Description

This writeup updates and expands on the work posted by AAOI, which originally got us to take a deeper look last year and remains an excellent resource. LMB shares have dropped a long way from highs in the 16’s following its move to NASDAQ and Q4 results, and we believe represent good value here. In the spirit of giving credit where credit is due and keeping thoughts in one place, we suggest comments be posted on AAOI’s thread: https://www.valueinvestorsclub.com/idea/LIMBACH_HOLDINGS_INC/138935#description

Summary:

Limbach Holdings is a small, still unknown E&C firm specializing in non-res building systems. It trades at a substantial discount to peers, likely due to its SPAC history, size, illiquidity/tiny float, lack of investor attention and light Q1 results. We’ll focus on (hopefully) new points below that should be less obvious from a review of public documents and reading AAOI’s work.

•       Despite pervasive concerns about weakness in non-res markets, the company and its peers are demonstrating strong backlog visibility as they benefit from sector tailwinds.
•       LMB’s gross margins and bottom line appear depressed now, but will benefit from a number of positive surprises already built into the backlog as the year progresses.
•       The company should outperform EBITDA expectations in 2017, but even if not, will provide strong 2018 guidance in the fourth quarter so long as the macro doesn’t reverse.
•       Management is ambitious, though guides and presents their financials conservatively
•       Accretive M&A, a Trump infrastructure program, and tax reform provide additional optionality, but are not key to the core thesis.
• For small funds, the idea can be traded through the common equity (illiquid) or warrants (super-duper illiquid).

Non-Res Construction Macro:

LMB’s project mix historically tilts toward healthcare, education, airports and more recently arenas, though with some exposure to office, retail and other areas. While investors have been concerned about a possible commercial real estate slowdown based on CRE loan data and weakness in retail and office markets, LMB’s disclosed projects are largely in the former categories, which have shown a decent continuation of prior trends. In addition, commentary from peers is similarly bullish and points to improvement in the underlying demand environment.

EMCOR Q1 ’17 Earnings Call Commentary

Got it, Tony. And then you talked about the non-res market and your ability to grow at least the alongside back in the mid-single digit. If you look how everything is shaping up over the last few months and I know it's too early. Do you think to that growth rate could be sustained into next year at this point or it's too early to say? - Tahira Afzal, KeyBanc

I think it's little early, but I see nothing right now based on the bidding activity that doesn't tell to me that the market is not strong. And I will say there is definitely over the last four months an uptick in our customer sentiment broadly. And they are willing to spend money. - Tony Guzzi, CEO

Got it okay. And it seems like that is showing up a leading indicator again as well, so really supports what you are saying. - Tahira Afzal, KeyBanc

Comfort Systems Q1 ’17 Earnings Call Commentary

So if I look out and really pay attention to your commentary, it seems like you're seeing a bit of resurgence on the construction side. Are you kind of seeing this concentrated in some regions, some areas? Or it seems like it's a little more broad-based? - Tahira Afzal, KeyBanc

Well, I guess, really a positive for us as we see it's broad-based. And we're looking at it this morning, Northeast, Southeast and the West, everyone has picked up, which is a really good sign, it's not one company or concentrated in one area. - Brian Lane, CEO

Q1 Results

Despite annotating their figures as “adjusted EBITDA”, management’s approach is not to back out one-time items for 2017, which for Q1 could have included more than $1.25 mm in accounting remediation and Westinghouse claims, resulting in only $0.6 mm in EBITDA. Margins remained depressed due to the disproportionate impact of the Red Wings Arena project (larger and lower margin cost plus project), but still showed quarterly improvement.

Regarding the extra accounting work, auditors had identified a material weakness in LMB’s financial controls related to the timing of revenue and cost recognition. It has not resulted in any restatement of financials, although more conservative timing for revenue recognition may have been a factor in Q1’s results according to one source - this will catch up in future periods, of course. Accounting controls have been fixed per the CFO and the notation regarding material weakness will be removed after two quarters.

2017 Earnings

Management has guided to 2017 revenue and EBITDA of 460-480 mm and 18-20 mm.

With current construction backlog of $373 mm, of which management indicates 76% will convert this fiscal year, plus steady and growing services revenue, guidance is 95% covered give or take. In addition, management commented that an additional $200 mm in projects won could not be entered into backlog this quarter, but will become backlog largely in the next two quarters as they pass from the design stage into construction. It takes approximately 6 months from when the design is finalized (and entered into backlog) to the revenue showing up as % of completion accounting kicks in with the project coming online, so much of the new stuff is 2018/2019 revenue, given an average 18 month construction duration.

EBITDA is harder to build up, but 1.) project GMs put into backlog last year (and showing up this year) will demonstrate better margins and 2.) built-in reserves for ongoing projects have been higher than normal due to the attractive contracting environment. As current projects roll off, we should expect to see the contingency release flow through the income statement (particularly due to a high % of fixed-cost projects), so it is feasible for them to approach pre-recession GM margins of 14-15% and EBITDA margins of 6%+ (though notably this was when they were private). In addition, continued growth in higher margin and recurring services contracts helps. Offsetting these positive drivers are the layering of public company costs on a small base, continuing accounting remediation costs (few hundred k) which continued into Q2 and the lower-margin Red Wings arena project completing substantially in Q3.

The company previously guided for the forward year in their Q3 2016 earnings release, and will likely do so again. Should the company underperform 2017 guidance, which is possible given their light Q1 print and the vagrancies of project work/% of completion accounting, so long as they continue to book high margin backlog, investors should turn their focus to very strong 2018 guidance towards the end of the year.

Investor Considerations

Between 1347 Investors (the SPAC), FdG Capital (LMB’s private equity sponsor), NJ’s pension and management, more than 92% of outstanding shares are untraded. Note there are outstanding convertible preferred securities and warrants which adjust the cap structure numbers should they be exercised (figures in the header assume 100% exercise/conversion with proceeds counted as cash, which the ownership % is based on 7.45 mm shares outstanding per their proxy), but suffice to say that liquidity is far smaller than the already tiny market cap at the moment.

There is extremely strong alignment of interests, most notably 5% economic ownership held by the CEO.

The company is covered by Roth, Craig Hallum, and DA Davidson. KeyBanc appears to be on the cusp of initiating.

Anecdotally, the investor presentation following the shareholder meeting last week had a good showing from investors new to the story who came to kick the tires, plus a cadre of committed early HF owners.

M&A

While management describes M&A as a core strategy and has an integration team ready to go, they have not historically grown via acquisitions and therefore sourcing, consummating and integrating peers is not part of their DNA.

Their target criteria is $100 mm revenues, to pay 3-5x EBITDA for construction and 6-7x for services, and to have acquired management stay on. Given large and expanding working capital needs, a deal of this size will almost certainly involve some stock.

In our view, investors should not be thinking about them as IESC or other roll-ups yet. While management indicates they are having many concurrent discussions, their approach will likely be slow and measured. And currently, competition from strategics and PE may blunt their ability to do good deals. Nevertheless, E&C is very much a relationship business and they have many partners whom may be persuaded to participate alongside them in the equity.

EMCOR Q1 ’17 Earnings Call Commentary on M&A

We have done two very, we think a very good deals during the first quarter. That being said, who knows, I mean some people have expectations that are outrageous, others understand that it takes two sides to actually get to a deal. Private equity in a lot of ways will always be there and even today in my mind it's crazy but with cheap debt, they can pay a turn or turn and a half sometimes even two turns of all what the assets really were. - Tony Guzzi, CEO

Valuation

Emcor and Comfort Systems are the two most relevant comps, trading in the range of 8.5x – 10.0x on current year EBITDA with HSD/LDD growth vs. LMB’s ~6.5x on current year EBITDA with mid-teens growth. This gets us to an $17-$19 valuation on 2017 EBITDA of $21 mm (note that consensus is a touch above $17 mm, below management guidance of $18 - $20 mm). Fast forward to 2018 guidance and if investors find the $24 million consensus estimate realizable with continuing growth, and/or LMB does a good acquisition, a $20+ share price would be very reasonable.

Catalysts

Earnings beat

2018 guidance

Backlog growth

Investor awareness

Other: Trump, M&A, Tax reform

Risks/Concerns

Construction macro

Project risk – E&C firms can suffer from write-downs if projects do not meet expectations even if the fault of project partners, as happened in Q4, or if claims cannot be recouped (Q1)

Capital intensity – This business does not generate much cash currently, as its WC requirements expand during this growth cycle

MTM – This can and will trade all over the place until shareholdings become more dispersed and volumes increase

1347 and FdG exits – They will tell you they will stick around for the story to mature, but they’ll eventually need to monetize, which depending on how successfully the story is by that time, may be good for liquidity and price

Multi-employer pension plans – extra disclosure schedules in the equity raise S-1 had spurred concern that underfunded MPPs represent an unrecognized, outsized off-BS liability that will come due soon. This cost does not seem to be underrepresented, since (as opposed to typical pension accounting) these costs are flowing directly through COGS in full. Underfunded MPPs are a well known phenomenon for many industries, and unlikely to break the story in the short term.

Catalyst

Earnings beat

2018 guidance

Backlog growth

Investor awareness

Other: Trump, M&A, Tax reform