Description

Overview

Aspen Aerogels (ASPN) presents the opportunity to buy into a growth company at 70% of book value and 4-5x FY16 EBITDA due to misplaced fears about the company’s exposure to the energy downturn.

Background

Aspen Aerogel came public at $11 per share in June of 2014.  They manufacture high performance insulation used primarily in energy infrastructure.  The aerogel insulation blankets they produce claim unique technical advantages over traditional insulation, providing superior thermal performance, lighter weight, and easier installation.  Their technology is supported by 82 issued and 65 pending patents.

I’m not qualified to opine on the technical merits of their products or the value of their patents.  However, I believe their ability to rapidly grow revenue while serving extremely sophisticated customers serves as testament to the value of their products.  ASPN has grown revenue at a 27% CAGR since 2011 and counts 24 of the 25 largest refining companies among its customers (incl. Exxon, Chevron, Petrobras, etc.) and 20 of the largest 20 petrochemical companies.

The limiting factor in their rapid growth has been their production capacity.  They have undertaken multiple growth capital projects to expand capacity, having built second (2011) and third (2015) manufacturing lines at their East Providence manufacturing facility.  They plan on building a second plant in Georgia that will come online at the end of 2017 to further increase capacity.

There’s a useful slide from the company presentations that shows historical capacity and utilization, as well as planned future capacity increases from the new facility:

Opportunity

The stock has been selling off ever since the Q3 earnings release in November when they presented initial 2016 guidance (the stock is down 70% from its IPO price and 60% from prior to Q3 earnings).  Below is a brief summary of their historical results alongside management’s FY 2015 and 2016 guidance:

 (n.b. that Adjusted EBITDA excludes stock-based comp, which has been high in the wake of IPO awards)

I see the selloff in the stock as a combination of two factors.  First, the company was pitched and came public as a growth company.  Guiding to flat YOY revenue after such strong historical growth has caused growth investors to reevaluate and rotate out of the stock.  Second, and most obvious, is the fear of investing in anything related to energy infrastructure during the current energy downturn. You can imagine the revulsion of growth investors as the fast-growing and innovative technology story they bought has now turned into a no-growth energy infrastructure company.

ASPN's End Markets

ASPN will not be as affected by the energy downturn as the market may think.  Over 70% of their revenue comes from downstream industries (refiners, petrochem, LNG) where sales are a function of routine maintenance and not oil prices.  Another 10% comes from non-energy-related building materials.  The balance comes from onshore (primarily oil sands) and offshore oil production.  This segment will see significant pain.

Given the lead time for insulation orders, the company has good visibility into the first half of 2016 and less for the back half.  The first half of 2016 is projected to be up 20% YOY, while the back half is down 15%.  Much of this is due to the declining subsea business, which did a record 20m+ in 2015, while 2016 is projected to be half that amount.

The company should be able to replace the declining oil-sensitive verticals with more refinery business, where they remain a small company capable of continued share gains. Despite forecast flat revenue, the company will actually be increasing production as the third manufacturing line ramps up, leading to continued margin uplift. The reason for this is the subsea business has higher average sales prices but similar gross margins as the rest of the business. As the mix shifts, flat revenue really represents more square feet of insulation being sold at lower average sales prices, with more gross profit dollars and increasing operating leverage.

Acquisition Target?

On a more speculative note, I think ASPN makes an attractive acquisition target at a current 50m EV and 2x EV/Gross Profit multiple.  OpEx is high as a standalone public company and could be slashed by a larger company that sees value in ASPN’s technology and installed base and who could move ASPN product through their own larger sales force.

I am perhaps reading too much into the tea leaves, but a recent 8-K shows an amended executive compensation agreement where the payment due to the CEO upon a change of control has been increased from 1x salary and 1x bonus to 2x salary and 2x bonus.

To be clear, I don’t believe a takeover is required for this idea to work.  Time is on ASPN's side as they have a clean balance sheet with 30m in cash and 13m available on their revolver, and they are cash flow neutral while on the cusp of being cash flow positive (excl. growth capex).

Risks

My primary concern with this idea is the financing and execution risk for the second manufacturing facility in Georgia. Management has done a good job executing on past capacity expansion projects, but this one is of a larger scale and in a new location, so it may prove more difficult. The project will likely require $80-100m over the next couple years. With $30m cash on hand and an undrawn revolver, they have a good start. If operational performance remains strong in 2016 and 2017 and they are generating cash, I think this will be very manageable.

Catalyst

Operational execution through 2016 and 2017

Investors start considering numbers in 2018 after completion of second plant and see a 25m+ run-rate EBITDA business