Monday, January 13, 2014

Enterprise Group Inc - Energy & Infrastructure Services

Enterprise Group Inc. (traded in Toronto under the ticker “E”) is roll up of service and equipment leasing businesses serving the energy, utility and construction sectors in (mostly) western Canada.

As it stands today, it consists of five businesses - TC Backhoe,  Calgary Tunnelling & Horizontal AuguringE-One, Arctic Therm and Hart Oilfield Rentals.

This is an opportunity that reminds me a little of XPO Logistics and, as I did in that case, I'll let Enterprise's  management narrate the investment case. This is the VP:

“We are a “growth by acquisition” company, but our target acquisitions – the absolutely critical makeup of an acquisition – has [sic] to be a company that is unique, that is in a competitive landscape that is not highly populated. So the uniqueness contributes to the fact that the competitive landscape is thinly populated. 
For example, the acquisition we made in September of 2012, flameless heating operations, (Arctic Therm) – they are the developers and patent holders on the large units. There is no other company like it on the planet. There is some competition out there in the availability of smaller units, but no competition in the large unit space. 
In June of this year [2013, ed.], we acquired Calgary Tunneling, which is a company that, again, very specialized, construction disciplines. There’s only five major capacity players in all of Western North America. So it’s a very lightly populated landscape for us. Margins are very good in both these businesses I have talked to you about, very good.
So those are the unique opportunities. Our strategy is to service the three segments that are important to us; that’s infrastructure, energy, and utility. Back in 2008, we were primarily oilfield focused, so when the oilfield went into a deep recession, we were completely reliant on that one segment. 
Just prior to the downturn in 2007, we acquired TC Backhoe & Directional It was part of our strategy to diversify our revenue stream, but it was a very good thing that we acquired that business going into the downturn, because their clients are mainly premier utility providers, that business made a million bucks a quarter while the other side was losing a million bucks a quarter. 
It opened our eyes to that utility segment as a much more stable environment. The reason why is - let’s be honest – these utility providers need to stand in front of a regulator when they need increases. So if they don’t spend any money, the regulators will see it on their P&L statements and they won’t give them the upgrades to increase their rates to the consumer. The utility segment maintains a fairly steady diet of construction and maintenance and we wanted to make sure that we were operating and servicing segments that weren’t just energy services, it needed to be across the infrastructure, utility, and energy services. 
Now, the new acquisition, Calgary Tunnelling and Augering, is a tremendous example of this. They service a great deal of infrastructure, utility, and energy services, and what we are really excited about is the long distance large diameter pipeline roster for construction looking forward the next three to five years is just outstanding. It has never been as rich as it has at this point looking forward.
With respect to Calgary Tunneling & Augering, and pipelines, they perform all the underground crossings for these major pipeline routes. 
For example, Kinder Morgan, I use as an example because the pipeline went through the Rocky Mountains and they did all the tunneling for that Kinder Morgan Anchor Loop, that went from Alberta, through the Jasper National Park, all the way down to the Vancouver harbour. 
At the moment they are on a three year pipeline build-out from North of Fort McMurray, all the way down South to the Enbridge liquid storage facility in Hardesty, They are tunneling all of the crossings. 
These crossings are usually roads, highways, or any other obstacle that you can’t trench through, you have to drill and basically cut a tunnel underneath the obstacle. 
So with the amount of pipeline build-outs that is in front of us, Calgary Tunneling is just terrifically positioned. 
The other example on the infrastructure side, most of the airports in Alberta, everything from Grande Prairie, Edmonton, Calgary, Fort McMurray, they are all going through massive expansions, Calgary’s airport is going to nearly triple in size. And Calgary Tunneling are doing a series of very technically difficult tunnels inside of the airport property right at this moment. The Company was also recently awarded a tunneling project at the Vancouver International Airport which should kick off in the coming quarter. 
CP & CN Rail Companies utilize their expertise as well. Much of this flooding that’s happened here in Western Canada all the way from British Columbia and into southern Alberta, all of those frontier areas where the rail lines are passing through, all of the culverts, both rail lines have to maintained and running clear.
You have to appreciate that many of these rail lines are built into an incline, on the sides of mountains, and you get lots of loose material when there’s heavy rains or melting and they clog up or damage, and sometimes completely wreck these culvert passes. So that’s the kind of work that we have been doing with the major rail companies. 
There’s an old saying in the auction business that “you make your money when you’re buying”. In other words, the key to a profitable enterprise is not paying too much for your input materials. In the case of Enterprise, management is keenly aware of that maxim and adheres to it religiously. 
“It’s important to note that we view it as absolutely necessary – it’s our discipline – that we do not pay any more than three times EBITDA for a company.”  
“You will see that our average of all our acquisitions is around 2.5 times EBITDA, we haven’t paid higher than 2.9 times EBITDA. 
And the reason why that’s important is that we believe that as we are a publicly traded company a good market may pay, and I am not convinced we are in a good market of course, but in a good market we may get 5.5-8 times EBITDA trading multiples. 
Well, if in a good market you are going to get 5.5 forward, then we have got to buy our deals under a 3 multiple. Our acquisitions are usually privately run operations. 
If you are a smaller private company operating regionally in Western Canada, there is a wholesale price and a retail price, and we feel that our shareholders require a bump. And if the vendor of the acquisition is interested in participating in a larger multiple, then that’s where we say, here’s where you need to take some of the price of the acquisition in shares of the company, so in the future you can achieve higher multiples, by the fact that there’s five other profitable divisions helping the price of Enterprise Group. 
We have been very successful in getting our targets to see it our way. You need to sell off your business between two or three times EBITDA, and you know what, you can get — for a portion of your proceeds you can get that 5.5-8 times EBITDA in a good market if you take some shares. We have been very successful at it. Calgary Tunneling was done just over two times EBITDA. 
“We have three targets at the moment [May 2013, ed]; two of them are at a certain level of dialogue. We would expect that one of them may close inside of this calendar year. 
Obviously growth is what we’re after, and again, the profile of a target company that we look at, it must have the market ability to be able to double in size within a short period of time, preferably in two or three years. If it lacks the potential to double in size in a short period of time, it’s not worth our opportunity.
Calgary Tunneling is a typical example. The proprietor who has ran this company, was very selective about which projects to complete. He was just taking enough work to match how busy he wanted to be, a lifestyle match if you will.
There was a meaningful amount of business that he could have gone after. He was quite risk adverse. 
So now that we have completed the acquisition there are several drivers that will increase the revenue here. We are going to look at those projects that are $3 million to $5 million because we have no problem bonding them. We already have bonding levels that are at these levels. So we will take on that business going forward. 
Every company we have bought, management signs on for five years. Not only had the manager/owner sign on for five years, but because his operations are so specialized, we had six key employees that were essential expertise also signed five year employment contracts."
Missing from the above monologue is Hart Oilfield Services, an acquisition that was closed at 3x EBITDA a week or ten days ago.

This is what the numbers look like to me:

If management is successful in continuing in this fashion, and if they can get 5.5x EBITDA in a sale at the end of 2015 (implying a 12% FCF yield to the buyer), this is what the valuation scenarios may look like:

Management presents its own calculations here.

There are newly issued exchange traded warrants ("e.wt") for the purchase of the common stock at a price of $1 at any time before the end of 2015. They were trading at 7 cents when issued and are at 15 cents now. After some dithering between the the common and the warrants, I've settled on the latter.

There are some things not to like about this opportunity. For one thing, other than Artic Therm, the acquired businesses are not so special. For another, this is the sort of opportunity that has all the appearance of message board bait, which I don't like. And, these fellas, as far as I can tell, have never done a roll up before whereas Bradley Jacobs was an old pro.

On the other hand, it seems to me that the downside risk is low and, if management can acquire another reasonably okay business at 3x and if the western Canadian pipeline construction, urban development and oil sands activity don't all come to a simultaneous halt, things should work out okay and in a timely fashion.

Useful supplemental resource

Disclosure: I am long the warrants  

Thursday, January 2, 2014

The Year in Review

In the end, 2013 looked like this (I have scaled the numbers to a beginning net asset value of US$100,000):

Security  Value  Gain Return Days held
Precia             6,819           1,609 23.6% 202
XPO Logistics           15,063             (183) -1.2% 38
Northgate Plc             9,013               540 6.0% 120
Hawaiian Holdings (equity)           24,530         11,104 45.3% 364
GEA           12,020           1,063 8.8% 13
Northgate           14,636         11,992 81.9% 337
Cybergun             3,290         (1,086) -33.0% 343
Lamprell           13,695           2,767 20.2% 213
Conrad             6,195           2,604 42.0% 177
Cybergun 8% bonds           14,007         18,075 129.0% 45
Hawaiian Holdings (equity)           10,018           1,374 13.7% 114
Consciencefood             7,521                 69 0.9% 132
Epicentre Holding             9,001             (222) -2.5% 201
Emeco             5,065               675 13.3% 104
Emeco             4,174           2,969 71.1% 62
Emeco           14,777           1,613 10.9% 124
Unitek Global Services             2,897               602 20.8% 13
Axia Net Media           11,052           1,103 10.0% 6
Hawaiian Holdings (calls)*             6,561           8,103 123.5% 134
Alaska Comm Sys             8,515         (1,282) -15.1% 104
Republic Airways Holdings             5,143               303 5.9% 22
The Dolan Company             5,773               110 1.9% 72
Mayur Uniquoters           13,483           9,986 74.1% 104
Zytronic Plc             7,117           1,416 19.9% 21
Lombard Risk Management             9,040               616 6.8% 65
Republic Airways Holdings           11,697               303 2.6% 54
"Reserved"           15,038           1,666 11.1% 22
Lamprell           11,112               681 6.1% 4
Tax Liability       (15,189)
After-tax Gain         63,384 63.4%
Average Cash         22,589 16.3%
S&P 500 31.9%
Performance relative to S&P 500 + 31.5%

and was experienced in this way:

Much of the year was spent trying to undo mistakes made in the back half of 2012. My posture on January 1, 2013 was not up to the task of keeping up with a bull market and, absent some fixes, would have resulted in a disappointing performance (again, the values are scaled to a start of year net asset value of $100,000):  

Cost ($USD) Gain ($USD) Return
GEA          11,376          1,415 12.4%
XPO Logistics          17,349          9,046 52.1%
Northgate Plc          17,058        11,943 70.0%
Hawaiian          26,912        12,534 46.6%
Cybergun            2,949         (1,182) -40.1%
Precia            6,383          1,808 28.3%
Tax Liability         (5,335)
After-Tax Gain        30,230 30.2%
Average Cash        17,973
S&P 500 31.9%
Relative Performance -1.7%

In any case, I've shifted things around enough that I am reasonably satisfied with how I am currently positioned:

The best laid schemes of mice and men / often go awry. Still, I suspect that there's enough wiggle room in there to see me through to a doubling of NAV within two years. Being explicit about the risks, catalysts and price targets of the portfolio-as-a-whole is a useful exercise that I should have engaged in this time last year but didn't.

And I'm still holding too many names but I hope to reduce the number down to four or five within a few months.

Happy New Year.

EDIT (January 3): It has been suggested to me that the "tracking portfolio" page is not particularly illuminating, not least since it doesn't correspond to calendar years. I agree & I've adjusted it accordingly. Also, I've taken the opportunity to reduce the number of holdings by selling out of Republic and Alaska Comm Systems.