Description

Chart Industries ("GTLS") operates a variety of business units focused on providing engineered solution for the production, storage and distribution of gases.  These solutions are focused on both industrial gases and hydrocarbon applications (LNG, GTL, CTL, etc.)  GTLS operates three separate divisions: Energy and Chemicals (E&C), Distribution and Storage (D&S) and Biomedical.  In each segment of its business GTLS is either positioned as the #1 or #2 firm in each of the primary markets each serve.  GTLS is headquartered in Cleveland, Ohio which is the site of the headquarters, but no operations.  In the past, GTLS has been a target of private equity.  Most recently, a private equity firm took GTLS private in 2005 and then brought it back public in 2006.  While GTLS operates three segments, only two of them, D&S and Biomedical, share much of a similar plant footprint.

GTLS trades for a little more that 5x TTM EBITDA.  GTLS has a fairly simple balance sheet and is currently carrying a $213 million cash balance which is about equal to its outstanding debt.  Management has publicly stated a five year goal of growing the business to $2 billion in sales from $528 million (TTM) and $400 million of EBITDA from $99 million (TTM).  Some of this growth will clearly need to come from acquisitions, but additionally we see robust internal growth from each of GTLS's segments.  GTLS has been a fairly careful acquirer over time and has only expended $37 million for acquisitions in the past three years and has stated that they use a 35% hurdle rate to analyze any potential deals.  While they view the potential of adding fourth leg to the business as a possible strategy, management has stated they are very interested in keeping close to their core of specialized engineering and cryogenics.

The E&C segment did about $255 million in sales in 2009.  This segment makes heat exchangers, cold boxes, process systems and LNG vacuum insulated pipe.  Heat exchangers comprise 68% of the segment sales and are used to super cool gases to turn them into liquids or to recover and/or purify component gases.  Cold boxes are metal enclosures covering a heat exchanger or several heat exchangers.  Roughly 30% of all heat exchangers are sold packaged as a cold box.  Vacuum insulated piping is typically sold for LNG import and export terminals.  When all the components of this segment are combined into a single integrated product offering it is called a process system.  Demand is mainly driven by LNG installations and industrial gas suppliers.  As LNG terminals continue to be built out around the globe (not a US focus as within US we are not expected to be large importers or exporters of LNG), this segment should see very large order flow.  While this will produce lumpy results, over the long-term the segment should generate high levels of profits.  One risk for this segment is that as industry capacity utilization has dipped, some competitors (Linde recently) have bid projects at rock bottom margins to generate order flow.  As demand picks up, we expect margins to rise (note in our model margins fell 1300 bps between 2009 and 2010 and we never forecast them going back to 2009 level as one of our many conservative assumptions).  We don't expect anymore large contract awards to be announced for the segment until 2011, but when they occur, major upward momentum is created in the stock.

The D&S segment did about $247 million in sales in 2009.  Long-term GTLS management projects this segment can grow at 1.5x to 2.0x GPD growth.  There are a range of uses for products from this segment including: industrial gas producers and distributors, chemical companies, restaurants, movie theaters, manufacturers, health care providers, food processors, oil and gas producers, etc.  The technology employed in most of the solutions has to do with vacuum insulation created between an inner vessel and an outer vessel.  Using such a vacuum, the inner vessel can be kept at very low temperatures - in some cases approaching absolute zero.  One huge potential application for this segment is the potential for LNG fueling stations for fleet vehicles.  At a recent conference GTLS management estimated that the market for such refueling stations could be up to 10,000 locations worldwide and that the cost of each station would be $1 million to $8 million.  We estimated that GTLS would likely be able to achieve a 45% market share worldwide in addressing this opportunity and that each of the stations would utilize products built be GTLS equaling 25% to 30% of the overall cost of a stations.  This would imply a multi-year revenue opportunity of $1 billion to $9 billion which is currently not accounted for in our estimates or the estimates of any analyst covering the stock.

The Biomedical segment did a bit under $150 million in sales in 2009 after considering the pro forma of the Covidien acquisition.  The segment makes storage devices for research facilities and animal breeding facilities (large share of cattle breeding facilities).  The balance of the segment's revenues are generated from respiratory therapy systems - portable liquid oxygen systems.  Within the Biomedical segment, the US oxygen therapy portion of the business is a relatively small portion (5%) and is the only market where there is any potential regulatory risk associated with health care reimbursements on the horizon.  Within the Biomedical segment GTLS made a very nice acquisition in 2009 when it bought an orphan division of Covidien for $11 million.  At the time, the Covidien business had $60 million in revenue and single digit operating margins and was run very poorly.  Management believes through restructuring and integration efforts, they can lift operating margins to 20%+ range effectively making the purchase price 1x go-forward operating income - stated in another way, the Covidien deal probably added nearly $80 million in incremental value over what GTLS paid for it equating to roughly 15% of the overall enterprise value - it was a home run.  The Covidien deal also gives GTLS about an 80% market share in the portable liquid oxygen market and management thinks there is an opportunity to grow out other oxygen offerings over time - market is roughly $1 billion in total.  There is little competition in this segment and lots of regulation from FDA and other regulatory bodies providing barriers to entry.  Annual capex spending is less that $1 million per year.

Our DCF valuation indicates a fair value of approximately $29 per share.  Given the cyclicality of the overall business, we assume 2012 to be a "normal" year for which we use to calculate our terminal value based on a multiple of 7.5x TEV/EBITDA.  To be conservative, we based our terminal multiple at a discount to the Company's historical median trading multiple, which is just below GTLS's comp set multiple of 9.0x.  We assumed a 10% discount rate.  Other key outputs include 2012 EBITDA of $130M on sales of $703M, which imply a 6% and 5% CAGR on sales and EBITDA, respectively, over the 2010 through 2012 forecast period.  Our comp set was comprised of AME, GDI, IVC, FLS, BMI, and THMD.  Other analysts have used industry comp sets which are often filled with much larger companies and also highlight the relative undervaluation of GTLS shares to even a greater degree than the comp set we utilized.  Such comp sets often include: PX, APD, ARG, WOR, NOV, CAM, FTI, DRC, DRQ, and DXPE.

The capital structure of GTLS is suboptimal.  After living through a highly levered LBO, management seems content to operate with a low leverage.  The management team readily admits that they could comfortably operate with a capital structure with debt equal to 2x EBITDA.  This would imply roughly $200 million of excess cash exists at GTLS today.  When pressed on plans to utilize the cash, management cites acquisitions as the intended use for the excess cash on the balance sheet, but they don't have a history of doing large deals - in the past three years combined acquisition activity is roughly $37 million.  Further, they also admit that large deals would both produce more borrowing capacity and they could issue equity to do the deals if the stock was in the mid $20 range or higher.  We believe that they need to undertake a major share repurchase campaign immediately.  At current levels, repurchasing their stock is more attractive than many of the deals they are currently considering.  Management seems to think they can find an unlimited number of deals that have similar economic characteristics to the recent Covidien deal, but this is a pipe dream.

On the acquisition front, GTLS needs to focus on deals that will add less lumpy recurring revenue.  This will help overall with the multiple.  An example of a deal that would have been perfect was NuCO2 ("NUCO").  NUCO is the firm that delivers beverage grade CO2 to restaurants, theaters, amusement parks, etc.  NUCO has been a big customer of the GTLS D&S segment for many years.  NUCO was taken private several years ago by a private equity fund and is in the process of coming public again.  NUCO would have been the perfect fit for GTLS, but is now probably too big and also given its attractive characteristics NUCO has historically traded at a large premium to GTLS.

Catalyst

Catalysts

• 1. GTLS announces a move to rationalize capital structure either in share buyback or special dividend.
• 2. Private equity or strategic buyer makes a bid to buy GTLS or management leads an MBO given the stock's current depressed valuation.
• 3. GTLS announces a major contract award won by the E&C segment.
• 4. LNG service stations begin gaining traction for vehicle fleets and GTLS begins receiving large orders for equipment in its D&S segment - $1 billion to $9 billion multi-year opportunity.
• 5. Activist investors are rumored to be circling the stock.