- MDU spun off KNF (aggregates) business two weeks ago. KNF has traded well, and pre-spin MDU has risen from $28-29 to $32.50 this morning.

- But post-spin MDU has not moved, and this is where the opportunity now lies.

- The current price is mis-valuing the Construction Services business, and conveniently, this is where the catalyst is

- There is a high probability the Construction Services business will be sold in the next month, and MDU is worth +20-30% from here.

 

MDU has 3 assets:

(1) They retained 5mm shrs of KNF, which are worth $1 per share to MDU.

(2) Utility/Pipeline segment (Regulated Energy Delivery, or RED)

(3) Construction Services

RED will produce $145mm of earnings in 2023, and the Construction Services business will produce $135mm of earnings in 2023. These segment numbers account for all the debt. Capex is slightly higher than D&A, but this is due to the growth. Both businesses are stable, and the Construction Services business has tailwinds from infrastructure spending. Management is OK (competent and not scummy) but has not been great at running these businesses. There could be some added upside in better operations, but that is not the thesis.

 

After taking out the KNF shares, MDU trades at 14x. RED is worth 15-17x, but the key here is that CS is worth north of 20x.

I believe this valuation is interesting (not compelling) even if the two remaining businesses remained together.

But what makes this compelling is the high probability of a sale of the CS business. The facts:

- Corvex went activist in Aug 2022. This is long after the KNF spin-off was announced, and there was no indication management intended to renege on the spin off.
- In Dec 2022, MDU announced Strategic Review of CS business. They have recently stated this review will be completed in Q2 and an announcement will be made on or before Q2 earnings are reported in early August.
- In Jan 2023, MDU and Corvex signed a Cooperation Agreement and Corvex got a Board seat. And importantly, "Under the cooperation agreement, Mr. Gemmel will offer his resignation from the board under certain circumstances, including completion of the separation of BOTH MDU Resources' Knife River business AND MDU Resources' MDU Construction Services Group business." (emphasis mine)
- In Feb and May earnings announcements, "MDU Resources' board of directors has determined the future company structure that is most likely to maximize long-term value for shareholders is to create TWO pure-play publicly traded companies, one focused on regulated energy delivery and the other on construction materials. To achieve this future structure, the company expects to spin off Knife River on May 31 and expects in the second quarter to complete a strategic evaluation of its construction services business.
- In recent presentations, MDU has slides that report numbers according to "Future state as a pure-play regulated energy delivery company." I.e. without the CS business. Comments in calls are consistent with this.
- "Long term goal is to become a pure-play regulated energy delivery company." The "long-term" is bothersome, but if the intention is to sell/spin in, say, 3 years, I doubt they would include these detailed slides or make the comments they have made.

Based on the comments and timing, MDU is well on its way to selling the Construction Services business. Based on the "two pure-play publicly traded companies" language, it is clear they intend to sell CS rather than spin it in 2024. The process must be fairly far along at this point, and they should have a good idea of the price at which that can sell the CS business. If the price were not adequate, MDU would simply announce a spin. At the least, Corvex would be protesting the sale of the CS business rather than a spin.

 

One relevant note is the lack of interest there has been in MDU given the activities over the past 18 months:

- spin off of KNF

- activist

- announced strategic review of CS business

- until the past week, the pre-spin MDU basket had barely budged, trading at the same levels it was before the KNF spin was announced

- I tried to re-start the old MDU thread on VIC. Crickets.

- Other than a cursory mention, I have seen almost nobody mention this name on Twitter, substacks, spin-off idea blogs, etc.

- KNF initially sold off to $34/shr. But has since rebounded strongly. KNF was not kicked out of MDU index, and it is 1/3 the total value of pre-spin MDU value. So it should not have suffered typical spin-off dynamics.

- Option open interest was tiny until recently.

- My impression has been that there has been little interest in the situation, and I like that.

Valuation of CS and Total

 

In looking at the CS business, several relevant facts:

- weighted towards infrastructure projects funded by government and utilities so less cyclical

- multi-year tailwinds ahead from the Infrastructure Bill

- boring, steady business

 

The closest comp for CS is $MYRG. It is also weighted towards electrical infrastructure projects. Similar size.

$PWR and $ACM are also good comps although much bigger. Quanta ($PWR) is the best run and largest player.

These 3 comps are weighted towards public/utility infrastructure projects and trade at similar valuations, with PWR getting a 5-10% premium.

They trade at 25-27x unlevered FCF (using maint capex) and also have similar EBITDA (15-17x) and P/E multiples.

 

One note is that I see some sell side use names like $EME as comps. And EME trades at 2/3 the valuation of the 3 names above. There is some overlap in the businesses, but names like $EME are much heavier weighted towards private construction projects. Much more cyclical. So these names deserve to trade at a lower multiple of their peak (current) earnings.

 

If they sell for 25x, after taxes, that will be $14/shr. If they sell for 20x, after taxes, that will be $11.50/shr. I do not think Corvex will sit idly by if they try to sell this for less than 20x, and I think there is a good chance this will fetch the high end of this range.

 

One intriguing possibility here is a RMT with $MYRG. This would eliminate the tax bill and add $2-3/shr to the value. They are a fairly ideal match in terms of functions.

 

My valuation is $14/shr for the CS biz + $11.50 for the RED biz + $1 for the KNF shrs = $26.50. One key here is that at 14x for the combined businesses, I do not see a lot of downside. Famous last words, of course.

 

There will be tax leakage of $2+/shr in the event of a CS sale. This is in the numbers above. However, they may get paid a premium to my price if they get paid for some of the synergies in a strategic acquisition. Again, at some point, they would spin CS rather than sell it.

The fact that Corvex is on the Board is important here as Corvex must have similar valuations to my numbers, or they would not have gotten involved in MDU in the high 20s and would not be pushing for a sale now. And they are not going to sit by if management seeks to sell the CS business for a song.

Risks
- The sale price of CS is less than $2.5bn. I think this is low probability due to Corvex's position. This is the big risk: I am wrong about the CS valuation.
- MDU announces it is not selling or spinning CS.