Global Power (GLPW, Financial) is a post reorg equity whose predecessor went into bankruptcy due to accounting irregularities. The structural rather than economic nature of the bankruptcy means that the business is good but the market’s perception of it is bad. As a result, a discrepancy exists between the price and value. GLPW has brought in new management, relisted on the NASDAQ, shed a loss-making unit, and has been growing and profitable. With cash piling up on the balance and attractive growth prospects, investor awareness should increase and the price should catch up to the value.
The company declared bankruptcy way back in 2006 and emerged at the start of 2008 and relisted in 2010. The bankruptcy was a result of a failure in internal accounting controls that resulted from acquiring a Chinese company. The company boasts many of the characteristics that portend the strong performance of companies upon emergence from bankruptcy: a non-economic reason for bankruptcy, a new senior management with an ownership stake in the company, a net cash and almost debt-free balance sheet, and a business revitalized from the waning stigma of its bankruptcy.
The business is divided in two segments: services and products. The services division was acquired in 2005 as a way to offset the cyclicality of the products division. The services division focuses mainly on maintenance and construction services at nuclear power plants within the United States. The business is split between recurring revenue and multiyear projects and requires little capital. The products division focuses mainly on gas turbine parts and heat recover steam generators to a small extent. The company outsources a large part of its manufacturing in order to focus on design, marketing, and relationships. Their products are custom made with past customers including Exxon, GE, Mitsubishi, and Southern Electric. This business line requires little capital as well. Both businesses possess attractive characteristics that make GLPW a desirable investment candidate, assuming the price is right.
Management was replaced during the bankruptcy process with people who have experience in the sector. Management and directors own 670,831 shares at current value of $14.7m or 4% of the company. They are compensated with RSUs and stock options that are well in the money currently. The new CEO was formerly the President and COO of McDermott International.
Services - This segment does maintenance and construction at nuclear plants in the US. They have a presence at 55% of nuclear facilities in the US. The US nuclear fleet is aging and their lives have been extended from 40 to 60 years. Stretching their life is going to require exactly the kind of work that this division provides and they are well positioned to get the contracts. They already have multiyear contracts in place for certain projects and have a growing backlog for their services. Management claims the normalized net margin on this business is around 10%-13%. Margins have been trending up, but 10% seems a little high or still further down the road, unless the full year report records more additional profit than revenue. The first 9 months of 2010 had 7.2% net profit margins, up from 2.7% in 2009 and a modest gain and loss in 2008 and 2007, respectively. The service contracts are structured as cost-plus and GLPW should have additional leverage in discussions as the bankruptcy stigma diminishes.
The services segment will benefit from strong tailwinds in the nuclear industry. The nuclear fleet operating in the US has been in operation for an average of 30 years. The expected life of these plants was 40 years, but the Nuclear Regulatory Commission in the government has extended many of their lives to 60 years. As if they weren’t already old, they will now be allowed to operate further into their operational lifetime. As with any machinery, the older it gets the more maintenance it will require. GLPW has been involved in increasing security features at plants, valve services, insulation, and other forms of maintenance. The industry dynamics present a huge opportunity for Global Power, which has an excellent safety record performing maintenance at nuclear plants around the US. Furthermore the maintenance sector for nuclear plants is fragmented and their net cash position and stated desire to acquire smaller businesses in the sector should boost earnings if done at appropriate valuations.
Management anticipates flat to mid-single digit declines in the service segment due to the completion of a $170m contract. There is about $225m in service contracts in the backlog, but service revenue for the first 9 months so far has been $287m and was $347m in 2009, $245m in 2008, and $195m in 2007. As the large contract about to be completed demonstrates, the business can be lumpy. The overall trend of the past few years has been one of growth, and the aging of nuclear facilities substantiates this. Management has cited the numerous contracts that are coming up for bidding as well as projecting higher normalized margins than are currently being achieved, which bodes well for the business. Management has stated a desire to acquire some engineering capabilities for this segment to broaden the type of work it would be capable of performing and leveraging their current relationships. This is a reasonable development and extension of the company assuming it is done at the right price.
Products – This segment primarily makes products used in gas turbine power plants (>90% of segment revenue) and heat recovery steam generators that are used in a variety of industrial processes such as pulp making and refineries. The HRSG product line is small and so discussion will focus on the natural gas turbine products. Orders are done on a fixed-price basis and so margins fluctuate more. The 10-K hit it on the head citing the benefits the product segments products offer: lower construction costs, shorter construction periods, lower CO2 emissions, rapid start-up and shutdown times. Natural gas is at low prices, even relative to coal currently, and the current supply-demand favors continued low gas prices. All the products are custom-designed and engineered in-house, while most of the manufacturing (70%-75%) is outsources. The segment is asset light and faces little technology risk.
The tailwind in this segment is long term in nature. The Department of Energy Annual Energy Outlook from December 2009 predicts that 46% of capacity additions in the power sector from 2008-2035 will come from natural gas. While predictions are usually not too great, the general idea that gas turbines have a huge tailwind is clear. As highlighted above, there are numerous inherent advantages to natural gas electricity production. At current prices, even without a carbon price, natural gas is even attractive relative to coal in certain areas of the world.
Earnings in this segment are cyclical as the products are part of greater capital spending projects. The largely variable cost business model leverages the company to the upside and protects it on the downside. In the first 9 months of 2010, this segment achieved 9.9% net margins compared to 4.7%, 10.5%, and 6.3% in 2009, 2008, and 2007 respectively. Sales have been lumpy and don’t follow a trend. The first 9 months of 2010 recorded $110m compared to $193m, $311m, and $208m in 2009, 2008, and 2007. Despite lower sales, higher margins were achieved YoY. When asked about this on the most 3Q 2010 conference call, the CEO or CFO attributed this the segment VP doing a better job with procurement and all around operationally. There is a lag between when these projects are planned and when they are built, explaining why 2008 was such a banner year for sales. This division is much closer to the trough than the peak of its earnings power. As financing becomes easier to get and projects are planned, demand for the products should pick up. The company already has $114m in product segment backlog as of Q3 2010, matching the sales of the first 9 months of 2010.
Valuation - The two distinct segments necessitate a sum-of-the-parts valuation. The company just announced that its term loan/revolver has been paid off. That leaves the company with a net cash position of around $60m. On the most recent conference call, the company stated it had about $10m in surety bond and at points over the past year that figure got into the high teens. For simplicity’s sake, excess cash will be considered $40m.
There aren’t many pure play companies in either of the fields these segments operate in. There is some overlap in construction firms out there or power equipment firms, but the product lines and services offered differ. The electrical equipment industry trades at an average of 23.5x earnings (TTM). The construction and engineering industry trades at an average of 26x earnings (TTM). GLPW is classified under the electrical equipment industry, but most of its business and profit is currently coming from the construction and engineering segment (that is how the services segment would be broadly defined).
The company has 16,388,351 fully diluted shares outstanding and currently trades at $22/share for a market capitalization of $360m. Net of excess cash, the enterprise value is $320m. The company has earned $32m ($36m if you include discontinued operations) in the past 9 months from continuing operations giving the company a current PE of 10.
The past 9 months are used for 2 reasons. First, there is no breakout of 2009 quarterly earnings by the company or in an SEC filing. Second a breakout of quarterly earnings in an S&P research report showed a sizeable loss in the 4th quarter of 2009 but profits in the first 3 quarters. The company was profitable on a full-year basis and there is nothing structural about the business that makes for a messy 4th quarter. For the full year of 2009, reorganization expenses declined considerably, interest expense moderately, and SG&A modestly. The company was more profitable in 2008 due to the delivery of products that had been ordered pre-Lehman. This back of the envelope valuation will assume a breakeven for the 4th quarter, but there seems to be enough of a margin of safety in the valuation for a surprise. Furthermore, it would be quite difficult to predict what a loss might look like for the upcoming quarter.
A super optimistic valuation might use the industry averages, but more modest multiples can be assumed for a base scenario. A multiple of 15x earnings for the services division and 10x for the products division values them at $300m and $100m respectively. The excess $40m in cash adds up to a valuation of $440m or $26.60 a share, a 20% gain from current prices. The service division receives a higher multiple because it requires very little investment, receives cost-plus agreements for work, and has a great growth runway in front of it. While the same might be said of the products division, it does face a little more commodity risk since it operates on fixed price contracts and is cyclical. Tinkering with the multiples will lead to a higher upside scenario.
More optimistic scenarios can be entertained due to the trough in capital spending, and the boost gas turbine construction should see in 2011 and 2012. The service division will naturally have more work to bid on as nuclear plants get older and require more services. Both segments should benefit from strong organic growth over the medium horizon and the stock price will reflect that. Additional earnings growth can be achieved through cash flow and current cash being utilized towards acquisitions.
Catalysts:
1) Additional service contracts
2) Greater analyst coverage
3) Smart acquisition
Risks:
1) A double dip recession/China collapse/Europe collapse could push out product division orders
2) Dumb acquisition (management does own 4% of the company which should prevent that)
3) Rising natural gas prices and/or no climate change initiatives
4) Nuclear plant operators decide to close down plants instead of maintain them for an additional 20 years (See Oytster Creek for a recent example, although it will still be in service for another 9 years).
Conclusion:
GLPW represents an attractive investment at current prices. The company is undervalued as a going concern and based on its future growth opportunities. Comparable companies trade at higher valuations and there is the prospect of substantially higher profits in the future. The company has a variable cost structure and debt free balance sheet that will help it weather whatever the economic future holds. A downside/base scenario values the company at a price 20% higher than current prices, although there is potential for much greater upside in the next 2-3 years.
The author is long GLPW. Do your own research before making investment decisions.
Other investment articles can be found on my blog:
http://frogskissvalue.blogspot.com/
The company declared bankruptcy way back in 2006 and emerged at the start of 2008 and relisted in 2010. The bankruptcy was a result of a failure in internal accounting controls that resulted from acquiring a Chinese company. The company boasts many of the characteristics that portend the strong performance of companies upon emergence from bankruptcy: a non-economic reason for bankruptcy, a new senior management with an ownership stake in the company, a net cash and almost debt-free balance sheet, and a business revitalized from the waning stigma of its bankruptcy.
The business is divided in two segments: services and products. The services division was acquired in 2005 as a way to offset the cyclicality of the products division. The services division focuses mainly on maintenance and construction services at nuclear power plants within the United States. The business is split between recurring revenue and multiyear projects and requires little capital. The products division focuses mainly on gas turbine parts and heat recover steam generators to a small extent. The company outsources a large part of its manufacturing in order to focus on design, marketing, and relationships. Their products are custom made with past customers including Exxon, GE, Mitsubishi, and Southern Electric. This business line requires little capital as well. Both businesses possess attractive characteristics that make GLPW a desirable investment candidate, assuming the price is right.
Management was replaced during the bankruptcy process with people who have experience in the sector. Management and directors own 670,831 shares at current value of $14.7m or 4% of the company. They are compensated with RSUs and stock options that are well in the money currently. The new CEO was formerly the President and COO of McDermott International.
Services - This segment does maintenance and construction at nuclear plants in the US. They have a presence at 55% of nuclear facilities in the US. The US nuclear fleet is aging and their lives have been extended from 40 to 60 years. Stretching their life is going to require exactly the kind of work that this division provides and they are well positioned to get the contracts. They already have multiyear contracts in place for certain projects and have a growing backlog for their services. Management claims the normalized net margin on this business is around 10%-13%. Margins have been trending up, but 10% seems a little high or still further down the road, unless the full year report records more additional profit than revenue. The first 9 months of 2010 had 7.2% net profit margins, up from 2.7% in 2009 and a modest gain and loss in 2008 and 2007, respectively. The service contracts are structured as cost-plus and GLPW should have additional leverage in discussions as the bankruptcy stigma diminishes.
The services segment will benefit from strong tailwinds in the nuclear industry. The nuclear fleet operating in the US has been in operation for an average of 30 years. The expected life of these plants was 40 years, but the Nuclear Regulatory Commission in the government has extended many of their lives to 60 years. As if they weren’t already old, they will now be allowed to operate further into their operational lifetime. As with any machinery, the older it gets the more maintenance it will require. GLPW has been involved in increasing security features at plants, valve services, insulation, and other forms of maintenance. The industry dynamics present a huge opportunity for Global Power, which has an excellent safety record performing maintenance at nuclear plants around the US. Furthermore the maintenance sector for nuclear plants is fragmented and their net cash position and stated desire to acquire smaller businesses in the sector should boost earnings if done at appropriate valuations.
Management anticipates flat to mid-single digit declines in the service segment due to the completion of a $170m contract. There is about $225m in service contracts in the backlog, but service revenue for the first 9 months so far has been $287m and was $347m in 2009, $245m in 2008, and $195m in 2007. As the large contract about to be completed demonstrates, the business can be lumpy. The overall trend of the past few years has been one of growth, and the aging of nuclear facilities substantiates this. Management has cited the numerous contracts that are coming up for bidding as well as projecting higher normalized margins than are currently being achieved, which bodes well for the business. Management has stated a desire to acquire some engineering capabilities for this segment to broaden the type of work it would be capable of performing and leveraging their current relationships. This is a reasonable development and extension of the company assuming it is done at the right price.
Products – This segment primarily makes products used in gas turbine power plants (>90% of segment revenue) and heat recovery steam generators that are used in a variety of industrial processes such as pulp making and refineries. The HRSG product line is small and so discussion will focus on the natural gas turbine products. Orders are done on a fixed-price basis and so margins fluctuate more. The 10-K hit it on the head citing the benefits the product segments products offer: lower construction costs, shorter construction periods, lower CO2 emissions, rapid start-up and shutdown times. Natural gas is at low prices, even relative to coal currently, and the current supply-demand favors continued low gas prices. All the products are custom-designed and engineered in-house, while most of the manufacturing (70%-75%) is outsources. The segment is asset light and faces little technology risk.
The tailwind in this segment is long term in nature. The Department of Energy Annual Energy Outlook from December 2009 predicts that 46% of capacity additions in the power sector from 2008-2035 will come from natural gas. While predictions are usually not too great, the general idea that gas turbines have a huge tailwind is clear. As highlighted above, there are numerous inherent advantages to natural gas electricity production. At current prices, even without a carbon price, natural gas is even attractive relative to coal in certain areas of the world.
Earnings in this segment are cyclical as the products are part of greater capital spending projects. The largely variable cost business model leverages the company to the upside and protects it on the downside. In the first 9 months of 2010, this segment achieved 9.9% net margins compared to 4.7%, 10.5%, and 6.3% in 2009, 2008, and 2007 respectively. Sales have been lumpy and don’t follow a trend. The first 9 months of 2010 recorded $110m compared to $193m, $311m, and $208m in 2009, 2008, and 2007. Despite lower sales, higher margins were achieved YoY. When asked about this on the most 3Q 2010 conference call, the CEO or CFO attributed this the segment VP doing a better job with procurement and all around operationally. There is a lag between when these projects are planned and when they are built, explaining why 2008 was such a banner year for sales. This division is much closer to the trough than the peak of its earnings power. As financing becomes easier to get and projects are planned, demand for the products should pick up. The company already has $114m in product segment backlog as of Q3 2010, matching the sales of the first 9 months of 2010.
Valuation - The two distinct segments necessitate a sum-of-the-parts valuation. The company just announced that its term loan/revolver has been paid off. That leaves the company with a net cash position of around $60m. On the most recent conference call, the company stated it had about $10m in surety bond and at points over the past year that figure got into the high teens. For simplicity’s sake, excess cash will be considered $40m.
There aren’t many pure play companies in either of the fields these segments operate in. There is some overlap in construction firms out there or power equipment firms, but the product lines and services offered differ. The electrical equipment industry trades at an average of 23.5x earnings (TTM). The construction and engineering industry trades at an average of 26x earnings (TTM). GLPW is classified under the electrical equipment industry, but most of its business and profit is currently coming from the construction and engineering segment (that is how the services segment would be broadly defined).
The company has 16,388,351 fully diluted shares outstanding and currently trades at $22/share for a market capitalization of $360m. Net of excess cash, the enterprise value is $320m. The company has earned $32m ($36m if you include discontinued operations) in the past 9 months from continuing operations giving the company a current PE of 10.
The past 9 months are used for 2 reasons. First, there is no breakout of 2009 quarterly earnings by the company or in an SEC filing. Second a breakout of quarterly earnings in an S&P research report showed a sizeable loss in the 4th quarter of 2009 but profits in the first 3 quarters. The company was profitable on a full-year basis and there is nothing structural about the business that makes for a messy 4th quarter. For the full year of 2009, reorganization expenses declined considerably, interest expense moderately, and SG&A modestly. The company was more profitable in 2008 due to the delivery of products that had been ordered pre-Lehman. This back of the envelope valuation will assume a breakeven for the 4th quarter, but there seems to be enough of a margin of safety in the valuation for a surprise. Furthermore, it would be quite difficult to predict what a loss might look like for the upcoming quarter.
A super optimistic valuation might use the industry averages, but more modest multiples can be assumed for a base scenario. A multiple of 15x earnings for the services division and 10x for the products division values them at $300m and $100m respectively. The excess $40m in cash adds up to a valuation of $440m or $26.60 a share, a 20% gain from current prices. The service division receives a higher multiple because it requires very little investment, receives cost-plus agreements for work, and has a great growth runway in front of it. While the same might be said of the products division, it does face a little more commodity risk since it operates on fixed price contracts and is cyclical. Tinkering with the multiples will lead to a higher upside scenario.
More optimistic scenarios can be entertained due to the trough in capital spending, and the boost gas turbine construction should see in 2011 and 2012. The service division will naturally have more work to bid on as nuclear plants get older and require more services. Both segments should benefit from strong organic growth over the medium horizon and the stock price will reflect that. Additional earnings growth can be achieved through cash flow and current cash being utilized towards acquisitions.
Catalysts:
1) Additional service contracts
2) Greater analyst coverage
3) Smart acquisition
Risks:
1) A double dip recession/China collapse/Europe collapse could push out product division orders
2) Dumb acquisition (management does own 4% of the company which should prevent that)
3) Rising natural gas prices and/or no climate change initiatives
4) Nuclear plant operators decide to close down plants instead of maintain them for an additional 20 years (See Oytster Creek for a recent example, although it will still be in service for another 9 years).
Conclusion:
GLPW represents an attractive investment at current prices. The company is undervalued as a going concern and based on its future growth opportunities. Comparable companies trade at higher valuations and there is the prospect of substantially higher profits in the future. The company has a variable cost structure and debt free balance sheet that will help it weather whatever the economic future holds. A downside/base scenario values the company at a price 20% higher than current prices, although there is potential for much greater upside in the next 2-3 years.
The author is long GLPW. Do your own research before making investment decisions.
Other investment articles can be found on my blog:
http://frogskissvalue.blogspot.com/
