We believe that the shares and warrants of NRC Group (NRCG and NRCG.WS) could increase 80%+ and 5-fold, respectively, over the next 6-12 months (or sooner). To accomplish this, we expect nothing heroic: merely that the company, which has exceptional revenue visibility, achieves its well-defined targets for the remainder of 2018 and 2019, and that its enormous multiple disparity with peers closes. Given our view that guidance is conservative and will be raised, we expect dramatic multiple expansion, particularly since the company is growing faster than its emergency services/waste management peers.

NRC Group recently became public via a SPAC with Hennessy Capital Acquisition Corp 3, and thus is on relatively few investors’ radar screens. We believe it shares many attributes with Hennessy’s first SPAC, which is now BlueBird, one of the 3 largest school bus companies, and one of the best performing SPACs of the last 3 ½ years, with shares up 80%, although down from their recent highs. As a newly minted SPAC, NRC became public at a discount to comps. However, recent non-fundamental trading (related to de-SPACing, and not broader market turmoil) has caused shares and, especially warrants, to trade lower – creating an especially compelling, and we think, short-lived, opportunity to buy a finite quantity of shares and warrants at a deep-discount to fair value. We think near-term catalysts, beginning with 3Q earnings, will quickly move shares higher.

We believe NRC is an extremely attractive company, with

·        high moats/barriers to entry,

·        exceptional customer diversity and retention,

·        significant incremental margins,

·        low capital intensity,

·        solutions that solve challenges that are likely to intensify going forward,

·        many acquisition targets available at multiples well below public valuations (and a history of successful integration),

·        significant insider ownership,

·        guidance that will almost certainly prove too low,

·        accelerating revenue and EBITDA growth in 2019 and likely 2020 – well above that of peers,

·        NOLs, acquisition expenses, SPAC expense, and other tax shields, that should result in no cash taxes through 2020 if not 2021,

·        largely non-discretionary well-diversified, customer-spend, with limited impact from macro events,

·        optionality if a disaster strikes – creates potential upside (i.e. Hurricane Michael),

·        meaningfully discounted valuation versus slower growth peers.

(As an aside, during our due diligence, we spoke with the management of the SPAC sponsor and NRC’s management, including its M&A team. We also spoke to most of the Board to get a sense of capital allocation priorities and views on warrants. We also spoke with several sell-side analysts to get perspective on the industry and company – we’re optimistic some of these analysts will pick up coverage).

NRC’s full investor presentation can be found here.

We will briefly discuss:

1.   NRC’s 3 business segments.

2.   Why the EBITDA bridge is too low, and numbers are going higher.

3.   The rationale for going public via SPAC and insider alignment.

4.   Blue Bird as a case study for short-term SPAC trading dislocation.

5.   Valuation/comps

1.   NRC’s 3 business segments.

NRC has 3 segments, Standby Services, Environmental Services, and Waste Disposal Services.

Source: NRC Group October 2018 Investor Presentation, Pg. 10

Each of these businesses has a high degree of regulation and licensing, creating high barriers to entry.

The company’s Standby Services business is an extremely attractive segment that resulted from government legislation enacted post-Exxon-Valdez (OPA-90) which requires onshore and offshore facilities and vessels carrying oil or a derivative to have a plan for worst case discharge. NRC gets paid for being on standby, with 75% of incremental revenue flowing through to EBITDA. Should there be an accident, NRC does even better, as they get paid for the clean-up and remediation work. Under prior ownership, the company generated over $600 million (versus the $360-$380 million in 2018 estimated revenue) from the Deepwater Horizon disaster. The Standby segment has over 2,000 customers, servicing over 20,000 assets, with 99% customer retention. Over 80% of customers have 5-year+ contracts, and 60% have 10 year+ contracts, resulting in exceptionally high recurring revenue, and revenue visibility. Mexico has recently passed similar regulations, and NRC has won all its bids, although management has guided to a 25% win-rate, which strikes us as unduly conservative. NRC’s one major US competitor, MSRC (a group formed by the industry) is not licensed outside of US territories. Mexico could become a $50 million annual revenue opportunity according to NRC management over the next 5 years. Finally, in speaking with NRC management they noted that they have not raised pricing in over 5 years and acknowledged that there is a room for price increases (a very minor cost to customers) which would fall entirely to the bottom line.

Environmental services entail high frequency, non-discretionary, small ticket suite of recurring services across a broad base (3000+) of customers.

Source: NRC Group October 2018 Investor Presentation, Pg. 39

According to the company, almost 75% of customers repeat from year-to-year, with virtually no customer loss – some customers simply don’t have an incident in a given year. Having built out a national presence via acquisitions, the company is well positioned to increase its national accounts and deepen its relationships in existing accounts. A stricter regulatory environment should also drive growth. NRC has a network of 150 Independent Contractors (“ICNs”) who fill-in when NRC is not adequately equipped for a certain job – or the job is too large. These ICNs are well-known by NRC and are potential acquisition candidates, which provides NRC the benefit of integrating a company they know well, and for which they likely don’t have a competing bid.

The final segment for NRC is Waste Disposal Services which has broad waste disposal capabilities servicing the Texas energy market. Again, this is a highly-regulated segment where spending is largely non-discretionary.

Source: NRC Group October 2018 Investor Presentation, Pg. 40

NRC’s major growth in Waste Disposal through 2020 will be in new landfills. NRC’s first landfill in Karnes is now running near full utilization, generating $15mn in EBITDA versus a build-out cost of $15 million. The company recently received permits ahead of schedule for 2 additional landfills in the Permian Basin, in Reagan County and Coyanosa, which should be up and running in early 2019. These sites were selected in response to customer location demand. A 4th site in Andrews should be permitted in early 2019, ahead of plan, with NRC only guiding to revenue and EBITDA in 2020.

Source: NRC Group October 2018 Investor Presentation, Pg. 41

2.   Why the EBITDA bridge is too low, and numbers are going higher.

While our thesis does not rely on numbers going higher, we’re confident that they will. Management provided the EBITDA bridge from 2018 to 2019 shown below:

Source: NRC Group October 2018 Investor Presentation, Pg. 28

We believe the Standby Services will win a higher percentage of Mexican business than management has outlined and will likely see modest domestic growth. In total, it will likely grow by more than $4 million. Environmental services should enjoy increased national account penetration and we believe management is being very modest in its growth outlook. In October the company has received permits for both landfill 2 and landfill 3 in the Permian. In its October 22nd press release the company states:

“Similar to the Pecos County permit that was announced earlier this month, construction will begin immediately, with operations expected to begin in the first part of 2019. With construction commencing on both landfill facilities simultaneously, NRC Group is ahead of its anticipated schedule for its Permian Basin waste disposal expansion which is further supportive of fiscal year 2019 revenue and adjusted EBITDA guidance.” (bold added).

We expect the 4th landfill to be approved in early 2019 and to contribute to 2019 results. We believe waste services EBITDA expectations are at least $5 million too low.

Finally, on October 3rd NRC announced the Quail Run acquisition. Quail run is a leading provider of wellsite wastewater treatment services throughout five disposal sites in the Eagle Ford Shale and Permian Basin. The financials are provided in NRC’s proxy, but target EBITDA for 2019 is $12 million, implying a 3.3x EBITDA multiple. The pertinent section of the proxy is below:

NRC Group expects to complete an acquisition of a leading provider of wellsite wastewater treatment services in the Permian Basin and Eagle Ford Shale Play (the “Interim Acquisition”) that could potentially provide NRC Group with up to $6.0 million of incremental Adjusted EBITDA in 2018 and up to $10.0 million of incremental Adjusted EBITDA in 2019, and up to $8.0 to $15.0 million in annual incremental revenues within 24 months of completing the Interim Acquisition.

NRC Group expects to acquire the target for an initial cash payment of $25.0 million, with an earnout of up to $15.0 million (payable, at the option of NRC Group, in cash or stock) consisting of up to $5.0 million payable if the target’s EBITDA in 2018 is at least $7.0 million and up to $10.0 million payable if the target’s EBITDA in 2019 is at least $12.0 million.  If the earnout is fully satisfied, the $40.0 million of total consideration payable by NRC Group in the Interim Acquisition represents an implied multiple of 3.3x the target’s estimated 2019 EBITDA.

Notably, the company anticipates being able to complete 1-3 acquisitions per year and historically has paid 4x trailing EBITDA.

Source: NRC Group October 2018 Investor Presentation, Pg. 25

3.   The rationale for going public via SPAC and insider alignment.

With any SPAC it’s a valid question to ask why the company is going public via SPAC rather than traditional IPO. In the case of NRC, the owner, Private equity firm JF Lehman 3rd Fund was in the 7th year of its ownership of NRC which is late in the vintage of the fund. Moreover, it had no additional capital to commit to the investment. Going through a traditional IPO brought uncertainty, whereas Hennessy, which had lined up a backstop from Nomura (and later from Cyrus Capital) brought certainty of deal closure, while also providing access to public markets.

With think its particularly noteworthy that JH Lehman’s 4th Fund invested $50 million into the transaction. While they are “sellers” they continue to own 65% of NRC, so they did not exactly abandon ship. With $50 million of fresh capital committed at market prices, we’re confident they’re playing for something much bigger and in this for the long haul. We’re reminded, that Hennessy bought Blue Bird from Cerberus, very smart money, which also maintained more than 60% ownership post deal close. Based on our conversations with Cyrus Capital, Hennessy, JH Lehman, and Nomura, we’re confident that we’re aligned with long-term capital with no interest in selling anywhere near current prices.

4.   Blue Bird as a case study for short-term SPAC trading dislocation.

NRC saw all but 4.9 million of its shares redeemed by SPAC shareholders. Of these, 2.5 million were bought in the public market at ~$10.23 by Nomura (per public filings), meaning only 2.4 million are truly freely tradeable. We believe that several hundred thousand shares (it could be 100,000 shares and it could be 1 million+) are likely held by investors who hoped shares would see an immediate bump post deal close and are now selling. We would submit that this overhang of shares could likely be purchased for under $10 without moving the share price. We suspect that when this overhang is cleaned up, shares will quickly move higher.

This may sound like wishful thinking, but it’s precisely what we saw in the case of Blue Bird. Blue Bird had only 4 million shares that weren’t redeemed when it merged with Hennessy 1 in February 2015. It too saw its stock fall below $9 and then hover in the $9s in the weeks following transaction close. By late April, shares had broken $12, and by early June, following only inline 1Q results and guidance, shares were above $13.

Source: Y-Charts

We’ve seen a lot of funky trading following SPAC merger closings and think with NRC there is absolutely nothing wrong or worrisome. Some cheap stock is being made available and the opportunity likely won’t persist. The difference between Blue Bird and NRC is that we expect a terrific print and guide when they report 3Q (likely November 14th), and positive coverage shortly thereafter – notably, NRC had a sell-side analyst day in September. We believe modest institutional sponsorship can take shares far higher very rapidly. As noted in the prior section, we also think 2019 numbers will prove far too conservative.

We think an interesting play if one concurs with our thesis are the warrants which we believe are arbitrarily priced for similar reasons. Specifically, since the NRC transaction was announced, only approximately 10 million warrants have traded. This suggests that upwards of 9 million warrants may still be held by SPAC arbs/day-1 SPAC investors who are non-fundamental investors in the entity. While they can redeem shares for what’s in trust (and most did), all they can do with warrants is sell. We think they continue to push warrant prices lower. One could probably buy hundreds of thousands, if not millions of warrants, with modest impact to the trading price. (typically, there are a few hundred thousand available at one price, and then more a few pennies higher, etc.). The warrants are full warrants, with an $11.50 strike, and a 5-year duration. Management can call them if shares exceed $18 for 20 of 30 trading days, meaning their value can be capped at $6.50. If one believes, as we do, that NRC will be an $18 stock, then warrants can return 5x. We believe they can achieve this in the next 6-12 months. Having spoken to various Board members, we believe they view the warrants as an overhang, and we suspect they will offer an exchange of warrants for stock (at a healthy premium) to avoid dilution – we’re hopeful that shares and warrants will have appreciated before then.

5.   Valuation/comps

NRC looks exceptionally cheap versus comps on 2018 estimates and even more so on 2019 numbers. Given the visibility into 2019, we believe NRC’s estimates are reliable, and as we’ve argued, conservative. In the below table, we use the high-end of NRCs EBITDA guidance for 2018 and 2019, which we believe is below eventual actuals. Notably the growth rate for NRC is far above that of peers.

Source: Company guidance, FactSet, our estimates

If NRC traded at peer multiples, inclusive of warrant dilution, it would trade between $14-$19 based on ‘18/’19 EV/EBITDA, $23-$28 on EBIT multiples.

In 2019, cap-ex will be higher than normal as approximately $25mn is likely to be dedicated to landfill buildouts. In sum $60 million is being spent on the 4 landfills which should produce $60 million+ in annual EBITDA. About the biggest downside is that’s all the landfills NRC has in its pipeline. In 2020, the company’s cap-ex should return to around 4% of revenue (or ~$20-25mn) and interest expense should be $25mn or less, assuming a successful refinancing of the current $347 million term loan (currently Libor +500bps) – which is part of the playbook they used with Blue Bird as well. Assuming no cash taxes and little change in working capital, free cash flow would be ~$100mn. To give context, NRC’s peers trade at an average of 18.1x 2019 EV/FCF (the low being 16.6x). Apply that multiple to 2020 yields a $30+ stock price. And its likely that NRC makes additional accretive acquisitions in the interim.

We think there’s a lot to like here. This is a defensive industry in uncertain times. NRC is diversified, has exceptional customer retention and recurring revenue, high competitive barriers to entry given increasingly strict and costly regulations, and excellent growth visibility at a discount. Looking out several years, assuming the company executes to plan, after several years of compounding, we’d expect the company to sell to a larger player, and further maximize shareholder value.