Description

KSW Inc. (KSW)

KSW has a market cap of about $41 million and $18 million of cash on its latest balance sheet (9/30/07) for an enterprise value of about $23 million.  KSW is trading at 30% of LTM revenues, 4x LTM EBIT, 6x LTM free cash flow,  and 6x LTM EPS (net of cash) and has an ROIC over 100%.  We think KSW is a good business trading at a relatively cheap price.

KSW furnishes and installs heating, ventilating, and air conditioning systems.  The company offers its products under direct contract with owners of buildings and subcontracts with general contractors or construction managers.  KSW also serves as a mechanical engineer performing project management services relating to the mechanical trades, such as dividing the mechanical portion of the project into packages for subcontractors and equipment, negotiating contracts, and coordinating the work. 

KSW specializes primarily in the NYC market and seeks to achieve a competitive advantage through its value engineering process.  Value engineering is a process where KSW works closely with the building owner or general contractor upfront to provide an equal or superior HVAC system at less cost.  Company management maintains that they almost never enter into competitive bidding situations, with most of their projects generated by relationships and word of mouth.  The cost savings which KSW can provide to building owners or contractors are significant enough to allow KSW to earn attractive margins (gross and EBITDA) relative to other players in the industry (see Comparables).

KSW has a list of current projects on its website including:  Fifteen Central Park West, 170 East End Avenue, 325 Fifth Avenue, Barclay Tower, One Brooklyn Bridge Plaza, Crest Lofts, Cocoa Exchange, North Side Piers, The Harrison, The Brompton, NYPH Cardiovascular Center, Trump International Hotel and Tower, Tribeca Green, Providence Rest Nursing Home,  and 20 Exchange Place.  

KSW has previously completed projects for the following industries:  Hospital/Research (including Weil Cornell Ambulatory Care Building, New York Hospital Greenberg Building, St. Luke’s/Roosevelt Hospital), Transportation (including JFK Terminal One, Grand Central Station), Education, Courthouses, and Specialty Buildings.   While KSW has completed public projects and has this capability, management believe the margins and terms are much better on private projects at present and has focused on that area.

You can look at the list of current and completed projects at KSW’s website, which is www.kswmechanical.com. 

Because KSW specializes in the NYC market its management team is more familiar with project conditions, labor unions, and other local factors which is another competitive advantage.  According to management, there is only one other player doing value engineering in the NYC market and KSW has not bid on projects where this player is involved and vice versa.  KSW’s customer base and revenues are somewhat concentrated but its customers are large, established design and engineering building firms:  Bovis Lend Lease (40% of 2006 revenues), Newmark Construction (18% of 2006 revenues) , Glenwood Management (10% of 2006 revenues), and Skanska USA (10% of 2006 revenues).

KSW has a strong backlog of projects which should bode well for continued strong revenues in 2008 and over the next 18 months.   Gross margins and EBITDA margins have been steadily improving as fixed overhead and project labor costs are being allocated among a larger number and dollar amount of projects.  We also believe the Company has been able to be more selective in choosing projects which have better terms and more attractive gross margin potential, which is a major reason why KSW’s profit margins have increased during 2007.  KSW has indicated that its 2007 year-end backlog was close to $110 million, about even with prior year.  However, we would note that KSW was recently selected as trade manager for an approximately $58 million HVAC project for Mt. Sinai Hospital in Manhattan to provide pre-construction services on a fee basis, providing value engineering and generating a final HVAC construction budget.  There is a good possibility that KSW would continue to serve as trade manager during the construction phase, which would result in this large project being added to KSW’s current backlog.  Also we believe the gross margins imbedded in the backlog are likely to be strong given management’s selective approach to choosing projects in recent periods.  Management says it would be extremely unusual to have a project cancelled out of backlog since backlog projects represent firm contracts.

KSW’s attractive non-capital intensive business model allows the company to earn high returns on invested capital and generate significant free cash flow.   The Company’s primary investment is the upfront working capital required to start a project before payments are received from the owner or general contractor.   KSW’s LTM ROIC (EBIT to the sum of working capital, excluding excess cash, plus net PPE) was over 100%.  We think KSW’s most important asset is its strong reputation, track record of performance, and relationships in the NYC marketplace.  We believe these are not insignificant barriers to entry for many other larger and smaller competitors.

The result of KSW’s strong business model and a resurgent NYC building market has been significant generation of free cash flow by KSW.  The net cash position on the b/s has built up from $4 million at 12/31/04 to $18 million at 9/30/07 (representing over 40% of the market cap).  Unless the NYC real estate market falls off a cliff, which we don’t think will happen but is discussed a bit below, we think KSW can generate $4 million or more of free cash flow annually at current levels of operation, so we expect KSW’s cash balance to grow absent major dividend, buyback, or acquisition programs.  (Note that cash balances can move around a bit quarter to quarter due to working capital ebbs and flows).  We think this annual free cash flow, which represents a 17%+ FCF yield on the current enterprise value, as compared to a 4%  ten year treasury rate, compensates us for the risks involved here.

Clearly the NYC real market could weaken more significantly that we expect, resulting in new projects being delayed or cancelled, and that is one risk here.   KSW suffered greatly after the 9-11 terrorist attacks and that is another risk here.  F.W. Dodge’s recent report on the non residential building industry had 2006 +18%, 2007 +7%, 2008 -2%, 2009 +1%, and 2010 +5%.  The industry has recovered significantly from very difficult years of 2001 to 2003, which were among the worst in 30 years.   One additional risk for the NYC market is the high concentration of financial companies located in NYC.  However, we think the long term prospects for the NYC real estate market are solid, helped in part by the sharp downturn and dearth of projects during 2001 to 2003.  We also believe that KSW could buffer any decline by participating in public projects.   Our review of comments by other industry players indicates that companies like KSW are late cycle participants if there is a downturn.  FWIW management says they presently have more project opportunities than they can handle, they see no indication of a slowdown, and are simply focusing on those with the best profit margins and terms and that the weak dollar is driving huge demand from foreign investors.  That said, if NYC has a huge commercial real estate downturn, it will clearly impact the company’s results and this risk has to be considered.

 

Financial Summary:

Recent financial information for KSW is presented below:

Price per share		$6.50
Shares outstanding		6.2
Market value		$41
52 week range		$5.70	$8.65
Income statements							9mos	9mos
FYE 12/31		2002	2003	2004	2005	2006	2006	2007
											Avg Daily
Sales		$46	$35	$26	$53	$77	$58	$58			Volume
EBITDA		$1	$1	($1)	$3	$5	$3	$4			22,000
EBIT		$1	$1	($1)	$3	$5	$3	$4
Net income		($2)	$1	($1)	$3	$3	$2	$2
EPS - diluted		$  (0.41)	$     0.15	$  (0.24)	$   0.50	$   0.48	$     0.30	$   0.39
Cash flow statements							9mos	9mos
FYE 12/31		2002	2003	2004	2005	2006	2006	2007
Net income		($2)	$1	($1)	$3	$3	$2	$2
Dep & amort		$0	$0	$0	$0	$0	$0	$0
Non cash adjust		$4	$0	$0	$0	$1	$1	$1
Working capital chgs		$0	$0	$1	($1)	$5	$3	$0
Cash fr operations		$1	$1	($0)	$2	$9	$6	$3
Capital expenditures		$0	$0	$0	($0)	($0)	($0)	($0)
Dividends		$0	$0	$0	$0	$0	$0	$0
Share repurchases		$0	$0	$0	$0	$0	$0	$0
Other		$0	$0	$0	$0	$0	$1	$1
Est. free cash flow		$1	$1	($1)	$3	$4	$3	$3
Balance sheets
FYE 12/31		2002	2003	2004	2005	2006	9/30/07
Cash		$3	$3	$4	$6	$15	$18
Total assets		$17	$17	$14	$23	$36	$42
Total debt		$0	$0	$0	$0	$0	$0
Shareholder equity		$7	$8	$7	$10	$13	$16
Backlog				$       36	$      82	$    110	$      101	**
Valuation & Valuation Ratios
Market value		$41		Enterprise value / EBITDA			4.0
Net debt		($18)		Enterprise value / EBIT			4.0
Preferred stock		$0		Enterprise value / Cash from Ops			4.0
Enterprise value		$23		Enterprise value / Free cash flow			6.0
				Enterprise value / Revenues			0.3
				Market value / Cash fr Ops			7.2
				Market value / Free Cash Flow			10.8

                                                                                                LTM P/E (net of cash)                                     6.5                                                                                         

 

** Mgmt indicated in a recent press release that 2007 year-end backlog was about $110 million.

 

 

Major shareholders
Warkol, Floyd                               730          11.7%			11.7%
Moab Capital Partners***             609           9.8%			9.8%
Nicusa Capital                              575           9.2% Morgan Stanley & Co.                  330           5.3%			6.9%
T.H. Lehman & Co                       293            4.7%			4.7%
Paul Bruce                                   288            4.6%			4.6%
Renaissance Tech                       170            3.4%			3.0%
			2.7%
*** Moab Capital filed a 13-D which included an industry comparable spreadsheet which we have updated below and some useful insights on KSW.

 

 

 

Comparable Company Analysis			KSW Inc (KSW)		CmfrtSys USA (FIX)		Emcor Group (EME)
Primary Business Area			Large commercial		Res & Inst HVAC &		Mech & Electrical con-
			HVAC engin/constrc		plumb install, maint.		struction and facil svcs
Regional Focus			New York City metro		Natl, South. States		Global
Stock Price (2/26/08)				$      6.50		$   12.00	$25.00
Market Capitalization				$        40		$     489	$1,640
Enterprise Value				$        23		$     392	$1,615
LTM Revenue				$        78		$   1,084	$5,927
Backlog				$       101		$     819	$4,500
Backlog-to-LTM Revenue				1.3		0.8	0.8
Year over Year Backlog Growth				(3)%		4%	29%
LTM EBITDA				$       5.8		$    54.0	$238.0
EBITDA margin				7.4%		5.0%	3.4%
Enterprise Value / EBITDA				4.0x		7.3x	6.8x
LTM Capital Expenditures				$       0.1		$      9	$22
LTM EPS				$      0.57		$    0.75	$1.86
P/E Multiple (net of cash)				6.5		12.8x	13.4
Enterprise Value / Revenue				0.3		0.4	0.3

 

 

 

 

 

 

Disclaimer

 

Disclaimer:  We own shares of KSW.  We may buy or sell these shares at any time without notice.  The information in the write-up is believed to be correct as of the date written but VIC members should do their own verification of this information and analysis of this potential investment.  We undertake no obligation to update this write-up if new information arises at a future date.

 

 

Conclusions

 

Good long-term business which is not capital intensive

Established niche competitive position and key relationships in NYC market

Attractive valuation on relative and absolute basis

Large backlog should lead to continued strong earnings and cash flow in 2008

Strong balance sheet with significant excess cash position (over 40% of market cap)

Attractive high ROIC business

Potential  acquisition candidate by a player seeking NYC presence

 

 

 

Risks

 

Severe downturn in NYC real estate market will impact KSW results.

Revenues and backlog are very lumpy. 

Income, working capital, and cash balances can vary from quarter to quarter

Small auditor and there have been some non-major accounting mistakes

Management team may not be aggressive in utilizing excess cash to maximize shareholder value

 

 

Catalyst

Good long-term business which is not capital intensive

Established niche competitive position and key relationships in NYC market

Attractive valuation on relative and absolute basis

Large backlog should lead to continued strong earnings and cash flow in 2008

Strong balance sheet with significant excess cash position (over 40% of market cap)

Attractive high ROIC business

Potential acquisition candidate by a player seeking NYC presence