Description

SLCA was last written up by user Motherlode in July of 2021.

In the time since the author’s exit recommendation SLCA shares have been down a little, while the company has continued to reduce their debt load – down an additional $50mm since end of Q2 2023. So, on an EV basis the stock is cheaper - $1.58 bn versus $1.72 bn.

The core – sum of the parts thesis – hasn’t changed here – that is still what I am pitching. 

What is different today in addition to the lower enterprise value is that we are getting closer to the point at which the company could conceivably split off these two businesses and get them valued separately – high leverage stood in the way of that before. 

The valuation exercise here is simple. 

We got a recent comp for the frak sand business.

In late February, Atlas Energy (AESI) acquired Hi-Crush Inc, for $450 MM comprised of $150 MM in cash, $175 MM in shares, and $125 MM in deferred cash payments. The deal is expected to close during 1Q’24. In the corresponding press release (linked here) AESI expects Hi-Crush to contribute $110-125 MM in adjusted EBITDA for FY’24 (or ~$118 MM at the mid-point). Assuming this mid-point EBITDA guidance (barring any deltas from transaction close timing), this implies a transaction multiple of ~3.8x forward EBITDA (including deferred cash payments) but it was reported by AESI at 3x. 

For our valuation exercise - let’s just use 3.5x for frak sand as a conservative multiple. 

The bigger question mark would then be the multiple for ISP – a business which they expect to see grow net margin in the 8-10% range for the next three years. ISP is a super sticky business where they have very specific products across a variety of end markets serving specific customers –almost 800 such products in total. Arguably the closest comp to this business is Martin Marietta which trades for 17X EBITDA.

Let’s be conservative assume 10X EBITDA for ISP. With the frak sand business worth 3.5X, and the ISP business worth 10X, you get a valuation of $19.28 versus shares today are at $11.66 as of close last Friday so upside of 65%.

Now splitting these two businesses has been something they have talked about for a while but the holdup has been debt – the company had too much leverage for any of these entities on their own to withstand. But today, we are at a net leverage ratio of 1.4x at year end 2023 (below their target of 1.5x). That leverage should come down as the frak sand business continues to generate significant free cash flow in 2024 (the vast majority of their tonnage has already been pre-sold). A split is something they can now consider in a way that they perhaps couldn’t before and that willingness has come across in our conversations with a management team that seems sick of the subdued valuation.  

This is a simple, clear valuation disconnect story. Fairly valuing the two businesses separately implies a >50% upside to current valuation, purely from investors taking notice of the valuation disconnect.

But there is further potential upside here in ISP if some of their new growth areas like a TiO2 replacement product take hold. They launched a product called EverWhite Pigment which they believe they can produce much more cheaply and in an environmentally friendly manner than current TiO2 products. Were this product to take hold in a significant manner – this represents potentially a huge new source of TAM.

Risks

• Weakness in frac sand market demand/pricing driving a lower multiple for the proppant business and SLCA as a whole
• Management increases leverage and strays from possibility of a business split
• Continued lack of attention from investors

Catalyst

Catalysts

• Increased investor awareness of SLCA’s disconnected segment valuations when operating as a combined business
• Continued ISP segment improvements driving higher multiple for the segment while sand business maintains fair EBITDA multiple value based on precedent transactions
• Potential to split the ISP and Oil & Gas businesses into two separate entities – should benefit ISP valuation by applying a higher multiple