Description

Innovate Corp (VATE) previously known as HC2 (HCHC) has undergone a transformation through an activist push, resulting in dismissing the former CEO, divesting non-core businesses, refinancing debt, reducing opex and raising equity through a rights offering that has allowed management/the new board to focus on three core businesses with an ultimate liquidation/asset realization of two businesses and ‘re-IPO’ of the third business to eliminate the holdco discount and realize significant upside. We believe that as these events occur, the sum of the businesses is worth $21.50, offering 5x upside over 2.5-3 years.

VATE has had a very sordid history, resulting in significant shareholder turnover, over the years. We invested in very small size in 2018 because we viewed Phil Falcone as a visionary (thoughtful around CDS trades in the recession, original spectrum trade that created a windfall for Charlie Ergen though Phil couldn’t have predicted the GPS interference with Lightsquared) but we were always a bit apprehensive of him as a fiduciary. In late 2018, as the debt markets seized, Phil issued extremely high-cost debt which caused the stock to drop precipitously. From then through late 2019, the stock bounced around all-time lows given HC2’s high corporate expenses and limited asset monetization until an activist filed in early 2020. A proxy battle ensued through 2020 and the activist prevailed, even turning original Falcone supporters.

The new board then raised capital through a rights offering to shore up the balance sheet, sold the insurance subsidiary which had certain holdco guarantees (eliminated in the sale) which allowed them to refinance corporate debt cheaper, sell additional subsidiaries and scale up in the infrastructure/steel fabrication business through the acquisition of Banker Steel. We are now left with three businesses, (1) DBM/infrastructure/steel fabrication, (2) Pansend biotech venture portfolio, (3) HC2 broadcasting.

The key here is that this is not a theoretical SOTP story. We believe management/the board will work to monetize and distribute assets over the next 2.5-3 years; that’s how we get paid.

(1) Infrastructure/DBM/Steel Fabrication

DBM is one of the largest steel fabrication, modeler, detailer, and erection companies in the country. They have a decentralized management structure with Chairman & CEO Rusty Roach having been with the company for 20+ years, beginning as an estimator and project manager. DBM has a presence on both coasts (post Banker acquisition) and has fabricated Apple’s and Facebook’s headquarters, the One Vanderbilt and JPM buildings in New York along with bridges, airports and other infrastructure projects around the country. The steel/commodity price risk is mitigated by locking in steel prices for the entire project at the RFP and passing the cost on to customers; backlog has grown considerably with the onshoring trends and Infrastructure Bill. While the North American steel fabrication industry was expected to grow at 6%/year from 2017-2026, we think the aforementioned incremental secular trends means 10%+ annualized growth which, again, we can already see in DBM’s backlog. We also expect continued margin expansion as low-priced contracts struck in COVID roll through backlog and the increased demand soaks up capacity, resulting in higher pricing.

Valuation: We believe DBM can do about $1.4bln in 2023 revenue at a 12% EBITDA margin or $170m in EBITDA. At 8x EBITDA (ex the small percentage of DBM they don’t own and $190m in debt), it’s worth $1.1~1.2bln or $14/VATE share. With about $8m in interest expense (though the debt is being paid off quickly), $15m in taxes and $25m in capex, DBM would do $120m in free cash flow excluding working capital; 10~11x FCF would yield a similar $14/VATE share in value. Obviously, this does not include holdco debt which we eliminate from our full SOTP.

(2) Pansend Life Sciences

The two major businesses in Pansend include R2 Technologies and Medibeacon.

(A) R2 is the manufacturer of the GlacialRX skin toning treatment, for which it received FDA approval last year. R2 was founded by Rox Andersen, a Harvard Dermatologist who also founded Zeltiq, the company behind CoolSculpt which sold to Allergan for $2.4bln. Most of the management team at R2 includes former Zeltiq management and VATE management views the path for R2 as similar to Zeltiq, an IPO at $25-30m in revenue and a potential sale, thereafter. In a nutshell, R2 uses a pigmentation/melanin freezing technology that stops production of melanin in the skin. We attended an R2 dinner for Dermatologists several months ago and were impressed by the technology and the receptivity. That said, candidly, we believe the true gem within R2 is their GlacialSpa/GlacialAI treatment in ‘Eastern Hemisphere’ countries where skin lightening in spas is a big business. This global treatment impedes melanin production in the skin to lighten the face, overall. We believe this device rolls out in Asia in 2023 and will massively accelerate revenue. We also believe the likely path of monetization is an IPO of R2 in late 2022 or 2023 (more likely 2023). We believe VATE holds onto shares post-IPO and spins/sells them (NOL dependent) through 2023/2024.

(B) Medibeacon is real-time GFR kidney monitoring device using a tracer technology. The initial Pivotal Study will begin with the FDA in Q2 2022, where the approval process is significantly faster than the drug approval process. Medibeacon is also testing their tracer technology for Gastrointestinal health, too. Bottom line here, Nephrologists with whom we’ve discussed Medibeacon say nothing like this exists on the market and would be a game changer in kidney health. People close to the company have thrown out $1bln+ valuation numbers on Medibeacon, alone.

Valuation: Assuming $1bln in equity value for both R2 and Medibeacon (40-50% ownership of each) would mean $6/VATE share in value. This could be conservative given the aforementioned thoughts on Medibeacon’s valuation and Allergan’s purchase price of Zeltiq. This also does not put any value on their other holdings in Pansend, Genovel and Triple Ring, though they have invested only about $7m combined in them. One of the other main points here is that both R2 and Medibeacon do not require additional funding from VATE so the holdco will not burn additional cash.

(3) HC2 Broadcast

Broadcast is probably the furthest out monetization based on cash flow though an acquisition by a strategic could happen sooner given the massive optionality in the business. Broadcast consists of 230 broadcast stations in over 90 US TV markets including 34 of the largest 35 markets. This comprises about 2.3bln Mhz-Pops of spectrum, 90% of which is UHF. There are about 80-90 networks on HC2 stations which offers significant ‘whitespace’ to continue leasing stations. The business is just that, leasing stations though management believes this is a placeholder for the time being. In an OTT streaming world where broadband customers cord cut, there is value to offering content over the air since viewers can buy a ‘bunny ears’ antenna and watch ad-supported content for free. In rural areas where broadband speeds are low, streaming services can lease HC2 Broadcast stations and stream shows in those rural areas where they otherwise would not get eyeballs. Broadcast is now free cash flow positive with high incremental margins which means additional station leasing will fall to the bottom line.

That said, in a 5/6G world, we view an entirely different use of Broadcast’s spectrum. We believe that over time, using the ATSC 3+ broadcast standard, broadcasters can wholesale their spectrum where the carriers need it for IOT/autonomous vehicles…etc. With so much data beamed to and from an autonomous vehicle, networks will be congested and broadcast spectrum could offer an additional distrution mechanism to beam information to the autonomous car which would have an antenna to receive data in a one-way transmission. This is extremely hard to value since it’s at least 3 years away but Falcone knows the industry well and we believe he was most excited about Broadcast’s massive optionality within HC2. We also think their scale of whitespace stations is unmatched which provides value to an acquirer or carriers in a wholesale lease.

Valuation: Again, this business is tough to value but we believe they can do $10m+ in EBITDA in 2023 so the bottom end is likely at least $100m at 10x. If we value their top 10 DMAs at $0.50/mhz pop, we get about $500m in value which assumes nothing for the other 80 markets.

Putting It All Together

We think VATE is misvalued because the business was previously poorly managed, has had a shakeup by an activist and a rotation in shareholders with limited liquidity, no sell-side coverage and is an orphaned, special-situation.

The new Chairman, Avie Glazer has bought significant stock in the open market and the company just issued a poison pill late last year so as not to impair the NOL. This means insiders cannot keep acquiring stock so they are likely incentivized to monetize the assets.

We think an IPO of R2 likely happens in 2023 with a potential spin to shareholders in 2023/2024. We think HC2 Broadcast either continues to lease up stations with potential wholesale data leasing in 2023+ with the rollout of ATSC 3+ and 5G with distributions to shareholders and we think Medibeacon is sold/IPO-ed in 2023, also. Finally, we believe we are left with DBM, at which point the company does a name change and ‘re-IPO’ of the business in 2024 with sellside sponsorship. We realize additional upside on top of the asset monetization from multiple expansion in DBM as it becomes a pure-play infrastructure business.

We view 2022 as a year where the market sees continued earnings power growth in DBM, all the potential at R2 and Medibeacon and some semblance of how the Broadcast business model will play out. We see the stock drifting higher as all this ensues and investors understand just how truly undervalued VATE is.

We view base case upside as DBM ($14)+Pansend ($6)+Broadcast ($7)-3 Yrs of Corp Opex ($0.50)-Holdco Debt ($5), yielding fair value of $21.50, offering 5x upside.

Catalyst

We think an IPO of R2 likely happens in 2023 with a potential spin to shareholders in 2023/2024. We think HC2 Broadcast either continues to lease up stations with potential wholesale data leasing in 2023+ with the rollout of ATSC 3+ and 5G with distributions to shareholders and we think Medibeacon is sold/IPO-ed in 2023, also. Finally, we believe we are left with DBM, at which point the company does a name change and ‘re-IPO’ of the business in 2024 with sellside sponsorship. We realize additional upside on top of the asset monetization from multiple expansion in DBM as it becomes a pure-play infrastructure business.

We view 2022 as a year where the market sees continued earnings power growth in DBM, all the potential at R2 and Medibeacon and some semblance of how the Broadcast business model will play out. We see the stock drifting higher as all this ensues and investors understand just how truly undervalued VATE is.