Description

Description: Hill International (HINT) is a little known construction project management company that recently came public via a reverse-merger into the Arpeggio SPAC.  Hill has generated organic revenue growth exceeding 40% on a YTD basis, and trades at approximately 12.5x highly visible 2007 earnings.  Hill is debt-free, and the new CFO recently made a small purchase of stock at these levels.    

Overview: Hill was founded thirty years ago by Irvin Richter and today is the largest project management firm not part of a general contractor / construction company.  Overall, it was the 17th largest project management firm in the world based on 2005 table rankings and is probably the tenth largest today.  The business is comprised of project management (2/3 of revenues) and claims consulting (1/3). 

The origin of the company is in the claims consulting business which is a global industry where, even as a relatively small firm in terms of revenues, Hill had an international reputation.  Excelling in claims consulting, which is a service provided at the end of a job, has allowed Hill to slowly win project management business in foreign markets.  Construction project management is a far more regional business where local projects and references are the key to winning new business.  On a YTD basis, 50% of revenue is in the US, 17% in Europe (primarily Eastern Europe), and 32% in the Middle East.  It’s worth noting that the vast majority of the revenue from the Middle East is being done in places like Dubai and Qatar; very few of their projects are reconstruction in Afghanistan / Iraq.  The client mix is 42% private sector, 32% state and local government, 16% foreign government, and 10% US federal government. 

Hill has grown revenues at a CAGR of greater than 20% organically for the last five years, but growth has accelerated to more than 40% this year.  (You have to look at “net revenues” to get an accurate read of top-line growth as certain projects have embedded costs that are a pure pass-through.)  The construction management business carries with it no cost over-run risk that the general contractor construction business does, which makes for a higher quality earnings stream.  Additionally, Hill has excellent visibility into forward revenues based on their backlog of projects which have an average duration of greater than two years. 

Industry: Large construction projects require the services of a project manager to represent the client’s interest with the general contractor.  The general contractor is a large construction firm that will deliver a project for a specified price in a given timeframe; e.g. they will agree to build a football stadium for $600 million in two years.  The client, in this case the team owner or college, has relatively little experience with large construction projects and so they will hire a PM firm to hold the contractor to the agreed upon cost structure and schedule.  The PM firm will also help the client identify in advance possible trouble areas and work to keep cost over-runs to a minimum.  Without the presence of a PM who knows the construction industry practices well, a contractor will aggressively bill clients for any project changes, often resulting in massive cost-overruns to the client.  A PM firm is paid as a percentage of project cost, typically 1% to 3%.  Most of the large PM firms are divisions of multi-billion dollar construction companies, such as Parsons, Jacobs, KBR, etc.

The second Hill division is Claims Consulting.  Nearly every large construction project (> $100 million) has disputed claims resulting from changes in the project design that lead to cost overruns which can sometimes be massive.  Project changes are the opportunity for a contractor to meaningfully improve the project economics if they can get the client to pay for it.  Hill is brought in to a dispute to audit the project and attempt to negotiate a settlement with the other side, or failing a negotiated settlement, to serve as expert witness in litigation.   Hill is the second largest CC firm globally after Navigant Consulting, which does $90 million a year in claims consulting revenues. 

Hill International: The relevant components to calculate 2007 earnings are as follows

-         Knowles: Hill purchased the London based CC firm on Sept 1 for $13m.  The company was breakeven on $46m in net revenue LTM.  There are a fair amount of cost savings opportunities from 1) the departure of senior management 2) consolidation of branch offices and 3) the exiting of two small money losing divisions.  Hill management estimates that Knowles will generate 5% EBIT margins for the balance of this year and 10% EBIT margins in 2007 on $42m in net revenue; net revenue is expected to decline by $4m due to the exiting of non-core businesses.

-         Backlog: Hill has historically generated revenues of 120% to 130% of their 12-mo backlog in a given year.  Importantly, this relationship holds on the pre-Knowles mix of business; as CC is shorter backlog work, the ratio cannot be applied to the entire backlog.  The non-Knowles backlog at the end of Q3 was $115m and is expected to be $125m at the end of the year, suggesting “core” Hill revenue of $156m plus the $42m of Knowles revenue.

-         Tax rate: Hill’s taxes are 21.9% on an LTM basis, but we are modeling 25% for 2007.  Taxes on their International business are substantially below that in the US, and we believe 25% is a long-term sustainable tax rate.

-         With the field structure mostly built-out, incremental revenues have approximately 20% EBIT margins versus current EBIT margins of 8.5%

Capital Structure: The terms of the merger agreement with Arpeggio call for the Richter family to earn 6.5 million shares from 2006 to 2009 if they hit certain EBIT thresholds.  Because of their recent acquisition of Knowles, it is a foregone conclusion that they will hit these triggers.  There are also warrants from the SPAC struck at $5 share (these trade freely under HINTW).  The capital structure is as follows:

Basic shares:                22.3m

2006 earn-out:              2.3m (trigger is $9.9m EBIT)

2007 earn-out:              2.3m (trigger is $13.5m EBIT)

2008 earn-out:              1.0m (trigger is $18.4m EBIT)

2009 earn-out:              1.0m (trigger is $24.9m EBIT)

Total earn-out shares:   6.6m

Total warrants plus underwriter units: 14.5m (generates cash of $75m)

Market cap:                  43.4m shares @ $6.68 = $290m

Warrant cash:               $75m

Enterprise Value:          $215 million

Hill has a credit facility for $25 million and modest net cash today. 

Richter Family: Irv Ricther is the founder and CEO; his son David Richter is COO and the liason to the investor community.  Together, the Richter family owns 60% of the shares of Hill International, and it represents 95%+ of their family’s net-worth.

Construction Industry: There are no pure comparables to use when evaluating Hill’s earnings multiple.  A valuable illustration is to compare them to the commercial construction group of Jacobs, Washington Group, Foster-Wheeler and Fluor.  These firms all trade at 18x to 22x consensus estimates for 2007.  Hill is growing faster than these firms and is insulated from the cost-overrun issues that periodically plague construction companies.  It seems reasonable based on growth rates and earnings quality that Hill is materially undervalued at 12.5x 2007 earnings.    

Catalyst