Description

ADES is a trifecta (i) quick trade for +15%, (ii) invest for +50% over 12 months, and (iii) an option for +100% over 3 months.  This opportunity exists because of a tax reform scare that is close to being behind us, allowing for upside to be realized in 1H 2018 with a chance for a legislative boost by year end 2017.  There are two different paths to win from current level (organic growth vs. legislative), and these paths compound the other's upside.  I could be jumping the gun by 48 hours on on tax reform (i.e. getting 100% certainty of outcome), but the stock is up +25% as the legislation unfolds, so I want to put this idea out there now for  consideration.  If the stock trades up post tax reform certainty, I think it is still a buy at that higher level; i.e., one may be able to wait for tax reform certainy if they are quick on the trigger to buy in once it crystallizes.

Preview: Trifecta 
I value the company on a DCF of cash flows through 2021 that should be worth ~$11.50/share at a 10% discount rate, with upside from future growth for another $9/share.  There is an additional legislative option that could take all of these amounts and double them (a low probability, but an option nonetheless); this option could also play out by year-end as part of a tax extenders bill which could benefit orphaned tax credits (the type that benefits ADES).  There are additional sources of upside in IP/Chemicals which I am not allocating significant value to, which could be another $1+ per share.

The only reason the stock trades today below $11.50/share is due to the scare related to tax reform (explained below), which had sent the stock from $12 to below $8, but is now normalizing with potentially limited impact to the company.  We aren't all the way out of the woods and I discuss this with more detail below.

Once the tax scare is behind us (we should know by Monday, but potentially earlier), the stock should quickly recover back to $11.50/share (+15%).  This assumes the stock does not price in any optionality for growth, which it should (as there is a potential 50%+ return from current levels (organic or legislative) .

At $10, ADES is an attractive investment with a trifecta of ways to win: as a trade, a fundamental hold, and as an option.  You can reasonably point a path to high teens through two very different paths that are separate from each other and can compound each other: (i) selling out Tinuum's facilities or (ii) winning the legislative lottery (described more below).  

Valuation Overview: $11.50+
1. IP/Chemicals business ($1.00/share, may be conservative)
2. A liquidating public holding company (the ADES trading entity) (-$0.50/share)
3. 42.5% stake in Tinuum ($11+/share)

I value the IP/emissions control business at $20MM ($1/share).  I assume the business can get to $2MM EBITDA-Capex at a 7x multiple = $14MM.  I toss in another $5MM for IP, which gets me $20MM, or $1/share.  Management once guided to the emissions control business doing 10x the EBITDA with similar bullish ideas for the IP; however, they did talk down expectations on their Q3 call.  This segment has gone from doing $0 annual gross profit to $1MM in the LTM period, so maybe $2MM is conservative.  Ultimately, I don't know the right answer is, but you create the assets pretty cheap in my analysis so its a source of potential upside. 

A liquidation of the HoldCo is -$0.50.  I think a straight liquidation of the balance sheet is $0.75/share (Cash, A/R, etc. netted against liabilities).  I back out the PV of G&A for -$1.25/share.  I have it running $4MM/quarter through 2017 and then $3MM to 2019, and then $0 in 2020 (as there won't be a business at that point as the vast majority of value is the minority interest in Tinuum, which goes away after 2021).

Therefore, the 42.5% stake in Tinuum driving the vast majority of value.  I think a tax-effected run-off of the existing business is ~$11/share, with significant upside to growth, which should materialize in 1H 2018.  I walk through Tinuum in more detail below. 

In summary, you have ~$0.50/share of value ex-Tinuum, and Tinuum can be $11/share = $11.50/share as a run-off of ADES.  These are PV values at a 10% discount rate on future cash flows.

42.5% Stake in Tinuum:
Tinuum sells facilities which produce refined coal, which qualifies for a Production Tax Credit (“PTC”), which is a tax credit that tax equity investors can invest in.  The refined coal tax credit is the highest IRR tax credit a tax equity can invest in, and is thus extremely valuable.  The short of it is Tinuum earns $3.25 per ton of refined coal the systems generate, and ADES gets 42.5% of that.  ADES also earns a 50% royalty on ~$0.40/ton for certain of the tonnage uses some of their technology in emissions control.  The actual numbers are slightly different, since Tinuum has some G&A and capex (although both of these should be very little).  Tinuum sells these facilities to tax equity investors, and the the tax credit expires in 2021, so all cash flows go to zero Q4 2021.  I value Tinuum on a DCF, and not a multiple. 

Tinuum has 28 facilities to produce these PTCs.  Of these facilities, they have sold 16.5 of them, leaving ~11 to go.  We know Goldman Sachs bought 10 of them per 10-K, and don’t know the mix of the other 6.5.  

ADES Q3 presentation says they were to get $225MM-250MM undiscounted cash flows from its Tinuum stake as of 9/30/17, which was 14.5 facilities.  They sold 2 facilities subsequent to 9/30/17 (in November) so the undiscounted cash flows will be something higher proforma for the 2 assets ($237.5MM + $6MM * 4YRs * 2 facilities = $285MM).  They also give you an annual schedule of cash flows that made up the $225-250MM (again this excludes the 2 facilities just sold), which delineates a a slightly front loaded cash flow stream (vs. linear or back end loaded). 

In my model, a 10% discount rate to linear cash flows is ~$11.  This valuation excludes cash I think Tinuum has on its B/S, taxes/453(a) payments which ADES will have to pay on these distributions, some other royalties I think ADES gets from Tinuum not included in the above.  I think all of those other items wash out to zero, so my value for Tinuum to ADES stays at $11.  Just to be clear, ADES has a lot of tax assets that will minimize any cash tax payments for at least a few years (and recall the cash flows stop in 2021), so there isn't a big tax drag here.  If Tinuum grows materially, ADES can create more tax assets by just having Tinuum run facilities for its own account.

November-December 2017 Tax Reform Scare / Am I Jumping the Gun?:
Over Thanksgiving, the Senate version of the tax bill proposed (i) a Base Erosion Anti-Trust Tax (“BEAT”) and (ii) a 20% corporate AMT.  Both of these
provisions were problematic, but I think you are able to get comfortable with BEAT.

The 20% corporate AMT was the killer.  It basically voided the value of any tax credit (because the corporate is at 20%, and AMT is at 20%, you effectively have a flat tax).  Not good for Tinuum or anyone else (Solar, Wind, Geothermal etc.).  However, it became clear the 20% AMT was never a true possibility, but a procedural inclusion to move the tax reform bill out of the Senate.  In the current tax bill being in conference, the 20% corporate AMT has been fully repealed.  If anything were to change here it would move to 11.4%, which leaves the tax credits still intact/valuable (e.g., Goldman only reduces its tax rate ~200bps via tax credits, and the a 20% tax rate vs. 11% AMT still leaves ~900bps room).  Nevertheless, news flow, lobbyists and the Republican leadership have all said the corporate AMT is going away, and so I expect it to go away. 

The BEAT tax was/is more nuanced. When I said in my preview I may be jumping the gun on tax reform, it is this particular provision I am referring to.   

• Basically it creates an AMT for certain multi-nationals (does not affect any domestic company and the majority of multinationals), and did not exempt PTCs/ITCs from the tax.  It is unclear whether this was intentional or not, but it certainly caught the entire renewable market by surprise (including wind, solar, etc.).  We don’t know the mix of Tinuum’s business, but we know at least 10 facilities are with Goldman, who is a multinational.  Hence, BEAT is an issue to focus on. 
• I don't think Tinuum will be materially impacted by the BEAT if the language stays as is.  Goldman is close to being totally exempted from the BEAT (their IR is surprisingly proficient on this subject), and even if subject to the BEAT, my math suggests Goldman has significant remaining appetite for tax equity (meaning, they wouldn't walk away from any facilities) as it looks like they only use tax credits to shield 200bps of their pre-tax income (see Effective Tax Rate walk in 10-K).  We obviously don't know (I am not an expert on Goldman's tax position), but I suspect Goldman is not walking away from all ten facilities.  Goldman also owns 15% of Tinuum and the refined coal tax credits are much higher IRR than Solar, Wind etc, so if they had to walk away from something, I doubt it would be refined coal.  Lastly, if you were to lose a handful of facilities (Goldman or otherwise), you would gain new ones to offset this once tax reform normalizes.  Not all multinationals are impacted by BEAT and no domestics are; there are plenty of Fortune 500 customers for these tax credits.  I don't think its a good headline if BEAT stays is, and stock could trade back down to the recent lows -- but I think future growth would offset this in early 2018.
• However, all of this BEAT tax analysis may be noise, as the media is reporting that the Senate/House bill preserves these tax credits to be used against the AMT; it is not a favor to Tinuum, but mostly honoring a 2015 deal with the wind/solar lobbies who were impacted by this legislation and are already being phased out right alongside refined coal.  I also think the JCT score here may not be that big (< $10BN over 10YRs) and that makes it easier to amend and move on in context of the overall budget.  Thus, all this analysis of walkaways etc. is probably going to get mooted by Monday or sooner.  To caveat, the media is not always right, and no one saw the Thanksgiving scare coming that sent ADES -30%, so I strongly suggest you conduct your own analysis of this situation for whether BEAT is amended favorably or not. 

So as we sit here today, the Thanksgiving tax scare is in process of being addressed.  We are still waiting for official confirmation on the BEAT issue, but the market is starting to price in resolution here.  ADES stock sold off from $11 to $8 over this period, but has retraced to $10 as the final legislation package (repeal of Corporate AMT / some sort of fix regarding BEAT) may not be as bad as initially feared. 

Value of Tax Credits Increases 40% Due to Tax Reform:
PTCs were historically used to help a company go from a 35% federal rate to 20% AMT rate, and going forward it can help you go from 21% federal to 0% (no more corporate AMT).  This change makes the tax credit ~40% more valuable coming out of tax reform.  As an aside, the IRS put out a Technical Advice Memorandum in September which serves as a catalyst for making the tax credit to new tax equity investors.  Lastly, you are in process of having the tax credit blessed through tax reform, which will serve as an accelerant.  So once we get through tax reform, I think the market will be hot to trot on these credits.

Tinuum Growth Opportunity: Selling More Facilities
Tinuum has been a perennial under performer (see all the prior VIC write-ups).  However, they have demonstrably gotten their act together in 2017.  After a period of selling perhaps 1 facility a year, they sold 1 in Q2 2017, 0.5 in Q3 2017, and another 2 in Q4 2017 – all while remaining bullish on their remaining pipeline.  They also said on their Q3 conference call that future monetizations will be ~30-60% larger (larger facilities = more tonnage = more cash flow to Tinuum), i.e. 4-5MM tons/facility.

I think a 4MM ton facility is worth $0.75/share (NPV at 10% IRR).  Tinuum has ~11.5 facilities left to sell.  Assuming they are all 4MM tonners, this is 11.5 x $0.75 = ~$9/share upside. 

Time is running out (there will be less interest in doing transactions as time erodes for a 2021 expiry date), so there is a lot of pressure to get deals done in 1H 2018.  Getting 3 facilities bumps up my valuation from $11 to $13, or +30% upside from current levels.  Getting 6 would bump it closer to $15 or +50% upside. These valuations are NPV at a 10% discount rate, so the total return would actually be higher  (so +30-50% becomes +40-60% total return over 1YR).  And you compound thereafter at a 10% IRR through 2021.  

Is getting 3 so unreasonable when (i) they did more than 3 in 2017, and (ii) IRS has provided guidance in Fall 2017, (iii) tax reform increases the value of the tax credit 40%, (iv) tax reform blesses the credit, and (v) U.S. corporate profits are on track to be +10% in 2018?  I think getting 3 is probably conservative, but it is a show me story... could be 0, could be 10.

Tax Extenders Bill Is a Near-Term Option (?Dream?):
Although we just came out of a big scare in tax reform, there is optionality to the upside.  If the PTC lobby can get an extension of tax credits as part of a Tax Extenders bill, then your 2021 expiration date could get kicked out a few years, dramatically increasing your DCF value.  Orrin Hatch actually proposed, prior to the Thanksgiving scare, a 10 year extension specifically for the refined coal tax credit as part of his Manager's Amendments.  You can run an NPV at 10% discount rate, and going from Year 1-4 cash flows to Year 1-14 --- the pick up is substantial no matter the discount rate.  That 10 year extension dropped out at some point (indeed we had the Thanksgiving scare instead), but one can't rule out some extension at some point ahead of 2021, or possibly as part of the Tax Extenders bill by Christmas (which has seen PTC/ITC tax credits get their life extended in the past).

Catalyst

The passing of tax reform is catalyst #1 to getting back to business as usual.  Business as usual should mean growth at the Tinuum entity in 1H 2018.  The legislative option for massive overnight appreciation is real (although unclear how likely).  The Company has a share repurchase program it announced 2 weeks ago.  There is also a 10% short interest in the stock, which surprises me for such an illiquid stock cooupled with positive catalysts ahead.