Introduction:

Headquartered in Jacksonville, APR Energy is a temporary power provider listed on the London Stock Exchange. The business model consists of buying aero-derivative dual-fuel turbine engines from General Electric (owns 17% of APR) and reciprocating engines from Caterpillar and then renting the equipment to emerging market utilities for the purpose of generating electricity. Essentially APR rents portable power plants to utilities across the globe. This is important for disaster relief situations when permanent solutions are off-line (think Fukushima) but the main structural growth driver of APR is the widening gap between the supply and demand of electricity in emerging economies. It is estimated that 1.3 billion people (18% of the global population) live without access to electricity and APR is helping to close this gap, as well provide electricity to countries with unstable or over-utilized power grids due to growing electricity demand. Permanent power plants can cost billions of dollars to build so many capital constrained emerging market utilities and governments choose renting instead of building (“small expensing is easier than large capexing” is APR’s unofficial slogan). The typical contract for APR lasts 6-12 months but the company has been winning new contracts with durations as long as 3 years. While these contracts are called “temporary power solutions,” the contract renewal rate is very high (>85%) since APR is supplying needed power, so in some respects APR is supplying permanent power.  

To incentive you to keep reading this report, I’ll go ahead and mention that APR has a $435mm market cap ($995mm enterprise value) and is a highly cash generative (EBITDA margin is >50%) growth business valued at 4-5x normalized earnings, 3-4x normalized EBITDA and a 40% discount to tangible book value. I believe the total return potential for a shareholder at the current stock price of GBp 300 is between 115-160% based on the existing financials. It’s also important to mention that the Chairman and Founder, John Campion, has a tremendous track record of execution and a long-term earnings target of $3.0 per share (equates to $275mm in net profit) to be achieved in 5-7 years. The stock is currently valued at approximately 1.5x the long-term EPS target. 

Background:

The company was built by John Campion (Chairman) and Laurence Anderson (CEO), who have been business partners since the 1980s. Collectively the two founders own 7% of the shares outstanding. Campion originally worked as a technician in road crews travelling with bands on tour, and he recognized the need for more electricity to power the elaborate lights and amplifiers. So Campion and Anderson founded a company called Showpower in 1987 and began supplying power to bands on tour. The business grew quickly and was ultimately sold to General Electric in 1999 for an undisclosed amount. After working at GE for two years, Campion and Anderson were hired by Alston Power Inc. to start a new business unit called Alston Power Rentals (APR for short) to supply power to a much larger market than concerts: the utility market. APR grew quickly but Campion and Anderson believed the business could grow even faster as an independent entity without the bureaucracy from the parent company. So Campion and Anderson led a management buyout in 2004 and subsequently received investments from Soros Strategic Partners and Albright Capital Management in 2011. Ten years after the management buyout, APR has grown into a much larger business with revenue of $490mm, EBITDA of $250mm and net profit of $75mm (consensus expectations for 2014). 

APR was listed in 2012 through a reverse merger (a listed shell company acquired APR) on the London Stock Exchange. One of the reasons APR was listed in London was because its sole competitor, Aggreko plc, is listed there so investors were familiar with the business model and applied a relatively high valuation to the stock (Aggreko was valued at 23x EPS and 12x EBITDA at the time of APR listing). What investors really liked about Aggreko was the growth division, International Power Projects (IPP), which is the identical business of APR. Suffice to say, APR was initially very well received by investors and received a valuation comparable to Aggreko’s. 

Investment Case:

The temporary power industry is a duopoly with APR (2,189 megawatts) and Aggreko (4,500 megawatts in IPP). However, there is a key difference between APR and Aggreko. Approximately 60% of APR’s 2,189 megawatt (MW) fleet is dual-fuel (gas and oil) turbine technology, which is basically a jet engine in a box. This is a highly sophisticated technology procured from GE that is relatively new to the temporary power industry. The remaining 40% of APR’s fleet is reciprocating engines (think car/truck engines) purchased from Caterpillar. This is low technology equipment but is typically the cheapest solution so certain customers prefer the cheaper alternative, although the emissions from reciprocating engines are significantly higher than turbines. The reason certain customers are willing to pay a premium for turbines rather than opting for the cheaper reciprocating engines, other than for lower emissions, is because turbines offer the same technology that most power plants already use. Renting turbines from APR is like renting an extra Cadillac SUV for your car driving service, which already consists of Cadillac SUVs. Reciprocating engines are more like Volkswagen Beetles to continue with the car analogy: great reliability but doesn’t look like the rest of the equipment. Turbines are rented in 25-30 MW containers offering large scale power solutions, while reciprocating engineers are sold in 1 MW increments and are viewed as temporary, low power solutions. Contrary to APR, Aggreko exclusively owns reciprocating engines leaving APR with a 100% global market share in turbine rentals. Aggreko has stated that they do not intend to enter the turbine rental market since they would be at a competitive disadvantage to APR, who has exclusive sourcing rights from General Electric. 

The pricing difference between renting turbines versus reciprocating engines is 1-2 cents per kWh. Renting reciprocating engines for 1 year from APR or Aggreko would cost on average 3 cents per kWh. This translates to $263,000 in revenue per year for 1 MW. The EBITDA margin for an average reciprocating contract is approximately 40%. Turbines typically rent for approximately 4 cents per kWh, which translates to $350,000 in revenue per year for 1 MW. The EBITDA margin for an average turbine contract is approximately 60%. While the cost difference of 1MW to the customers between reciprocating engines ($263,000 per year) and turbines ($350,000 per year) sounds like a meaningful amount, it’s critical to understand that traditionally over 80% of the entire cost of temporary power is fuel cost, which has declined by approximately 50% recently. This should serve as a tailwind for APR and Aggreko since the total cost of temporary power has been significantly reduced. Just to clarify further, the customer purchases fuel separately so fuel cost is not a revenue source or cost for APR, excluding the fuel cost when APR initially delivers the equipment. The important point to understand is the bulk of the cost is fuel, not renting the equipment, so if APR’s fleet is more fuel efficient than Aggreko because it is newer (which it is) and also burns gas (which it does), then APR can reduce the total cost for customers while actually charging a higher rental price than Aggreko. 

Since listing in 2012, APR has fallen approximately 75% at the writing of this report. There are several reasons for the decline which are explained below:

• Bad perception of founder – Born and raised in Ireland, John Campion is a savvy, energetic entrepreneur that has built APR from nothing. His passion is commonly mistaken by the UK investor community as aggressive, brash and arrogant. Prior to his appointment to Chairman in 2014, he was the CEO and face of APR so investors developed an aversion to Campion and the company in general. What UK investors have failed to recognize is that Campion’s personality closely resembles many successful CEOs and entrepreneurs. I’ll refrain from drawing direct parallels to avoid the risk of impoliteness but certain key managers at Apple, Oracle and Ryanair immediately come to mind. If you ask the old Aggreko CEO, Rupert Soames, who the most knowledgeable person in the temporary power space is, Soames will quickly respond: John Campion.
• High management turnover – APR delayed results shortly after listing in 2012 and the stock dropped over 20% that day and nearly 50% over the next 3 months. The reason for the delayed results was due to accounting complications arising from the shift to IFRS from GAAP and the reverse merger. Given the failure out of the gate, the board fired and replaced the CFO and over the next 12 months the stock slowly reached its original valuation prior to the earnings delay, although there was underlying distrust brewing from UK investors. Making matters worse, the newly appointed CFO, Andrew Martinez, suddenly decided to leave for personal reasons in mid-2014 after two years at the helm so investors again became paranoid about the company’s management turnover, as well as Campion’s brash nature. As a result, the board appointed Laurence Anderson as the new CEO and moved John Campion to Chairman. In terms of personality, Anderson is a more traditional polished CEO so he has been well received by investors, as well as the new CFO, Lee Munro. Munro previously worked at General Electric for 10 years and most recently served as the VP of Operations at APR. I believe the current management structure is how it should have been from the beginning. 
• Excessive contract concentration – Aggreko has a diversified portfolio of contracts, while APR is more concentrated. The two largest contracts for APR in 2014 were Uruguay (14% of fleet) and Libya (20% of fleet). Generally speaking, the market is short-term focused so APR’s lumpy contract business does not bode well for a stable share price. This obviously creates buying opportunities for rational investors which is the current situation. Given the negative feedback from investors on contract concentration, management has recently decided to increase contract diversification to reduce earnings volatility. It is also worth mentioning that APR’s revenue and equipment is always fully insured by reputable western banks prior to signing a contract. 
• Libya turned ugly – In 2013 APR won a 450MW contract in Libya, which represented approximately 20% of APR’s 2,189 MW fleet. The pricing of the transaction was not disclosed (this is standard) but the contract may have contributed as much as 30-40% of EBITDA in 2014. Initially this contract was well received by investors given the supposedly attractive pricing and because 450MW represented the largest contract in temporary power history. However, the political situation in Libya deteriorated throughout 2014 and APR was unable to extend the contract. Management announced APR was exiting Libya on Jan 26, 2015, which is when the stock touched its low of GBp 146 (down 87% from listing in 2012). It is important to remember that APR will simply rent the equipment in another country – this is not lost revenue forever. 
• Weak balance sheet – The severity of losing the Libyan contract was compounded by the perceived balance sheet issue. The company has $560mm of net debt (consisting of a term loan and revolving credit facility held by a consortium of banks) with a maximum covenant ratio of 3.25x net debt / trailing 12 months EBITDA. Interest payments are LIBOR plus 2.25%-3.25% dependent on the total leverage ratio. Meeting interest payments is not an issue at all for APR – annualized interest payments range between $20-35mm so interest coverage (EBITDA/interest payment) should not be lower than 4x even in a dire scenario. However, if EBITDA falls below $170mm, investors are concerned the ND/EBITDA covenant will be breached and the reaction by the banks is uncertain. Historically the banks have recognized the nature of APR’s lumpy contract business so the covenants have been temporarily waived for several months, providing APR sufficient time to redeploy the equipment. It is also worth mentioning that the bank debt was renegotiated in mid-2014, and the banks were privy to the potential loss of Libya, yet the terms for APR were significantly improved. If the Libyan contract had been renewed, APR’s total EBITDA was estimated to be between $250-300mm so without Libya, EBITDA will likely fall to an annualized $150-200mm assuming the equipment in Libya is not redeployed elsewhere. If covenants are breached, temporarily waiving covenants would likely be the scenario. Of course, the APR sales force is aggressively marketing the unutilized equipment (half turbines and half recips) to potential customers and if the equipment is contracted within 6 months, APR could avoid breaching covenants. I believe the market does not fully understand the balance sheet situation. 

APR has 1,280 MW of turbines and 909 MW of reciprocating engines for a total MW capacity of 2,189MW. Traditionally APR has operated with utilization of 70% for recips and nearly 100% utilization for turbines. To be conservative, let’s assume APR has 70% utilization in recips but only 85% utilization in turbines during a normal year. Therefore, estimated annualized revenue would equal $550mm. Here are the assumptions to arrive at normalized revenue: (909MW of recips x 3 cents per kWh x 8,765 hours per year * 70% utilization = $168mm in revenue from recips) + (1,280MW of turbines * 4 cents per kWh * 8,765 hours per year * 85% utilization = $381mm in revenue from turbines) = $550mm in total revenue. We can sanity check these assumptions by looking at the quarterly revenue when utilization was at similar levels and applying the annualized run-rate figure. For example, total utilization was 70% in Q2 2014 and revenue was $134mm (implies run-rate annual revenue of $536mm). With an EV of $995mm, APR is currently valued at normalized EV/Sales of 1.8x EV/Sales. As a point of comparison, Aggreko is valued at 3.0x forward sales. The total normalized EBITDA of APR is approximately $300mm. The reciprocating engines generate $67mm of EBITDA during a normal year (40% EBITDA margin * $167mm of revenue) and the turbines generate $230mm of EBITDA (60% EBITDA margin * $380mm of revenue). This values APR at normalized EV/EBITDA of 3.4x. Aggreko is valued at 8.1x forward EBITDA. Lastly, subtracting D&A of $130mm, interest payments of $35mm and taxes of 20%, net profit would equal approximately $105mm, valuing APR at 4.1x EPS. Aggreko is valued at 20x forward EPS.

The normalized ROCE for APR is approximately 10%, while the ROCE for Aggreko is approximately 21%. The main reason Aggreko has a higher return on capital is due to the fleet age – Aggreko’s equipment is simply older than APR’s. The life of the equipment is typically longer than the depreciation schedule suggests but pricing remains the same throughout the equipment life (reciprocating engines are depreciated using a straight line method over 8-10 years, while turbines are depreciated based on hourly usage, similar to the airline industry), so the ROCE improves as the equipment ages. Customers rarely ask the age of the fleet so Aggreko is generating revenue on fully depreciated equipment (but of course the equipment is freshly painted every year to avoid looking old). Generating revenue on fully depreciated equipment is an important nuance of the APR and Aggreko business model that is overlooked by investors. 

The tangible book value of fixed assets of APR is $1,289mm. With net debt of $560mm, APR has a tangible book value of equity of $729mm. The current market cap is $435mm, which offers a 40% discount to tangible equity. APR is trading well below liquidation value. It is also worth noting that General Electric acquired a 17% stake in APR at a share price that was 280% higher than the existing share price of GBp 300. 

Conclusion:

Due mainly to uncertainty driven by contract concentration and the balance sheet, the stock currently offers attractive value. John Campion’s long-term objective (next 5-7 years) is to generate $1bn in revenue, $3.0 in EPS and achieve a return on capital of 20%. If the long-term targets are achieved, APR is extraordinarily undervalued, but I believe APR is undervalued based on the existing financials and asset base. Given the attractive growth prospects, strong competitive positioning and comparable valuation of Aggreko (19.6x forward EPS and 8.1x forward EBITDA), I believe a conservative valuation for APR is between 10-12x EPS, 5-6x EBITDA and offer a return on tangible equity between 8-10%. These assumptions suggest a total return potential of 115-160% from the existing share price of GBp 300.