|Shares Out. (in M):||13||P/E||21.4||22.6|
|Market Cap (in $M):||1,076||P/FCF||50.3x||47.7x|
|Net Debt (in $M):||47||EBIT||38||40|
|Borrow Cost:||General Collateral|
Florida-based NV5 Global Inc, (Ticker: NVEE, "NV5") provides professional and technical consulting for infrastructure and other construction projects. Since their JOBS Act IPO in September of 2013, they have grown revenue over 5x (> $300 million from ~$60 million) primarily through acquisition. The stock is significantly overvalued under any methodology especially in comparison to the business quality and organic growth prospects. Management more than tripled the share count since the IPO, issuing shares at elevated levels based on their misleading organic growth disclosure and aggressive accounting.
Dishonesty, Obfuscation, & Aggressive Accounting
NV5 does not provide a revenue bridge to calculate organic vs. acquired growth, which is highly questionable since the company has acquired 32 businesses since 2012 contributing over 2/3 of current revenue. In the preceding fiscal year 2014, the company generated $108 compared to $333 million in fiscal 2017. Using estimates of acquired revenue from deal announcement press releases, the total annual revenue generation of the businesses bought should be about $280 million.
|Date||Name||Annual Sales ($M)|
(333.0-108.4) – 276.5 = -51.9
So $52 million of the bridged revenue growth is negative, implying a drastic decline for either the acquired companies or the legacy business. Yet management’s (sparse and undetailed) commentary on organic growth is for a positive contribution in every year for the entire period in focus.
“The organic growth of 9% we created in the full year 2015 far exceeds our industry standard.” - Dickerson Wright, CEO. March 10, 2016
“Our organic growth for the full year ended December 31, 2016 was 5%.” - Michael Rama, CFO. March 10, 2017
“Net revenues for the full year 2017 were $268 million, an increase of 48% when compared to the full year of 2016 of a $182 million. These increases were due to organic growth, as well as contributions from our acquisitions closed during 2017.” - Michael Rama, CFO. March 9, 2018
Three straight years of positive organic growth in conjunction with the acquisition information leave three possibilities:
· NV5’s acquired businesses are in drastic decline, losing a cumulative ~$52 million in annual revenue plus the undisclosed revenue of 5 businesses from the table above
· Management misled investors about the revenue of acquired companies at announcement
· Management is misleading investors about core organic revenue growth.
With respect to possibility a), NV5 has not recognized any impairments of goodwill or acquired intangibles in the three-year period we highlight. Perhaps conveniently for them, not all deals were large enough to merit a pro forma income statement disclosure. Each of these acquisitions have also been consolidated into larger segments reviewed for impairment as a whole, perhaps masking the need for a write down.
The alternative case for management dishonesty is buttressed by evidence of aggressive revenue recognition. While acquired intangibles are the largest and fastest growing asset on the balance sheet, receivables are not far behind. The percentage-of-completion method accounts for approximately 14% of 2017 revenue so receivables are worth scrutiny.
· Allowance for doubttul accounts has declined from 10.8% of receivables in 2012, to 7.9% in 2013, with a trough at 2.6% in 2016 and 3.7% as of the most recent quarter.
· The company has under-provisioned for doubtful accounts in three straight fiscal years, requiring charge offs in excess of provision in fiscal 2015, 2016, and 2017.
· Unbilled receivables have grown steadily from 28.4% of total receivables in 2012 to 36.4% in 2017 and 34.2% in the most recent quarter. Year to date numbers for unbilled are also growing over 2017 periods in terms of day sales outstanding.
· Finally, the company discloses the concentration of government related revenue and receivables (68% of revenue in 2017). The implied days sales outstanding from these types of customers has grown steadily from 53.8 days in 2013 to 108.0 days in 2017, more than double.
Earnings Power & Quality
Since fiscal 2012, NV5 has generated a cumulative $48.8 million of free cash in comparison to $65.0 million in GAAP net income and $124.2 million of management’s preferred metric, (you guessed it?) adjusted EBITDA. These amount to 4.3%, 5.7%, and 10.8% of revenue respectively. Margins are the highest of their publically traded peers (ACM, JEC, STN, TTEK, WLDN) and have climbed consistently, although free cash margin is down recently on the working capital issues described above.
|Fiscal Year||2012||2013||2014||2015||2016||2017||17 Comp||YTD '18|
|Adjusted EBITDA margin||6.3%||7.8%||9.4%||11.0%||10.8%||11.8%||10.2%||11.7%|
|GAAP EBT margin||3.2%||5.3%||7.4%||8.7%||8.1%||7.4%||6.0%||7.2%|
|FCF % of sales||1.6%||4.2%||0.5%||3.5%||6.4%||4.6%||2.4%||4.7%|
Offering professional services, NV5 does have low capital requirements and generates a high teens ROIC as measured by adjusted EBIT. But with free cash consistently below net income we do not consider the business or the earnings to be high quality. Their industry is also highly fragmented with no major player dominating the space, a probable cause of low industry margins.
We estimate NV5 is worth $35 per share vs. a market price of $88 (a 60% downside). Key estimates to our DCF include $23 million of free cash in 2018, growing about 3% per annum on 2% organic revenue growth in perpetuity with a discount rate of 9.5%. We also assume that margin expansion (and possibly the level itself) is unsustainable based on peer benchmarking, but give the company a terminal adjusted EBITDA margin of 12.3% vs. 11.9% in 2017 rather than forecast a decline.
Organic growth is the most important mystery input here and we don’t trust the disclosures. Management’s verbal descriptions hover around mid-to-high single digits which “far exceeds [sic] industry standard”. Their investor presentation claims 10% organic, which according to our prior analysis is not in evidence since 2015 except for a few recent quarters. We are left to assume that engineering consulting is unlikely to grow faster than GDP on a secular basis and that industry competition will eventually pressure organic growth downward towards “industry standard” even if management’s claims are true.
In short, if management lied about single digit growth, we assume the lower single digit industry level they referenced; if they didn’t lie, then we assume it can’t go on indefinitely. $35 per share and 60% downside is a big margin of safety if growth surprises positively for a few more years; it also assumes margins remain well over peer average, forever.
We also included the recently closed secondary equity offering in our share count (12.6 million). It is crucial to note the company is a serial issuer of stock.
Alternatively, at 16.0x the company trades at a 47% premium to its peer median EV/EBITDA forward multiple of 11.3x and 40% premium to the average of 11.9x.
With 47.1% director and officer ownership as of 12/31/2013, and numerous secondary equity offerings more than tripling the company’s share count since the same date, management has been highly incentivized to maintain a growth multiple. Qualitatively, they promoted an aggressive growth story. They have suggested on multiple occasions that the company will reach $600 million in revenue by 2020, a totally arbitrary target. While openly admitting that acquistions are necessary to reach this level, company disclosures remain inadequate to confirm whether the core or acquired business is shrinking. We think this will eventually unravel and cause a fall toward intrinsic value on one or more of the following catalysts:
· NV5 will no longer qualify for JOB Act exemption from Section 404 (auditor attestation requirements) of Sarbox at the end of this fiscal year. A roll-up strategy like this provides a higher likelihood for an auditor to conclude a material weakness in internal control over financial reporting requiring restatements/late SEC filings
· Management may run out of acquisitions to hide the underlying business weakness. If the absolute revenue growth (including acquisition) begins to decelerate and the multiple compresses, the company will have less valuable shares with which to acquire more revenue, causing more deceleration and a destructive feedback loop.
· Potentially inflated receivables may be written off.
· Weak municipal finances could create more genuine collection trouble. (Public and quasi-public customers account for 60% of revenue).
· The investment public wakes up to the ridiculous nature of promoters behind the company, including Roth and the cheerleaders on their earnings call (the call from today is decent on this front)