Babcock & Wilcox: Largest Shareholder Switches to 13D

(Full Version of this article published on 10/1/17 for OA Subscribers):

In my April Newsletter, I had highlighted this stock – it was, back then, trading at ~$9.  I had stated “I am a firm believer of the “cockroach theory of investing” which says that if you see a problem appear at a company, you will likely see a few more follow it.”  There is no such thing as a single cockroach in the kitchen.. my beloved Cockroach Theory almost never fails to deliver and so it did.

stock chart

Let’s take a fresh look then?

BW is a stub from the July-2015 spin-off of BWX Technologies (Ticker: BWXT).  Since the spin, BW stock has performed atrociously due to operational missteps and then the bottom fell off in August 2017 when the company announced Q2 results and along with it a financing deal with a fund.   These are hardly reasons for me be interested and look closely at a situation but then I noticed that Vintage Capital, an activist fund, has taken a 15% position in the stock and that caught my attention.

BW has three operating segments.  Power Segment is 52% of revenues, sells aftermarket parts and services to utilities and 70% of its revenues are from coal-fired power-gen sector.  Industrial segment is 26% of revenues, produces and sells environmental, cooling and steam generation systems.  Renewables Segment is 22% of revenues and sells products to waste-to-energy and biomass power generation market.  Geographic revenue breakdown is North America 56%, Europe 24% and Asia and Other 20%.  Sales of aftermarket parts and services account for 54% of total revenues and Products 46%.

 

Here is some financial data since the spin-off.  Notice the deterioration in revenues, destruction in book value and a healthy cash position turned into a net debt position.

Table 9: BW Quarterly financial data

  Q1-15 Q2-15 Q3-15 Q4-15 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q2-17
Revenue 397 437 420 503 404 383 411 380 391 350
Y/Y 1.7% -12.4% -2.1% -24.4% -3.2% -8.7%
GAAP EPS 0.21 0.08 0.11 (0.10) 0.20 (1.25) 0.18 (1.47) (0.14) (3.09)
Adj EPS 0.26 0.27 0.25 0.47 0.29 (0.18) 0.24 (1.60) 0.04 (2.56)
 
CFO 52 3 37 77 (38) 22 (24) 42 (75) (7)
CapEx (6) (9) (7) (13) (4) (9) (7) (2) (4) (3)
FCF 47 (6) 31 64 (42) 13 (31) 40 (79) (10)
 
Cash & Equiv. 343 374 402 324 285 94 124 71 91
Debt 3 3 2 3 3 45 14 103 131
Book Value 774 777 748 731 646 642 561 564 418
Change in BV 0.34% -3.62% -2.33% -11.67% -0.51% -12.67% 0.55% -25.97%

 

Where do things stand: But I am also mindful of the fact that two of BW’s three segments are doing fine and are profitable.  BW’s problems appear to be limited to its Renewable Segment and within it, six specific projects, that management claims, will be completed by mid-2018.  The larger point is, the company may be able to turn things around and a fixed-up BW could get back to generating $100 million of EBITDA in a year or two.  At 5x-7x EV/EBITDA, this would mean a multi-bagger potential for the stock.  That’s why I am even highlighting this situation.

New Guidance: Power Segment is expected to generate revenues of $825-$875 million in 2017 and gross margins in the low 20s%.  This segment had a backlog of $562 million as of 6/30/17.  CEO’s comment from Q2 conference call on segment revenues “Based on current market expectations, we believe we can hold this level steady in 2018.”

Industrial Segment is expected to generate 2017 revenues of $400-$450 million and gross margin of around 20%.  This segment had a backlog of $317 million as of 6/30/17.  Things appear to be stable here.

Now the problematic Renewables Segment.  In 2014 and 2015, it did fine, with gross margin of 23% and 17%, respectively.  Guidance is for 2017 revenues of $350 million and margins returning to positive in the second half of 2017.  Longer term, management asserts that normal gross margin should be in the high-teens.  This segment’s backlog was $1.1 billion on 6/30/17.

Balance Sheet:  As of 6/30/17, cash balance was $90.7 million and total debt $131 million.  With this new financing announced on August 9, and taking into account cash burn to fix  the Renewables projects, the company could end up with net debt of less than $100 million by the end of 2018.  Not a huge amount of leverage if they really do fix what’s broken and get back to $100 million EBITDA run rate.  BW’s CapEx needs are fairly modest since a lot of the business is design and services.

Vintage Capital Involvement: Finally, this is what caught my attention, not the 70% stock price drop on August 10.  On August 28, Vintage filed a 13G disclosing a 9.99% stake and then on Sep 15, it filed an amended 13G disclosing a 14.9% stake.  On Sep 19, it had to file a Form 4 (as a 10% owner) and disclose that of the 6.6 million shares, 0.6 million were acquired at $3.015/share and $1.1 million at $3.15/share.

Now as a follower of activist investors, I have come across Vintage before.  Link to Fund’s website.  This is a private/public equity fund run by Brian Kahn.  These guys have taken activist positions and run a few proxy fights in the past.  They have also made offers to take public companies private.  For example, in the case of Anaren (ANEN), they acquired the stock at $18.80 in 2011, made an offer for the company at $23 and in 2013, it was acquired by Veritas Capital for $28 per share.  Next, it acquired a 10% stake in Aaron’s (AAN) in 2014 at $27 per share and offered to buy the company for $2.3 billion or $30.50 per share. It also ran an activist campaign at IEC Electronics.

However, it is important to note that in the case of BW, the fund has chosen to file a 13G, not a 13D, and so it is unclear at this point if it intends to take an active role or not.  Babcock, IMO, needs shareholder representation on its Board like nobody’s business.  The current Board members own very little stock.

So the key event that I am looking for is what role Vintage Capital might play in this story, if any, and my biggest concern is whether BW will deliver more negative surprises in the near future.

I will continue to follow BW’s future progress with great interest and suggest that you do the same.


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