Description

Target Hospitality (TH) is an under-followed (3 very fatigued analysts cover), under-loved (SPAC history and “oil service” beta taint = hated-on situation) and under-appreciated (trades for 2.5x – 2.75x 22E EBITDA factoring in FCF generation). I like both the debt (ARWBID 9.5% note due March 24, likely refinanced anytime w/ 104.75 call pro through March 22 and steps to 102.375 through March 23) as well as the equity (FV of $8-$9 / share using a punitive ~6x multiple vs ~$3.68 current or >135% upside over the next 6-months). The market’s rear-view mirror focus on the past has created the opportunity as lot of things have changed providing a low hurdle set-up in the future: 1) biz mix has significantly shifted away from oil into gov’t insulating the biz from the oil-volatility as gov’t currently generates >50% of revenues and I expect the shift to continue to favor gov’t, 2) gov’t is sticky w/ very attractive margins + lot of upside momentum ahead (more disclosure to come from mgmt but anticipate further contract wins / expansion of existing) and 3) the entire biz (legacy oil and gov’t) are experiencing a significant upside inflection largely lost on the market and I see a path to beating sell-side estimates by ~20 – 25% in 21E and >30% in 22E. Additionally, I expect a n-term refinancing of the capital structure (M&A bolt-on or plain vanilla) and expect the interest savings to be meaningful ($15-$20MM per annum on a $375MM market cap) putting the equity more on the radar.

Quick biz overview: Vertically integrated specialty rental accommodations with network of ~15k beds across 26 geographic sites. Historically recognized as an “oil bet” given hefty exposure to Permian + Bakken. What’s changed is that the government portion of the biz is fast growing (>50% of revenues) and has the potential to continue to surprise to the upside. Additionally, mgmt. is focused on ancillary services (away from accommodations) and I anticipate further clarity on bolt-on M&A in the n-term on this front which could potentially result in an enhanced multiple. Biz was formally owned by TDR Capital (bought out Algeco Global) and Target Hospitality went public in 2018 as a SPAC. TDR / Algeco remain a substantial holder of the equity at >63% ownership (alongside Sagansky who helped lead the SPAC w/ another 3.5%). While some might point out this dynamic being an overhang, I view it as a positive in the n-term as the float is relatively small (~$375MM market cap is closer to ~$100MM of real float) particularly in light of the biz inflection and heightened possibility of M&A in the n-term. Additionally, worth noting that in the depths of COVID, TDR Capital lobbed in a lowball bid to acquire the minority shares at ~$1.50 / unit (Nov 2020). The bid was rejected by shareholders and TDR backed away, but this ultimately highlights the credit support in the biz (the 9.5s are in a very strong position and will likely be refinanced in the very n-term) and also highlights the strategic interest in this asset from the majority owner. Perception of the biz has been tainted from the past largely given: 1) SPAC history and 2) oil service beta play.  Set-up at current $3.68 / share de-risks for these 2 overhangs given entry valuation (<3x 22E EBITDA) and the biz mix now more heavily weighted toward gov’t + potential for further oil dilution given ancillary service M&A is highly likely.

Why now: Key biz driver is bed utilization driving higher ADRs + upside event risk of an M&A transaction expanding the mix into ancillary services (more visible and better multiple biz). Most notably, the market focuses on what the biz was in the past (oil beta) and assumes that’s the key driver to future (which its not). Versus the past, lot of beds have been re-allocated to gov’t end-mkt w/ 2 large contracts (1 contract won earlier this year and expect further updates expanding this program).  This ultimately means the “Permian” / oil service beta recovery can be very muted (i.e. less than 30% recovery from trough levels (versus 100% to prior peak) to drive >$160MM of EBITDA. As noted further below, any recovery back to 2019 Permian activity levels will likely result in >$210 - $220MM of EBITDA. On a sidenote, doesn’t hurt that 2 board members purchased shares in the open market couple months back at levels not too far off of current (~$3.30 for Sagansky, serial SPAC player w/ DraftKings a more notable recent deal, and ~$3.50 for Studdert).

Peak vs trough vs “new normal” analysis: To put everything in context, “oil service” beds were approximately 8-8.5k beds in prior peaks when the biz did >$160MM of EBITDA. The trough in 2020 was in the <3k bed range (when biz generated closer to ~$80MM of EBITDA). Gov’t has expanded since the prior peak and utilized >3k of the beds (and much higher margin so actually improved the go-forward peak unit economics). As a result, to get back to prior peak levels of >$160MM EBTIDA, I estimate “oil service” bed utilization has to expand by roughly 1.5 – 1.75k beds (i.e. 4.5 – 4.75k beds versus prior peak of ~8 – 8.5k beds). Also, I estimate the biz will likely be driving these unit economics in 2H 2021E and this will become more evident. As noted below, I estimate 2H 21E EBITDA to be in the >$150MM EBITDA range. Under “good” and “strong” assumptions (i.e. 73% recovery off of trough / not yet to peak … and 93% recovery off of 2020 trough / not yet to 2019 peak), I estimate 2022E EBITDA should be in the $190MM and $214MM EBITDA range, respectively. Additionally, in speaking to management, I believe they area laser-focused on M&A bolt-on (or transformational) opportunities as the balance sheet is in rapid deleverage mode and adding incremental ancillary revenue streams is attractive. I expect more disclosure to come on this front, but anticipate this potentially being a meaningfully positive event.

y view relative to market: I peg EBITDA for 21E at 120-125MM (versus mgmt. guide of ~97-107) and next year at >150MM (versus Street in the low 120s). Additionally, think the leverage profile is de-risking significantly allowing the management team to focus on bolt-on and transformational M&A (tbd, but there are opportunities to shift more into ancillary services which is high multiple).

Cap structure snapshot: As noted below, balance sheet is in rapid deleverage mode given minimal capex needs and biz inflection = resulting in decent FCF. Peg Net Debt at under $150MM by YE 22E on my numbers and leverage inside of 1x. The company will likely be focused on M&A (and likely will refinance the 9.5% note under any condition).

Fair value sensitivity: Noted below, the equity mis-pricing should become more evident upon 1) refinancing of the 9.5% note, 2) M&A bolt-on event(s) and 3) further clarity on the biz inflection / KPIs … as the creation multiple under the current biz at <3x 22E EBITDA is way too cheap. Ultimately think a 6x multiple (w/ possibility of upside) is prudent which drives >135% upside.

Catalyst

1) refinancing of the 9.5% note, 2) M&A bolt-on event(s) and 3) further clarity on the biz inflection / KPIs