|Shares Out. (in M):||34||P/E||Negative||2.5x|
|Market Cap (in $M):||17||P/FCF||Negative||2.5x|
|Net Debt (in $M):||0||EBIT||-5||9|
If it's late summer, it's time for my annual Aeroquest writeup. Please refer to my past two writeups for more information about the business. I think this writeup is timely because the company now trades a good deal below book value and a dramatic turn in the business is only a few quarters away. Finally, the shares have hardly ever been cheaper. I think there's now the opportunity to make 3 to 5-fold in the next year and likely more in the next five years. I apologize in advance for this being such a small cap--however, a year ago, it had a $100m market cap.
For a quick refresher, Aeroquest provides aerial geophysical surveys to the mining and energy industry. Their technology is superior to competitors and allows companies to save significant quantities of money when they explore for new deposits. The technology allows companies to visualize how a deposit lays in the ground which means that a company will then drill directly into the deposit rather than trying to guess where the deposit actually is within a large area. This saves in bad holes drilled and allows a drill program to more accurately target the best zones and create an intelligent mine plan. If you are drilling core, a meter costs you $150 to drill. A bad hole, at 300 meters is $45,000 wasted. A few bad holes will more than pay for the typical Aeroquest survey. In particular, the surveys are useful when looking for targets that are under overburden and not outcropping. This defines almost all new discoveries in the last decade as prospects closer to the surface have all been found decades ago.
Of the last 25 years, 23 of them had world mining companies deplete more than they found. This clearly is not sustainable. Rough estimates are that to simply maintain current worldwide mining reserves, the industry (gold, silver, diamonds, uranium, copper, lead, zinc, nickel, etc.) will need to spend $8-10 billion a year. Even at the peak in 2008, the run rate was only $11 billion. The lack of new discoveries and the depletion of existing large mines is a significant factor in the continued strength in worldwide commodity prices. China's increasing demand has only exacerbated this issue.
Until Q3/2008, Aeroquest rode this wave to explosive growth and profits. Just nine months ago, the real issue was how fast the company could build systems and get them into the field with qualified staff. The company had a backlog which was greater than their capacity and they were turning away significant quantities of business because they could not grow rapidly enough. It seemed that mining companies had finally discovered the benefits of Aeroquest's product lineup. Then the economic crisis hit. As worldwide commodity prices went into a tailspin, large producers cut all non-essential expenditures as they panicked to pay down debt. Many did dilutive equity offerings. Mid-tier producers shelved all growth plans. Juniors were vaporized as the funding for them disappeared. Worldwide, all exploration effectively ended. This is not sustainable. If mining companies do not find new projects, they don't have much of a business looking into the future-nor can they properly mine their existing assets. There's no way to know when companies will begin to spend again, but anecdotal evidence seems to point towards early next year.
There are three reasons that I think spending will significantly increase early next year. Firstly, worldwide metal prices have recovered almost to pre-crash levels and in some cases like gold (about half of all exploration spending historically) it looks like a move to new all time highs is imminent. It is once again lucrative to find and build new mines and many mining companies are now flush with cash. Secondly, 2009 budgets contained almost no exploration allocation for producing companies. I hear from multiple companies that 2010 budgets are back to 2008 levels, or at least 2007 levels for exploration. Once these budgets are funded, it takes a few months for the geologists to figure out how to spend it and plan the exploration program. That would mean spending starts in Q2/2010. Finally, Junior mining companies have always been a significant portion of total exploration spending. After nine months of raising almost no capital, the funding window is wide open again. In Q2/2009, as a group, they raised more money than in any quarter since Q4/20007. Q3/2009 once again looks like a real bonanza for capital raised. These guys are now gearing up to spend the money. That normally takes a few months as promoters hire geologists and figure out how to spend the money. They will likely be ready by Q4/2009, but the holiday period along with bad weather in the northern regions, will likely push spending out into late Q1/2009.
From conversations with the CEO, Roy Graydon, he notes that there has been no turn in their business and only a moderate pickup in the backlog. However, he says that in the past few weeks, the number of companies submitting proposals has been the highest all year and he anticipates a few of these converting into work in the next few months. This is all anecdotal, but it's encouraging that the worst is hopefully now behind the company. He doesn't expect much of a turn until Q2/2010 either, but he thinks they've seen the bottom.
This all sounds good, but what do you get today. At the current 49c price, the total market cap of the company is $16.5 million. They have no debt, $8m in cash, $.51 in book and can likely be liquidated for more than book. Sold to a competitor, they could likely get at least $1.50 for the company. In 2008, with a soft Q4, the company produced around $9 million in cash flow on $55 million in revenue if you exclude some one-timers. That includes significant costs to gear up for future work which never arrived. By Q4/2008, the company had built up capacity for $80-$90 million in revenue. If you figure that the buildup likely cost them a few million dollars, even with lower margins and $45 million in revenue, the company should be able to earn $9 million again within a year or two. A reasonable 10 PE gets you to something like $90m market cap or $2.70 a share. Even a really conservative estimate on earnings makes the company worth a double from here. If exploration recovers to 2008 levels and Aeroquest continues to gain market share from other exploration technologies, the company could easily earn a dollar a share within a few years and be a spectacular investment-as long as they can make it until the turn comes.
Excluding some charges and bad debt expenses, in Q1, they roughly broke even and Q2 was a complete bloodbath. They've now significantly cut staff levels and reduced all spending to the bone. They feel that the current backlog will be sufficient to bring losses down to a few hundred thousand dollars a quarter. With $8m in cash, they can wait for a turn. The real risk is that they have another quarter where they lose significant amounts of money. The other risk is that they make a stupid acquisition. They just announced the acquisition of Optimal Geomatics. Optimal does aerial surveys to help companies analyze engineering work. It should be a huge beneficiary of any infrastructure work from the stimulus package. After eliminating duplicative public company expense and SG&A, they think it will be immediately profitable to Aeroquest based simply on recurring contracts that they have. If the Obama infrastructure spending materializes, this could be a huge winner. The danger is that the company gave away 8% of the shares outstanding at silly prices for a company that will likely only add a few hundred thousand dollars a year of profits-though it will diversify the company. I am worried that Aeroquest will make more acquisitions like this and one of them doesn't work right. At the same time, so far, all prior acquisitions have paid off rapidly for the company. In particular, the acquisition of UTS which diversified the company into fixed wing surveys was brilliant as they are now almost all of Aeroquest's revenue as the more expensive helicopter surveys are being passed over by mining companies currently.
In summary, you are paying $16.5 million for a company that had $9 million in cash flow last year. The company is just coming out of a cataclysmic drop in its core market that evidence indicates will reverse itself in the next few quarters. For protection, the company has $8 million in cash, no debt and trades a hair below book value, which doesn't include some bad debt which was charged off-yet could potentially be collected on. 49 cents is the wrong price for the company, I think a conservative scenario gets you to at least a triple from here, and a more realistic scenario gets you a company that could be trading at a few dollars a share within two years.
Renewed demand for exploration expenditures.
|Subject||A couple of other points|
|Entry||09/14/2009 02:55 PM|
Aeroquest has also diversified aggressively over the last 12-18 mos into the oil/gas E&P space. Although exploration budgets have been negatively impacted here as well, I think it's been an important move because until the Company has a more diversified revenue stream I don't think it will ever garner a very attractive public market multiple.
Also, I appreciate the fact that you're a bit wary of the Optimal Geomatics acquisition, but I actually think this has a high probability of being a huge home run for the Company. There's a decent argument to be made that pro forma the removal of a duplicative set of public company expenses, they're only paying about 2x earnings for a business that will go a long, long way towards diversifying their revenue base. Optimal has actually been growing its top line in the current environment; pretty impressive given how ugly things have been for most companies.