Value Investors Club / HILL INTERNATIONAL INC (HIL)

Description

Hill international (HIL)

$4.30

Company Description:

Largest independent project management company. Also has a claims resolution business that is in the

process of being divested. Non-capital intensive fee-for-service people business that is contractually cost-plus

in nature i.e. no risk of cost overruns. Please see prior VIC write-ups for additional history and context.

Thesis:

1) Due to a few factors, the enterprise can currently be created for 4x EBITDA versus the current

appearance of 13x EBITDA. On a synergized basis given takeout potential, HIL can be created for 2.6x

EBITDA today. Comps trade at 8-10x EBITDA.

2) After a decade of management-led value destruction, for the first time the company is controlled by an

independent board with the majority being controlled by highly motivated and aligned investors.

3) Due to the pending divestiture of the claims business, the company has become a strategic target.

Why the stock is mispriced:

1) The stock appears to trade at 13x EBITDA due to two factors: depressed EBITDA and bloated

receivables. On the surface, it doesn’t appear cheap.

2) The company recently violated their credit facility covenant due to the write off of a receivable which

penalized EBITDA. As a result, available liquidity is tight and the company can be perceived to be in

financial distress.

3) For the past 5 years, the company has generated poor FCF and has at times resorted to expensive debt

and dilutive equity financing.

4) Management and the BOD have historically been entrenched, overpaid and resistant to shareholder

overtures including turning down multiple offers to sell the company at a premium.

What has changed to make the stock attractive right now:

1) 2016 EBITDA is depressed due to a receivable write-off and under-utilization of labor due to a decline

in middle east infrastructure work. The receivable is now written off and labor is being rightsized.

Meanwhile, as of last quarter, the backlog has inflected positively for the first time in 18 months due to

the US business growing double digits and the ME beginning to stabilize. There is a credible case for

revenue growth beginning in 2017 and acceleration in 2018 as the US region becomes larger as a % of

the total. Trump’s infrastructure ambitions in no small way provide a tailwind for both the business

and an upward re-rating of the stock once investors begin to notice the transformation occurring.

2) After two years of resisting overtures including two back to back proxy fights with an investor group,

on September 19, 2016, a settlement was reached. As a result, the BOD now has a majority of seats

taken by investors or investor appointed nominees. Their stated agenda is to cut costs and sell the

company.

3) On December 20, 2016, the company announced the sale of their claims resolution for $147m. This

business is earning $12m of EBIT and $14.8m of EBITDA. Thus, it was sold for 12x EBIT and 9.7x

EBITDA. With these proceeds, the balance sheet will be transformed and net debt free, rendering the

credit facility covenant violation irrelevant. The deal is scheduled to close in Q1’17.

Financials:

1) The EV can be created for ~$170m proforma for Q4’16 FCF of $22m, the receipt of the proceeds from

the claims division sale $143m net, $8m of past due but money good receivables from Oman and $16m

of retainage receivable due upon project completion of an airport in Oman.

2) Proforma 2017 EBITDA looks to be about $34m driven by about $52m in project management EBIT,

overhead of about $25m and D&A of about $7m. 2018 EBITDA looks to be about $42m as corporate

overhead is reduced further to a normalized level of $22m and the project management business

enters year 1 of a multi-year cyclical recovery. We believe this 2018 estimate is representative of

current run-rate earnings power with upside potential from further corporate overhead

rationalization—as stated to be the primary focus of management now that the business has become

far less complex. As importantly, it appears very likely that revenue growth will accelerate above our

highly conservative forecasts for a decline of 1% in 2017 (despite backlog inflecting positively) and

growth of only 4% in 2018.

3) We believe a sale is highly likely though it’s unclear if it occurs in 2017 or 2018. When it occurs, we

believe all corporate overhead will disappear and there will be additional synergies from segment

SG&A consolidation. Taking only the $22m of corporate overhead assumed in 2018 and adding it to

our run-rate estimate of $42m, suggests partially-synergized EBITDA of $64m.

Valuation:

We believe the most appropriate three comps are Jacobs Engineering (JEC), AECOM (ACM) and NV5 Global (NVEE). We are intimately familiar with all three companies. Presently, their respective FWD EBITDA multiples are 10.3x, 10.1x and 8.3x.
HIL is being created for 4x run-rate EBITDA today as noted above.
HIL is being created for 2.6x partially synergized EBITDA as noted above.

What we are playing for:

Under the scenario of at takeout, which we believe is likely within 2 years or less, we believe 7.5x partially synergized EBITDA is reasonable based on past precedent. 7.5x $64m + ~$76m of net cash by the end of 2017 assuming receivables are collected is a mkt cap of $556m. With 52m S/O, this is $10.70, 145% upside. Alternatively, 10x un-synergized EBITDA is $9.53, 120% upside.
Under a standalone scenario, within 12 months, we believe we are playing for at a minimum 8x $42m of EBITDA + $76m of net cash = mkt cap of $412m, stock price of $7.90, 80% upside.

Downside risks and mitigation:

If the claims business sale fails to close, HIL will remain in an over-indebted situation and in negotiation to amend covenants. How low the stock “trades” under that scenario is a matter of guesswork but we fail to see a scenario lower than about $3.25, 25% downside.
As importantly, should management execution stumble, the urgency of a sale will increase.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts:

Q4’16 - FCF generation worth 10% of mkt cap (due to seasonality and partial Oman receivable collection)
Q1’17 - 2017 guidance provides visibility into corporate overhead reduction and revenue growth inflection
Q1’17 - Proceeds from claims business transform the balance sheet to a net cash position
Q1’17, the net cash balance sheet should be reported with Q1 results or by Q2 at the latest.
Q1’17 - Street analysts begin to feel comfortable recommending the stock with the certainty of the deal closing combined with comfort around management’s
2017 guidance and revenue growth inflection
2H’17 - the story will be really great: accelerating organic revenue growth, pure play on Trumponomics, cost cutting run-way, net cash balance sheet, under-followed small cap has plenty of room for additional analyst attention, Middle East revenue will stop declining as budgetary pressure subsides given the stabilization in the oil price, M&A in the fastest growing region (US) begins, generating the next leg of growth
2018 - company is sold

show sort by

			2017	2018
Price:	4.30	EPS	.34	.48
Shares Out. (in M):	52	P/E	12.6	9
Market Cap (in $M):	223	P/FCF	8.3	5.7
Net Debt (in $M):	-30	EBIT	29	37
TEV (in $M):	193	TEV/EBIT	5.9	3.5