Montrose Environmental Group (MEG) has gone public in an offering which went well with shares up 50% on their opening day despite a soft pricing process. The company is basically an acquisition play on the fragmented market for environmental services.
While the ”core” businesses do not look very profitable, the company still shows resilient growth. A recent deal looks compelling, although all these deals and related costs, Covid-19 and leverage make the situation uncertain. All this uncertainty is not compelling enough to initiate a position here and now, yet the situation is interesting enough to keep a close eye on.
An Environmental Business
Montrose claims to be the future of environmental solutions since it was founded in 2012, helping clients and corporations to reach sustainability goals and needs, while the company itself aims to grow in a fragmented global environmental industry which exceeds a trillion dollars.
MEG operates through an integrated platform and focuses heavily on innovation with environmental challenges growing in number, size and complexity as the company focuses heavily on greater information and innovative solutions.
The company is quite diversified with more than 4,500 customers across a range of geographic and customer end markets. It is not reliant on either public or private customers themselves, and thus should be quite resilient to economic cycles while benefiting from consistent organic sales growth trends.
It is active across three segments: assessment, permitting & response; measurement & analysis; and remediation & reuse. The company benefits from greater environmental awareness of consumers, companies, investors and regulatory forces. More stringent regulations make demand for its services quite solid, providing real tailwinds for such a company to operate and play a consolidating role in a fragmented industry.
This role is taken seriously as the company is basically a product of acquisitions, with more than 50 businesses being acquired since inception.
Valuation Thoughts & Offering
Montrose initially aimed to sell 10 million shares in a price range between $15 and $17 per share. Demand was a bit soft, which is somewhat surprising in this market as pricing took place at the lower end of the range, resulting in gross proceeds of $150 million.
Note that there are just 20.3 million shares outstanding, giving the company an equity value of $305 million at the offer price of $15 per share. The business ended the month of June with a net debt load of around $164 million, as the IPO proceeds were used to pay off preferred stock, making for an enterprise value of around $470 million.
The dealmaking strategy resulted in the company seeing solid growth. Between 2016 and 2019, sales essentially doubled from $115 million to $234 million, mostly on the back of dealmaking, yet accompanied by some organic growth as well. Disappointing was that GAAP operating losses were reported in all years, actually increasing from $9 million to $11 million over that time period.
The company reported adjusted EBITDA of $31 million in 2019 with EBITDA margins improving, yet after accounting for relatively fat depreciation charges, MEG was not really profitable. First-quarter sales continue to grow with sales seen at a run rate of $250 million, and while EBITDA margins were stable, the company continues to report losses on an operating basis.
Montrose reported preliminary second-quarter results with revenues seen at $70-75 million which is very strong, driven to an unknown extent by the acquisition of CTEH in April of this year. While I have not seen an acquisition price being reported, it was very good to learn that CTEH generated $35 million in operating income in 2019 on sales of $110 million! Not accounting for organic growth, I peg the run rate in terms of sales around $350 million, EBITDA at around $80 million and operating income might come in around $40 million, mostly because of CTEH.
With the normal cost of debt on net debt of $160 million and statutory tax rates, I peg the net earnings potential to be around $25 million, which actually works down to $1.25 per share!
After the public offering, shares quickly rose to $22, boosting the equity valuation to roughly $450 million and enterprise value towards $600 million, with valuations on that latter metric trading around 1.7 times sales and 7.5 times EBITDA. The CTEH deal looks very good, yet the company already warned that CTEH earnings are seen down 30-50% in 2020 on the back of fewer large incidents, something which it thrives on as a very specialist environmental business which basically thrives on big incidents.
So based on earnings potential of $1.25 per share under normal conditions, appeal was luring at just 12 times earnings, certainly as leverage ratios seem manageable, even as CTEH’s earnings will likely fall this year.
The situation is highly fluid as of course we are dealing with complicated finances of the legacy business, the impact of Covid-19 and what appears to be a very nice deal of CTEH. All of these uncertainties come as the legacy business is effectively not making money, but more or less is breaking even, as leverage ratios are high and the CTEH deal only just being closed, all in a very uncertain environment.
Nonetheless, the CTEH deal itself looks very compelling with operating earnings of that acquisition alone under stand-alone conditions almost being able to support the valuation of the firm, certainly at the public offering level.
I find the current situation too uncertain as the core business was not really profitable, yet with depreciation and amortization charges not being isolated, I am not sure about the real profits or losses of the core operations. The interesting part is the acquisition of CTEH, which looks compelling, even as 2020 is set to become a softer year. Putting all of this in the mix, I very much look forward to learning more about the performance of the business in the coming quarters as I feel valuations might look compelling here, yet there is too much uncertainty for me to pull the trigger, certainly after a post-IPO move to the tune of 50%.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.