Limbach: 6x EBITDA, Huge Discount vs. Peers – 64% Near-Term Upside by Eric Gomberg, Dane Capital
- Direction: Long
- Timeframe: 1 – 12 months
- Expected Gain: 91%
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Limbach, a company with a 115-year operating history, trades at 6x EV/EBITDA, a 3+ EBITDA turns discount to its sector. Peer multiples imply a share price of $15, 64% upside.
The company expects revenue and EBITDA to grow 20%+ and 30%+, respectively, in 2016, and has excellent visibility for substantial growth in 2017. It also has double-digit FCF yield.
Accretive bolt-on M&A at 3-5x EBITDA and new service offerings, in MEP, can further accelerate growth. Near-term catalysts should drive shares higher.
We recognize reasons for the mispricing: micro-cap, public via SPAC, no coverage, bulletin board. There’s a logical reason they pursued a SPAC and the sponsors have a strong track record.
This is a durable, asset-light business, with a top-flight CEO who previously ran Bovis, a $3bn+ general contractor. We expect shares to trade higher over the next several quarters.
We believe that Limbach (OTCQB:LMBH) is a company whose price is detached from its business fundamentals. The company provides a single source for the design, installation, service, maintenance, repair, retrofit, and energy efficient optimization of nonresidential mechanical and HVAC systems.
Its peer group trades at 8x-10x CY16 EV/EBITDA, with a mean of 9.1x, while Limbach trades at just 6x, despite growth at, or above, peers, a diversified, top-tier customer base, terrific growth visibility into 2017 (and likely sustainable beyond), and an asset-light business model. At a peer multiple, Limbach would trade at $15-64% upside. At the high end of peers, shares would approach $18, almost a double from current prices.
We expect shares to quickly move to fair value, with multiple near-term catalysts that we discuss at length below. We expect revenue to increase from $331 million in 2015 to $410 million in 2016, ~23% y/y growth, and EBITDA to increase from $13 million in 2015 to $17 million in 2016, 31% y/y growth (per management’s recently increased guidance), and to $22 million in 2017, 29% y/y growth. We expect at least $7 million of free cash flow for 2016, implying a 13% FCF yield on equity (we expect excess free cash flow to pay down $13 million in high interest sub-debt). As of the end of March, 47% of budgeted revenue for 2017 was covered by bookings, considerably ahead of the typical 66% coverage seen in November/December. Clearly, 2017 looks great. In sum, this is a stock that is cheap on absolute and relative terms, has a diversified, tier-1 customer base (more on that below), and if it were trading at $15 instead of $9, we don’t think anyone would blink (or be inclined to short it). This is a highly asymmetric opportunity, with little risk of the company missing near-term numbers, many potential incremental buyers of this essentially unknown company (in public markets, not in their industry), and the potential for outsized returns.
To be clear at the outset, this is not your typical bulletin-board listed micro-cap stock (it has been trading several hundred thousand dollars of stock in recent days, so it is buyable, as are its warrants TSFCW). What we think makes Limbach unique, particularly for a bulletin-board listed security is:
- 115-year operating history.
- World class customer base that includes: Abbott Labs (NYSE:ABT), Amgen (NASDAQ:AMGN), Disney (NYSE:DIS), Honda (NYSE:HMC), Hospital Corporation of America (NYSE:HCA), University of Michigan, Tyco (NYSE:TYC) and numerous others.
- No noteworthy customer concentration.
- 14 offices nationally, with no geographic concentration.
- Enough scale to pursue, and benefit from, accretive M&A (at 3x-5x EBITDA).
- High insider ownership – by our calculations, approximately 80% of shares outstanding (possibly more) – with significant lock-ups.
- Insider buying – in recent weeks Limbach Director Gordon Pratt purchased 100,000 warrants in the open market, in multiple transactions.
- Excellent visibility. Projects are booked well in advance of construction activity. TFSC had 47% backlog coverage for 2017, as of the end of 1Q 2016. The company typically has 66% of following year’s budget booked by November/December.
- Exceptional leadership team. The company’s CEO is Charlie Bacon who, since college 33 years ago, has worked for just 2 companies, Bovis (acquired by Lendlease), where he became CEO of North and South America, which generated over $3bn in annual revenue, and Limbach since 2004.
- Low capital intensity at approximately 1% of revenue – likely $3-$4 million in 2016.
- Why this opportunity exists
- Company background
- Why the SPAC route
- Industry background
- Risk factors
Why this opportunity exists
With any investment we ask ourselves: why does this opportunity exist? What do we believe we understand that the market or the counterparty selling us shares does not. Sometimes these answers are not obvious. In the case of Limbach, we feel they are very clear. We think several of these issues will quickly go away, and expect shares to rapidly trade to fair value, and, given the company’s growth trajectory, towards the high-end of comps.
- Limbach is a micro-cap security with a $55 million market cap making it interesting to only a small number of institutional investors. We expect shares to move significantly higher – a doubling (or more) in 12 months is reasonable in our view. With a move higher, there could be an exercise of several million warrants (dilution is accounted for in our valuation, and strike prices vary from $11.50-$15.00). In addition, we’d anticipate M&A over the next 12 months, which could also increase the share count. In aggregate, with share price appreciation (we like), and increased share count (we don’t like, but is factored into our projections) this could easily be a $150-$200 million equity value security, which would mean that it’s still a smallish small-cap, but one that’s ownable by a wide swath of institutions that focus on small caps, and garner inclusion in various Russell indices.
- Limbach is currently listed on the OTC bulletin board. We, like many institutional investors, typically don’t touch bulletin board stocks with a 10-foot pole – too many have dubious stories. However, in this case we are comfortable because 1) we have no doubt this is a legitimate company and 2) it should be uplisted to NASDAQ in 60-90 days. Limbach simply doesn’t meet the 300 shareholder requirement at the moment. Taking the contrarian view, we think it’s an opportunity to buy a high-quality, but bulletin board listed security ahead of an uplisting, which could potentially be a catalyst to take shares higher.
- Limbach has no research coverage. We note that on May 6, 2016 Craig-Hallum was engagedas non-exclusive financial advisor to the company. That, of course, does not require Craig-Hallum to pick up coverage, but it certainly would make sense. In fact, given the strong growth story, well-defined industry sector, and M&A story (potentially of interest to investment banks), it would make sense that many analysts would pick up coverage or invite the company to their conferences, non-deal road shows, etc.
4a. Limbach came public via a SPAC (Special Purpose Acquisition Company or “blank check” company). Despite the many SPACs that have been formed over the past few years, they still have a fairly awful reputation among most investors – their day 1 funding likely reflects the fact that day 1 SPAC investors are guaranteed all of their money back. This reputation appears well deserved: data shows that SPACs, on average, have underperformed the market (keep in mind, on average). There is something of an inherent conflict of interest (cited in every SPAC prospectus) between a SPAC sponsor and investors. If a SPAC is completed, the sponsor receives a meaningful promote with founder’s shares and warrants. If the SPAC fails to get completed, the sponsor will be out several million dollars for fees. The motivation to complete a SPAC is significant.
When we mention SPACs to our investor friends at other funds, most of them have no interest in discussing the specifics of the SPAC and learning anything about the potential opportunity. This is part of the reason we look at them. There is a large portion of the market that seems to dismiss them out of hand. While there clearly are many SPACs that have performed poorly, there are others like Blue Bird (NASDAQ:BLBD) sponsored by Dan Hennessy and his team, which has traded well, Del Taco (NASDAQ:TACO), which is up only modestly, but has meaningfully, relatively outperformed Mexican concepts like Chipotle (NYSE:CMG) and El Pollo Loco (NASDAQ:LOCO), and Lindblad (NASDAQ:LIND), which is down $0.08 over the past year, but we continue to believe is a terrific, enduring brand (itself 37 year old) that will ultimately create significant shareholder value. Iconic Hostess (with its Twinkies, and without burdensome union contracts) is set to merge with Gores Holdings (GRSH) – a transaction that looks highly probably to close, and relatively attractive in our view. (For those who would ask, we believe AgroFresh (NASDAQ:AGFS), whose stock to date has performed poorly, will be ultimately proved a solid investment, and we remain long). The bottom line is that with SPACs you have to be careful, but there are winners and losers, and we’re highly convicted that Limbach will be a big winner.
Notably, the principals of Limbach’s sponsor, previously sponsored a SPAC which merged into United Insurance Holdings Corp. (NASDAQ:UIHC), which has achieved positive performance since its public inception 9 years ago, more than doubling in price and distributing consistent dividends – by our calculations providing a steady, if not spectacular, 10%+ IRR over that period. We expect far bigger things from Limbach.
We also note, that in the E&C space, Primoris (NASDAQ:PRIM) came public via a SPAC in 2008. Primoris has seen its value per share, including dividends, triple. A tripling in value over 8 years is an outcome with which we’re comfortable. We note, that Limbach cites Primoris’ success in its presentation. In speaking with Limbach CEO Charlie Bacon, he disclosed that years ago, he spent significant time with the team that ultimately merged with Primoris – while Limbach didn’t consummate a merger with those sponsors, it made Mr. Bacon comfortable with, and open to, the SPAC process.
4b. According to our analysis, since the Limbach SPAC’s completion, there has been some forced/indiscriminate selling of both shares and warrants. We will discuss the share structure of the SPAC at greater length below – broadly, they’re essentially as favorable as any that we’ve seen.
We think the forced/indiscriminate selling is coming from rights holders of Limbach. In its IPO, Limbach sold units comprised of a share of stock, a 1/2 warrant with a 5-year duration from the close of a transaction with a strike price of $11.50, and a right worth 1/10 of a share. The warrants and rights had been freely tradeable since the initial SPAC was consummated. The warrants remain freely tradeable, while the rights, which last traded at $0.54 prior to the close of the transaction, have been converted to shares.
We believe the 4.6 million rights converted to 460,000 shares, and since the SPAC’s close, many are being sold at a profit versus the last right’s trade of $0.54 – given the stock is above $9 (we think that also explains some of the sloppy selling in the high $6s and $7s). We believe that when this “inventory” of stock (from former, disinterested rights holders) is cleared, we will see a parabolic move higher in shares (if not parabolic, at least to a level in-line with peers). As we discuss below, we believe that other than these shares, shares are held by 1) locked up insiders (80%+ of shares) and 2) fundamental investors like ourselves. We think it’s a pretty tight float and shares could, and should, quickly move to fair value.
We also note that there are 4.6 million warrants (two are required to buy shares at $11.50), of which we believe many may remain in the hands of day 1 LMBH investors (a.k.a relatively disinterested parties). Based on our calculations, they are $0.15-$0.20 (20-25%) undervalued at LMBH’s current stock price, and a very interesting investment. We believe that if TSFC shares move higher, LMBHW warrants may remain mispriced for a somewhat longer duration, until warrant “inventory” is cleared, given the larger number of freely tradeable warrants. Our fund is expressing its view through holdings of both stock and warrants.
There are many reasons this opportunity exists. We think the opportunity will not persist, and shares (and warrants) will quickly move to fair value.
Limbach provides a single source for the design, installation, service, maintenance, repair, retrofit, and energy efficient optimization of nonresidential mechanical and HVAC systems. Its most recent investor deck can be found here. It was founded in 1901, is the 12th largest mechanical systems solutions firm in the US, and expects revenues to exceed $400 million in 2016. There are just 300 companies listed on the NYSE or NASDAQ that were founded 100 or more years ago. We are not aware of others listed on the bulletin board.
The company provides design and engineering services for non-residential tier-1 HVAC customers across the healthcare, entertainment, education, transportation, hospitality and government sectors.
The below slide gives a sense of some of the current ongoing projects:
For more visuals of historic or ongoing work, one can go to Limbach’swebsite.
Its customer base is a cross-section of tier-1 customers.
We believe that Limbach wins its business based on quality, reliability and service. Based on our conversation with Limbach’s CEO Charlie Bacon, they are not the low cost provider, although given their reliability, they may have the lowest cost of ownership. Regardless, our checks and many contacts in the real estate development industry suggest that reliability and long-term relationships are a key driver in the selection process for major contracting.
Over the past several years, Limbach has seen an increasing amount of maintenance revenue. Even when the company has seen down years for total revenue, higher margin maintenance revenue has increased, with pull-through of additional business.
Currently, the company’s business is extremely strong. In 1Q, revenue increased 25% y/y while Adjusted EBITDA grew 39%. At the end of 1Q, 47% of 2017’s revenue budget was already covered, versus typical 66% in the November/December timeframe. We believe a positive update on this figure when the company reports 2Q in mid-August should provide a positive catalyst for shares.
Perhaps most impressive, is that despite the exceptional 1Q revenue growth, backlog growth is meaningfully accelerating. In 4Q 2015, backlog was up 14.9% y/y. In 1Q 2016, it was up 6.2% sequentially (it was up in what is frequently a seasonally lower quarter) and it was up 35.6% y/y –meaningfully outpacing the company’s significant revenue growth.
We’ve had the opportunity to speak with Limbach CEO Charlie Bacon at some length. We believe he’s a very Wall Street ready CEO. He started from the ground up at Bovis before becoming a member of the Executive Committee and serving as CEO of the Americas where he was responsible for over $3bn of annual revenue. Since leaving Bovis, he’s been at Limbach. We believe he’s established a deep bench at Limbach to grow the company similarly to how he grew Bovis, and has the ability to take Limbach to the next level.
According to our conversations with Mr. Bacon, Limbach’s current potential pipeline is as robust as any time in the company’s history. Preceding the great recession, there were approximately $1.1-$1.2 billion in addressable bid opportunities whereas currently the figure approaches $1.9 billion. With the explosion in infrastructure build, educational facilities, high-end healthcare structures, entertainment complexes, airports, etc., the opportunities are abundant. We believe these are extremely good credits and in our view, whether US GDP grows 1% or 3% next year, the 7 projects that Limbach has in its pipeline with Disney will go forward and be fully funded. In fact, Mr. Bacon stated to us, that there have only been 3 full blown cancellations of note in his tenure at the company. That’s not to say all business has been good business. Change orders can cause cost over-runs, and they have occasionally had money losing projects. One notable current large sporting complex is being done on a cost-plus basis, which reflects the company’s conservative business philosophy. That said, should Limbach come in under budget, it will receive a bonus based on the savings.
We believe Limbach has additive growth opportunities. Specifically, the company is looking to enter adjacent areas such as electrical and fire protection. It has done a successful electrical pilot in the mid-Atlantic and is likely to grow this business in high-growth regions such as Texas, the Carolinas and others. We expect the company to take a judicious approach to its growth, and pursue both organic and inorganic growth opportunities, although management has been clear that they will be prudent and will also be thoughtful in pursuing only accretive acquisitions. We believe the private market provides opportunities in the 3x-5x EBITDA multiple range. Notably, for Limbach, they are small enough that a relatively small acquisition can be meaningfully, positively impactful to numbers – and they have a management that has experience running a far larger business.
Why the SPAC route
We recognize that SPACs are not well-loved by Wall Street. In this case, we think the Limbach SPAC makes more sense than most – perhaps, more than any we’ve seen.
Limbach was the last remaining company in the FdG Private Equity Fund, in its 14th year in the fund. Charlie Bacon had been CEO of Bovis or Limbach for 18 years and was not interested in selling to a larger player. Mr. Bacon also had engaged with the sponsor that ultimately acquired Primoris and has observed their success as a public E&C SPAC. Mr. Bacon has the confidence that he can independently build Limbach to a $1 billion annual revenue company, and public currency would help in that goal.
If we look back to January, the stock market was messy for IPOs – it’s still not terrific – and particularly for micro-cap IPOs. This path provided some immediate liquidity for FdG, a longer-term path to liquidity with potential upside, and currency for Limbach to grow. At the end of the day, success will come down to execution, but it strikes us as a very reasonable rationale to pursue a SPAC versus other alternatives.
Brief industry background
Since there is an abundance of sell-side research, write-ups on this site, and publicly available information on construction, we are going to keep this section brief. This year is expected to be the strongest year for US non-residential construction since 2008, with revenue in excess of $480 billion.
Non-residential building activity is anticipated to grow at a 6% CAGR for the remainder of the decade.
With interests rates likely to remain contained for some time to come, we anticipate building activity to remain relatively robust. Moreover, as we stated previously, we believe other than a repeat of the great recession, most of Limbach’s customers are highly unlikely to cancel major development projects. Further, one could certainly hedge a long position in Limbach against a peer enjoying a far higher multiple. If there is a sea change in the industry’s outlook, we’d suspect Limbach’s peers will be equally impacted.
Limbach is something of an unusual SPAC for several reasons, which we believe should positively impact the company’s valuation. First, upon the original IPO of TFSC, 4.6 million warrants were issued, but unlike many other SPAC IPOs, the warrants were for half a share. Like most other SPACs, the warrants have a 5-year term (from the time of consummation of a merger) and an $11.50 strike price; however, instead of 4.6 million shares possibly eventually being added to the share count, there are just 2.3 million (and of course, buy-in is at $11.50). Second, the warrants given to the Sponsors, 1347 Capital, are at $12.50 and $15.00 versus the typical SPAC where sponsors receive warrants at $11.50. The impact is that using the treasury method for calculating share count, there is relatively de minimus dilution until shares reach the upper teens.
There are currently 5.93 million shares outstanding – at $13 per share, that figure is 10% higher, at $15, it is 20% higher.
At current prices, shares trade for 6x EV/EBITDA. At a 9.1x, accounting for the increase in share count, shares would trade at $15. We believe the company will likely grow faster than peers over the next 12-24 months, in which case, we think shares could easily be $20+, even accounting for higher share count due to warrant exercises.
For reference, the comps which we have used in our analysis include AECOM (NYSE:ACM), Comfort Systems (NYSE:FIX), EMCOR Group (NYSE:EME) who incidentally reported a very strong quarter last week, NV5 Global (NASDAQ:NVEE), and Stantec (NYSE:STN).
Notably, there is higher-than-typical insider ownership. Limbach’s historic owner, private equity fund FdG now owns 1.74 million shares and while the SPAC sponsor 1347 Investors owns 2.56 million shares, representing 4.3 million shares. Limbach’s CEO Charlie Bacon owns 218 thousand shares and Limbach Management Holding Company owns 109 thousand shares. In sum, we believe there may, at most, be just over 1 million freely tradeable shares – suggesting 80%+ are tightly held and subject to lock-up.
According to our understanding of the lock-up agreement, FdG can sell up to 50% of its holdings if the stock exceeds $12.50 for 20 days in a 30-day period, with the remaining 50% required to be held for a year. We believe 1347 is locked up for a year, although our sense in speaking to its management is that they are in this for the long haul. Certainly, 1347 President and CEO (and now Limbach Director) Gordon Pratt’s open market purchases of warrants would suggest a distinctly positive view in the company’s future. Clearly, this in a significant insider ownership base and one which is exceptionally aligned with independent shareholders. Moreover, for them to achieve a windfall on their warrant positions, shares will have to go dramatically higher.
An investment in Limbach comes with numerous risks.
The company is bulletin board listed, and despite our expectations of an uplisting and coverage, that might not come to fruition.
Limbach is tied to ongoing building activity. Should interest rates change or general economic activity slow, they would undoubtedly be impacted. We believe this can largely be hedged by shorting more highly priced competitors facing similar economic conditions.
At inception, Limbach will have almost $40 million in debt at a blended rate in the high-single digits. We believe its interest coverage is more than adequate and there will be significant opportunities for debt paydown, including via cash flow and cash generated from warrant exercises, as well as refinancing opportunities. That said, a sharp turn in the economy could create risk of financial distress.
We believe Limbach is an extremely mispriced security. We expect strong performance to drive the stock higher. This has proved a durable business over decades and numerous business cycles. We expect that as Charlie Bacon gets in front of investors and they learn the Limbach story, institutions will get involved in the stock. Further, we believe growth via accretive M&A will bring additional attention to the company.
We believe shares are likely to quickly move to fair value, which we see as $15 in the short term. While one may make the argument that Limbach deserves a lower multiple because it’s small, it has top-tier customers and is geographically, end-market, and customer diversified – and is growing faster than most peers.
We also note that warrants on Limbach also trade, and may actually prove more liquid than the stock – they have had a tighter spread in recent trading sessions. They have a 5-year duration and a strike of $5.75 (that is you need 2 warrants to purchase a share for $11.50). At $15, by our calculations, a warrant should trade at $2.50-$3.00 and represent an interesting opportunity as well, given the relatively limited number of freely tradeable shares.
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Disclosure: I am/we are long AGFS, AGFSW, GRSHW, LIND, LINDW, LMBH, LMBHW.