|Shares Out. (in M):||20||P/E||0||0|
|Market Cap (in $M):||254||P/FCF||0||0|
|Net Debt (in $M):||143||EBIT||0||0|
Layne Christensen Company (LAYN)
New management in 2015 catalyzed the reversal of Layne Christensen’s (LAYN) fortunes as new CEO Mike Caliel and new CFO Michael Anderson divested unprofitable businesses (Geoconstruction and Heavy Civil Engineering), cut overhead from $50M to $20M and began investing in extremely high IRR business opportunities (midstream water delivery). LAYN has executed a turnaround that has largely gone unnoticed by investors and now presents investors with an opportunity to purchase a very attractively priced collection of infrastructure businesses with a significant new growth opportunity in midstream water delivery to E&P. On a sum of the parts basis, we think LAYN is worth over $25 per share.
LAYN operates in four business segments
Inliner: Manufacturing and installation of Cured-In-Place-Pipe (CIPP), a trenchless water pipeline rehabilitation solution, LAYN is the #2 player in the US.
Mineral Services: Exploratory mine site drilling/core sampling primarily for gold and copper. LAYN also owns 50% of an unconsolidated South American JV that participates in the same business.
Water Resources: #1 US water well driller. LAYN is engaged in drilling wells, repair work, and treatment of wells for municipalities, agriculture, and industry
Water Midstream: Water delivery to E&P unconventional shale drillers (fracking) through LAYN owned pipelines and water sources in Texas
Owing to the crumbling infrastructure in the United States, particularly in the East, Inliner is LAYN’s consistent secular growth contributor. Cured-In-Place-Pipe (CIPP) is the most cost-effective way to repair leaking and deteriorating pipelines. It’s comprised of flexible resin sleeves between 4”-96” that are fed into existing bad pipes, subsequently inflated, then cured with hot water, steam or UV light. No digging up of old pipe is required and the new pipes last decades or more (50 years+). Jobs are short term in nature, generally taking days or weeks rather than months or years. For the past decade, Inliner revenue has compounded at 14% to an LTM $201M and EBITDA has compounded at 21% to an LTM $32.4M. Growth is driven by the obvious need to repair failing water infrastructure as well as a variety of government programs including the Safe Water Drinking Act, the Clean Water Act, and related EPA/municipal consent decrees that guarantee a robust demand for CIPP.
The company reported its 10/31/17 CIPP backlog of $108.7M, which represented a 3.3% decline, however management revealed that backlog spiked an additional $45M, or 40%, immediately after quarter ended to $154M. The earnings release had effectively “buried the lead.” Aegion (AEGN), the public #1 player in CIPP is experiencing similar growth in its North American CIPP business with its backlog also at historical highs and a line of sight to continued demand. LAYN’s EBITDA in CIPP for FYE 1/31/18 should fall in the $35M range with 15% growth toward $40M for FYE 1/31/19. While AEGN is not a pure play comparable due to its corrosion protection and energy services segments, CIPP represents about half of its business and AEGN trades for approximately 8.75x EBITDA. Ascribing a similar multiple to LAYN’s CIPP segment implies a value of $350M or $17.60 per share. In a sales transaction we estimate the multiple would be over 10x EBITDA implying a $400M or $20 per share of value.
LAYN is the number three mineral services driller in the Americas (predominantly US and Mexico), providing exploratory core sampling and some water services to large and junior minors. While this segment is highly cyclical (and seasonally weak in the winter), we are two years off the bottom with continued growing demand. At its peak in 2012 the business produced over $60M of EBITDA on $300M of revenue. Perhaps equally important, the business continued to generate positive EBITDA at the trough in 2015 ($1.8M of EBITDA on $86M of revenue). For FYE 1/31/18, the business is on track to do $20M of EBITDA. The last 2 quarters have each produced $5.2M of EBITDA while utilizing only 50% of the capacity of its mineral drill fleet.
Despite the uptick in mineral financials, management has indicated that drill pricing has not yet firmed up due to the available capacity. The obvious drivers of the business are gold pricing which has increased from $1,080 in early 2016 to >$1,300 today and copper pricing which has increased from a low of $2.00/lb in early 2016 to >$3.10/lb today. Continued commodity strength bodes well for this sector as do a few additional green shoots. LAYN points to the number of distinct mining projects more than doubling from 100 to near 225. Comparable pure play driller Boart Longyear publishes a chart of “Equity Raises by Juniors” showing capital raised has more than doubled in the last five quarters versus the five previous quarters. When junior miners raise capital, they drill. As of August, Boart continues to see an “uptick in coring activity driven by increased exploration” and “bidding activity remains robust.” Comparable Major Drilling also sees “exploration activity levels continue to increase…we are very pleased to see a return of demand from our services… coming out of one of the longest downturn in the industry.” Major Drilling provides a valuation comp of 20x current year USD EBITDA of $21M and 10x next year’s estimate of USD $45M. For conservativism we apply 6.5x our $25M estimate, which feels appropriate for mid-cycle earnings and results in a $160M value or $8.15 per share.
Mineral services bonus round- 50% ownership of South American JV
LAYN has a hidden asset in its 50% ownership of South American mineral services driller Boyles Bros Serviciois Tecnicos Geologicos that is unconsolidated in its income statements. Boyles operates primarily in Chile and Peru with the balance of the company owned by the founder operators who are highly reputable industry veterans now in their 70s.
For the 12 months ended 10/31/17, the division generated $11M in EBIT ($7.8M in the last 6 months) and is following the same rebounding growth trajectory as LAYN’s operated mineral services division. Boyles also earned approximately the same EBITDA as LAYN’s mineral services in their peak year 1/31/13 ($60M). We extrapolate a value for LAYN’s ownership of approximately $60-75M ($3.00-$3.80 per share). This ties to managements estimate of the division’s value in its investor presentation premised on 1-1.5x LAYN’s book value of the investment of $55M. Given the age of the operators, we think it is likely the JV is monetized in the next few years.
LAYN operates the largest water well drilling business in the US, primarily for agriculture, municipalities and industry and they have been doing it for 130 years. There are strong secular trends for the business with population growth moving west to arid regions and a general dearth of water forecasted for the next millennium. However, the significant rainfall received by California over the past two years has negatively impacted Water Services demand and its resultant financials. Further exacerbating the problem were a few large jobs that were mispriced resulting in a business that was doing $23M in EBITDA in 1/31/15 and 1/31/16 to a business that posted negative -2.4M EBITDA in 1/31/17. The bad jobs were behind them by the first quarter of this year and EBITDA rebounded to $0.5M in the first quarter after posting a -$7.5M EBITDA loss in the preceding quarter. For reference, the average water drilling job is $250-300K revenue and new wells only represent half of the business.
The other half of water services consists of repair and pump installation jobs (avg revenue of $30K) and water treatment. For the FYE 1/31/18, Water services should do $170M in revenue but will likely only produce $4.5M of EBITDA. Management contends that the business should generate 10% EBITDA margins even during a rainy year in California and closer to 15% in a drought year. The backlog at 10/31/17 was $63.4M, up 6% over the prior year. Given the relative stability of the topline, the 3-6-month timeframe for well jobs, and an unlikely three-peat for massive rainfall, we think $15M of EBITDA is a reasonable assumption for FYE 1/31/19. In a drought scenario, $23M is possible. If they can’t stabilize the margins, $10M could be in the cards. We think 9x our base case $15M EBITDA is the right valuation for $135M or $6.80 per share.
The newest business for LAYN is likely to be the crown jewel, providing rapid growth. LAYN is quickly building a midstream water pipeline business servicing unconventional E&P companies in the Delaware basin. LAYN’s thesis is simple; Water required per horizontal fracking completion in Texas have increased water demand from 130K barrels in 2013 to 500K barrels today owing to longer laterals, more frack stages per well, and more water per lateral foot. The oil rich areas are short on water and it’s not feasible to truck water in for 500K barrel frack jobs. The company announced its first deal and project in June of 2017 and in its first quarter of operation is already annualizing above the low end of its run rate guidance. The first foray was a 20 mile long high-capacity water pipeline from 1,000 water productive acres of company owned land in Pecos, TX. The entire cost of the pipeline was $18M with its initial anchor E&P providing a guaranteed payback in 4 years utilizing only 25% of the system capacity. LAYN now has 5 customers and has since invested $1M to increase the capacity from 100K barrels per day to 175k barrels per day and is investing another $4M to extend the pipeline 6 miles further into Reeves county with an expected 2-3-year payback. The extension will likely be finished this month. The Hermosa pipeline alone should annualize at $9-11M of EBITDA per year, generating a 30-50% ROIC.
In November, LAYN announced a first of its kind partnership with the Texas General Land Office (GLO) to develop and distribute non-potable water to E&P companies on 88,000 acres of state owned land. The GLO will receive an undisclosed revenue royalty. While the ink is barely dry on the deal, there are metrics to assess the size of the opportunity. There are 10 rigs within 3 miles of the Hermosa pipeline and 50 rigs within 3 miles of the GLO land. Simple math implies an opportunity 5x the size of Hermosa or something in the $50M EBITDA range. Further, LAYN management has indicated they expect the same 2-3 year payback as Hermosa. LAYN has hired experienced midstream energy professionals and CFO Michael Anderson came from a midstream service company. The long term aspiration is to connect the pipelines together as an individual unit and/or carve out the division as an independent MLP.
We estimate the Hermosa pipeline today (assuming no additional expansion) is worth 15x $10M EBITDA or $150M or $7.50 per share. The GLO business has the mid-term potential of tremendous value. If they can execute on $50M of EBITDA, I thinks it’s reasonable to apply the same 15x multiple, though I hesitate to publish such a blue-sky figure. Given the speed at which they created Hermosa, we will gain line of sight into opportunity quickly.
Management and Cap Structure
The hiring of Mike Caliel as CEO in January 2015 and Michael Anderson in July 2015 created much of the opportunity at LAYN today. In three years they have exited money losing businesses and reduced corporate bloat:
Reduced unallocated annual corporate expenses from $50M to $20M
On August 17, 2015, LAYN sold its Geoconstruction business segment for a total price of $42.3M. Geoconstruction had lost between $0.5M and $28M in each of the three years prior to divestiture
On April 30, 2017, LAYN sold its Heavy Civil business to the former Heavy Civil senior management team for $101M. Heavy Civil lost between $3M and $21M in each of the three years prior to divestiture
The capital structure largely takes care of itself in the second half of 2018. Currently, LAYN has $26M in cash, $0 drawn on a $100M revolver and two convertible debt issues. There are $100M of 8% second lien converts ($11.70 conversion) due 5/1/19 and $70M of 4.25% unsecured converts ($22.93 conversion) due 11/15/18. The 8% converts have a springing maturity to 8/15/18 to the extent the 4.25% are still outstanding. There is also an open redemption period for the 8% that begins 2/15/18, however that route requires a significant amount of make whole additional equity. The simplest solution, which I believe is the company’s intent, is to allow the 8% notes to spring in August and have them convert into equity assuming they are still in the money. If they are not, they could refi both converts with sub 4% term loan in the second half of 2018.