The government is now clearer in their intentions for 10,000 ICF beds (or 3 Pecos sized facilities). In the past, the exact number of beds needed was unclear.
• Other clues:
  • The government is currently running an IDIQ process for the transportation of unaccompanied children and families to various ICF facilities. The final contract term will be 5 years with a maximum contract value of $1.8bn.
  • Don’t listen to what they say, look at what they do. The government’s need for ~10k ICF beds has actually been very evident through their actions. Today, there are ~9k ICF beds: Pecos (3k), Fort Bliss (5k), Greensboro (1k). The likely reason why the government continues to extend Fort Bliss despite 1) Fort Bliss being essentially empty, and 2) the government announcing last year they will eventually close the site is that the government needs ~9-10k ICF beds on standby IN CASE the UC volumes surge. Given the IDIQ process has taken longer than previously expected, the government (probably has no choice) has to keep extending Fort Bliss until the IDIQ awards are given and the IDIQ facilities are open to maintain an insurance policy.

TH’s potential for winning multiple bids within this IDIQ process have increased

• TH perhaps isn’t in direct competition with the other listed bidders in this IDIQ process
  • Target Hospitality also just stated in the earnings they’ve partnered with more government service providers in addition to their Pecos partner Endeavors. Remember I previously listed in the writeup/comments section that many potential providers did not have facilities that are ready to go. These bread crumbs lead me to conclude that there is a high probability that Target Hospitality will actually win more ICFs through partnering with these other providers who are in the bid.
  • This would be a win-win for TH and these providers. TH has expertise in facilities management and have the physical land and buildings. The providers have expertise in bidding for government contracts (through relationships etc.)
• The timeline from the various clues I’ve gathered suggest TH has a good shot at potential sites in addition to Pecos:
  • In Dec 2022, the government issued an RFI on Turnkey ICF facilities that can be ramped up within 1-2 months of award.
  • The closing date for the RFI Q&A period was April 21, 2023
  • On April 17, 2023, TH announced it acquired assets to increase portfolio capacity in support of the humanitarian aid mission. We see in the latest earnings release that the amount spent was ~$5m. This was likely just for land rights.
  • In mid May 2023, the government stated it identified three potentially viable ICF locations in California and New York.
  • It’s very possible that the assets TH acquired in April are in California given the government’s commentary and TH’s statement that the assets are close to the Southwest border.
• I was previously under the impression that only 2 facilities were up for bid given Greensboro was awarded. I’ve now come to the view that 3 Pecos-sized facilities are up for bid as part of this IDIQ process.
  • The government said they want 10,000 ICF beds. Greensboro’s capacity is ~1k and cannot be increased significantly. This suggests 3 more 3k bed facilities are needed.
  • Greensboro’s award is through a separate Blank Purchase Agreement Call Order that has already been awarded and lasts 4 years and thus is not part of this IDIQ process.
  • The government said last week it will award 3 facilities as part of the IDIQ process. This statement comes months after awarding Greensboro’s 4 year contract.
  • An extra facility should boost TH’s chance of renewal or another win.
• TH’s additional bids in the IDIQ process all made it into the pricing round
  • The process for the awards is as follows:
    • IDIQ award à technical proposals à pricing à final award with terms and compensation
  • All of TH’s bides made it past the technical proposal stage and are in the pricing stage. There were some IDIQ award winners who did not make it into the pricing stage.

TH has potential to win bids outside of this IDIQ process

• TH has put in bids totally $1 billion of capital between this IDIQ and additional new ICF facilities. This is the first time the company has mentioned involvement in ICFs outside the scope of this IDIQ process. The scope of what TH is involved in is much larger than I had expected (which was one facility within this IDIQ process + some guesses that they may be involved in something else).
• These bids totaling $1bn of cumulative capital are incremental to the previously announced $500m of net growth capital (which is unrelated to the IDIQ or new ICFs)

The uplift in TH earnings for any new facility may be significant

• Pecos has a revenue potential of $200-400m year after spending $230m of capex from phase one (2021-2022) and phase two (2022-2023).
• $1 billion of capital deployed between IDIQ and additional ICFs could see attractive ROIs and earnings for TH

Recent evidence suggest the current Pecos $200m guaranteed revenue is fair

• The current Pecos pricing seems fair. You can refer to the prior per bed analysis. The incremental insight here is Fort Bliss’ renewals over the last few months
  • Fort Bliss was supposed to close in 2022. It has since been extended multiple times at similar (and attractive) pricing for effectively no volumes.
    • 9/30/2022: extended 9 months for $310m
    • 3/30/2023: extended 60 days for $166m
    • 5/17/2023: paid Fort Bliss $26m to ramp capacity from 1000 beds to 1500 beds in preparation for Title 42 expiration
    • 6/30/2023: paid $30m for an extension of 21 days
    • 7/20/2023: extended 2-3 months for $90m
    • For most of this period, Fort Bliss has had 0 to <500 kids in the camp.
• Greensboro was signed in April 2023 (when UC volumes were extremely low) for $70m a year for 800 beds for four years. Greensboro has been on warm status and has yet to accept any children.
• Given these very recent comps, paying $200m take-or-pay for 3,000 Pecos ICF beds really doesn’t seem that egregious.
• The government keeps stating in filings that the price/cost to the government is fair and reasonable. They’ve said this in Fort Bliss’s (now multiple) extensions as well as Peco’s renewal. Pricing for a government contract will always be difficult to predict ex-ante, but the clues do suggest that the pricing will likely be maintained.

• In addition to the bed comps provided previously, here is an additional one: Yuma SSF is a soft-sided tent facility that has been in operation since 2019 and is operated by Deployed Resources. The latest contract is for $261m for 1375 people (adults/families). Several key takeaways:
  • Given TH operates permanent hard structure facilities at Pecos, the cost should be higher than operating “temporary” tents.
  • TH operates a children’s facility, which requires much more ancillary services and support than a camp that holds mainly adults. The costs should also be higher.

Valuation:

I think the range of outcomes has changed given the above, especially the commentary about supporting another bidder with solutions, the specified timeline of awards, and the stated goal of 10k ICF beds.

My ranges of outcomes:

• Renewal of Pecos at a pricing discount of 25% and ~12x FCF: ~20% upside
• Renewal of Pecos at current pricing: 40-50% upside
• Win 2 facilities bids at a pricing discount of 25%: 70-80% upside
• Win two facilities at current pricing: 110-170% upside
• Win three facilities at current pricing: a lot of upside
• No renewal but assume they can reallocate assets and earn 2018 EBITDA of 120m: -40%. I think the probably of this is quite low. The government has said it needs 10k ICF beds. If they don’t renew Pecos’ 3k beds, it will impossible to hit that target (which would mean the multi-year process that the government has been running to secure ICF beds…. just stops a few weeks after they said they will award 3 facilities??)

Catalyst

Pecos renewal

More ICF wins