Spruce Point issues “strong sell” investment opinion on CECO Environmental (Nasdaq:CECE): sees 30% – 60% downside potential

Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving CECO Environmenta Corp. (Nasdaq: CECE, “CECO” or “the Company”), a poorly constructed roll-up in the environmental control, energy, fluid handling and filtration industrial segments. We have conducted an extensive fundamental and forensic accounting review, and believe the 83% appreciation in CECO’s share price in 2016 is unwarranted given the change in the environmental regulation regime under the Trump administration, and the likelihood of a significant goodwill impairment, covenant breach and heightened balance sheet risk in 2017. As a result, we have a “Strong Sell” opinion and a price target of $4.85 – $9.00 per share, or approximately 30% to 60% downside.

Executive Summary

Spruce Point is Short CECO Environmental For the Following Reasons:

Spruce Point is short CECO Environmental (Nasdaq: CECE, “CECO” or “the Company”), a poorly constructed roll-up serving the environmental, energy, fluid handling and filtration industrial segments. Based on our forensic financial analysis, insider behavior, and anticipated changes in the regulatory environment driving its business, we believe CECO is at high risk of a covenant breach in 2017. We urge investors to consider the following when evaluating CECO:

  • CECO has acquired 7 companies since 2013 at the expense of punitive dilution, and mounting leverage on its balance sheet. With 55% of its assets as goodwill and intangibles, we believe CECO is forestalling a crippling goodwill impairment of Met-Pro, its largest acquisition, and a deal it touted as a “success.” CECO’s shares appreciated 83% in 2016 on the false perception that its recent PMFG acquisition has also been a winner. However, we believe CECO pulled forward cash flow through rapid synergy realization and working capital maneuvers to pay down debt ahead of schedule. However, recent performance suggests that both CECO and PMFG are now declining organically by double digits, and management stopped disclosing key contribution metrics
  • We thank Street Watchdog Research’s recent note alerting us to CECO and the fact that its single most important business driver is a stringent environmental regulation regime that drives its clients to comply with issues such as air pollution control. With the election of President Trump, and his new Executive Order designed to expedite environmental reviews and eliminate burdensome environmental compliance issues, CECO’s future is at best uncertain, and at worst materially impaired. Not surprisingly, the same day of the Executive Order, the Company’s CEO abruptly resigned, but not before cashing in options, and leaving unexpired RSUs tied to 2017 EBITDA. Based on our research, we found other key executive departures at CECO, particularly in Asia, where it touts a large and growing opportunity to gain market share
  • The Company’s CFO also left his position prior to the CEO’s departure. We are concerned that CECO recently appointed its 5th CFO since 2011. Pay close attention to new language about material weaknesses of financial controls in the recent 10-K. Specifically, the Company cited issues with accounting for revenues. This should be a big red flag to investors, particularly because CECO uses the “percentage-of-completion” method of accounting, which is notoriously abused and a focus of SEC investigations according to a recent speech from the enforcement director
  • CECO’s governance is weak and should give investors’ cause for concern. The current Chairman is the son of the former CEO Phillip DeZwirek, who settled with the SEC for insider trading, without admitting guilt. The rest of the Board is stacked with allies of the DeZwirek family, and many have questionable backgrounds that offer little relevant experience to CECO’s core businesses. The Board has shown a willingness to pay management cash bonuses for completing bad deals, and rubber stamping annual cash bonuses for failure to hit financial targets

We See 30% – 60% Downside As Covenant Breach Comes Into Focus:

  • CECO has been touting to investors that it has been successful in delevering its balance sheet post-PMG acquisition, and that its current Net Debt to EBITDA ratio is down from 3.6x to 1.6x as of 9/30/16. On the surface, this appears impressive, but the picture is not so simple. CECO should be pointing investors to is “Leverage Ratio” covenant per its credit agreement which looks at gross leverage (not net of cash) and includes significantly more debt obligations beyond just its term loan. When factoring in CECO’s earnout obligations, leases, and outstanding letters of credit, we find that its current leverage is closer to 3.4x
  • CECO has no room for misstep in 2017 given its Leverage Ratio covenants will tighten twice, from 3.5x to 3.25x in September, and finally to 3.0x in December. Based on our analysis, at CECO’s current LTM EBITDA of $56.5m, it will most certainly trip a covenant absent material improvement in EBITDA or a dilutive equity raise. CECO has also said it has no additional assets of materiality to sell to accelerate the deleveraging process. In short, the Company is stuck between a rock and hard place
  • Optically, CECO’s share price looks cheap, and analyst’s argue that its valuation discount to peers will narrow, while its organic growth accelerates and its margins improve. The average analyst price target is $13.40/share, implying 7% upside. This is wishful thinking, and represents a terrible risk/reward. Don’t be fooled: there is no visibility in CECO’s business, it has suffered significant executive turnover, and its #1 risk factor just materialized. The easiest way to value CECO is on a book value basis. We expect a goodwill impairment to eliminate $79m of equity. By adjusting the book value and applying a generous 1.0x – 1.5x multiple, we get $4.85 to $7.25 per share or 40% – 60% downside. We also conservatively estimate sales declines of 8% – 12%, which at 1.0x to 1.2x multiple (in line with its small cap peers) and using our adjusted debt gets us a valuation range of approximately $6.25 to $9.00 per share or 30% – 50% downside
  • Follow the money: The CEO just exercised options and dumped shares prior to resigning, and as a reminder, left on the table restricted stock units (RSUs) specifically tied to 2017 EBITDA, a critical target necessary to avoid a covenant breach. CECO’s Chairman and largest shareholder just altered the terms of his large warrant to allow for “cashless exercise” – a way to avoid tying up capital in the stock, and using stock sales to fund the warrant exercise. The remaining executive team owns virtually no equity, and has little at stake if CECO fails

CECO’s Stock Appreciation Merits Scrutiny In The Face Of Multiple Red Flags


CECO’s Poorly Executed Acquisition Spree and Deal Promotion

CECO Is A Motley Collection of Speculative Acquisitions


CECO’s Business Under Pressure


CECO Promotes Its Met-Pro Deal As A “Success Story”…


But In Reality…CECO Appears To Be Forestalling A Large Goodwill Impairment At Met-Pro

In our opinion, CECO has realigned its business segments (2014) and altered its goodwill testing methodology (2015)

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