Arnaud Ajdler, “Investing in Change”

by Travis Johnson, Stock Gumshoe | April 4, 2014 6:27 pm

These are my notes and instant reactions from a presentation at the Value Investing Congress, the notes below might contain errors, paraphrases, incorrect quotes, or misinterpretations.

Arnaud Ajdler runs a new special situations hedge fund called Engine Capital (he’s been at Crescendo for a decade and is an experienced activist investor, but moved to start this new fund), and is focused on companies that are going through change — looking for catalysts that will close the value gap. He think that improves your odds of avoiding value traps.

Different kinds of change: Proactive, where his firm is the activist investor trying to make them change; Anticipatory, seeing changed management incentives or changing trends or M&A likelihoods, or maybe other activist investors; Reactive, where the management is already changing or announcing changes but it hasn’t gotten into the stock price yet.

There is good opportunity now, because he says change is coming — companies are under pressure to unlock value and use their cash, there’s pent up demand from private equity, and the sentiment toward activist shareholders is much better now.

What kinds of changes does he look for?

Operational — sales growth, margin improvements, management change
Allocation — return of cash to shareholders, acquisition, capex changes
Capital Structure — refinancing, optimizing balance sheet
Strategy — Separating assets, spinoffs, sale of company or assets, changes in industry (consolidation, etc.)

They’ve been involved so far with Imvescor, Stewart (title insurance), Vitran, LSB Industries, Baker, FTD.com, Starteck, Entrec. Some still active, some have been sold or recently settled. They sometimes do it publicly to pressure companies, sometimes send private letters or communicate informally and get enough reaction that way.

They look for high free cash flow yield
They want multiple ways to win — margins too low, balance sheet lazy, conglomerate discount, takeout candidates, bad capital allocation.
And they want to understand up front what the mechanism of change iwll be.

Examples:

Hill International (HIL)
Global project management firm. 100 offices globally. Family run and 30% family owned, transitioning CEO from father to son.
Consulting revenue growth about 14% annualized since 2011 (including guidance of $575-600 million for this year). They have good visibility into next year’s revenue, and the backlog is around $1 billion at the beginning of 2014.

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Diversified globally, big presence in middle east. About half private/half government customers, but only less than 20% is US federal, state and local government clients.

Why does he like it? High quality business, high barriers to entry. Experience and reputation are more important than price — you don’t get hired to manage the building of an airport unless you’ve built a bunch of airports.

It’s one of the few companies in the sector that’s not tied to a construction firm (they use the “agency” model vs. the “contractor” model). Capex is low, but working capital requirements are high, and they generate a high return on capital.

Revenue growth is fast, and leverage means that revenue growth leads to bottom line growth.

Enterprise value at $5.40 is about $312 million, revenue was up more than 20% last year and margin miproved substantially. Growth should be 15% in 2014, so they’re trading at about 6X next year’s EBITDA. Looks good even if you assume growth trails off to about 5% in 2016.

Peers are Stantec, WSP Global, Arcadis, WS Atkins, Tetra Tech, they trade at 20-40% higher valuations of 10-13X 2014 EBITDA and are not growing any faster than Hill.

Why is it cheep? Most of those peers aren’t US companies or US-traded, so analysts compare it to consulting firms (FTI, Navigant, Huron) or Engineering and Consulting firms (Jacobs Engineering, URS, Emcor, Aecom), not the global project management firms.

And they have an issue in Libya. They have receivables of about $50 million in Libya that hasn’t been paid. They’re considering new Libya work, if they go back they’ll be paid some of their receivables (other companies have gone back, too, and been paid, and HIL has gotten a small amount of the receivable already). That’s in the process of being resolved, shouldn’t be important in a year.

But because they didn’t get paid by Libya, they broke the lending covenants on their debt in 2012. They had to refinance with expensive debt which is now choking the company. The company has hinted that they’re trying to refinance, which would be a major catalyst perhaps this year — because of the debt pressure, the company has been very focused on operations and cost cutting, which is good too.

So part of that is that they’re somewhat overlevered now — not terrible. They think the payment from Libya, refinancing of debt, and deleveraging as EBITDA grows will give them a better multiple and market will look at their growing numbers, he thinks the likely potential value range of about $8.50-$11. They are currently trading a the low end of their historical valuation range.

Free cash flow projectiosn also get to a $8-10 share price (at 8-12X multiple of free cash flow) in the next year or two, so that’s two ways to get returns of perhaps 80%.

Negatives: They aren’t going to be sold because of family control; they talk to much about growth through acquisitions, the leverage is high though that’s also an opportunity; and the insiders are selling some of their stock to fund their lifestyle

How does he generate ideas?

Look for 13Ds from strategic buyers or private equity (not just hedge funds, but people who might buy the whole thing). Often there’s a long delay from the 13D to the acquisition at a big premium.
Look for companies that are delaying their annual meetings — or shareholders pressuring them to have the annual meeting that had been ignored or delayed.


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