Advanced Emissions Solutions (ADES) – Tender Offer + Expected Dividend – 20%+ upside

Current Price –$9.85

Expected Price - $12

Upside – 20%+

Expiration Date - June 2017

This is a two part special situation. The first one is a simple dutch tender with odd-lot provision. The second part comes from general undervaluation of the company where expected dividend (yet to be announced, but already communicated by management) could serve as a catalyst. At the same time the company is trading below contractually secured cashflows in the RC segment and has significant upside optionality from other business segments.

SEC Filling


Tender Offer (odd-lot)

Advanced Emissions Solutions is offering to purchase up to 925,000 shares (representing approximately 4% of our outstanding shares as of May 1, 2017) of its common stock, par value $0.001 per share at a price not greater than $10.80 nor less than $9.40 per share.

No proration for odd lot holders: “If you own beneficially or of record fewer than 100 shares in the aggregate, you properly tender all of these shares at or below the purchase price prior to the Expiration Time and you complete the section entitled “Odd Lots” in the Letter of Transmittal and, if applicable, in the Notice of Guarantee Delivery, we will purchase all of your shares without subjecting them to the proration procedure.”

Source and amount of funds: “Assuming that 925,000 shares are purchased in the Offer at the maximum purchase price of $10.80 per share, the aggregate purchase price will be approximately $10.0 million. We anticipate that we will pay for the shares tendered in the Offer, as well as paying related fees and expenses, from our cash and cash equivalents on hand.”

Upper limit pricing unlikelyThe tender is very likely to be oversubscribed as only 4% of the outstanding shares will be acquired. Taking into account small capitalization and overall small size of the offer (only $10m or 925k shares), my guess is that tender is more likely to be priced at the lower than the upper limit. However, I might be wrong if it turns out that majority of shareholders consider ADES to be undervalued as outlined below.


LT Perspective – strong downside protection with material potential upside

ADES is quite a complicated micro cap where the main value (and cash) is generated from tax credits of refined coal (RC) facilities. The company is not in coal business, but rather tax credit business. I recommend reading through this write-up, which clearly outlines business background and undervaluation case. I would not be able to describe the situation any better. In a nutshell, ADS has been mismanaged over the recent years and new management has been put in places that has righted the ship. Therefore past financial performance is not indicative of the true earnings power of ADES and going forward ADES will be generating substantial amounts of cash which will be returned to shareholders.

Contractual cash payments (over the next 5 years) from the tax credits part of the business are higher than the current market cap. Management estimates these payments alone (almost fully FCF) to be worth $13/share undiscounted (see Q1 presentation, slide 18). Big part of this cash flow will be distributed to shareholders, including already announced tender offer, planned recurring dividend as well as any additional or incremental dividends. All of these should provide strong downside protection.

At the same time the upside remains from:

  1. Still unleased RC facilities (14 remaining). One additional has already been leased during Q1 2017, proving that there is still demand for it. Presidential election and resulting uncertainty regarding reg environment for coal and taxes in general has caused hesitation among potential facility operators to start using these for tax purposes, but management believes the skies have cleared now and mentioned being in active discussions with potential RC investors (to be fair similar discussion have also been mentioned on the previous conference calls, but so far resulted only in one incremental leased facility)
  2. Any extension of refined coal tax credits beyond 2021. Currently tax benefits expire on 2021, but keeping in mind Trump’s rhetoric regarding coal industry, these could be extended allowing ADES to continue its tax credits business beyond 2021.
  3. Value of the growing emission controls chemicals business;
  4. Value of the patent portfolio.


Dividend to be announced in June

I expect initiation of dividend to be a strong catalyst to move the shares upwards. Management has communicated intention to start recurring dividends already with Q4 release (March 2017) and reiterated the same with the latest earnings. Dividends of $0.25/share quarterly are now scheduled for announcement in June 2017, at which point the company would be yielding 10% on current share prices.

Further catalysts would be announcements of new RC facility contracts. Each new contract is expected to add c. $1/share in value.


Bottom line

Investment in ADES seems to provide strong downside protection from contractual RC payments, which more than cover the existing market cap. Management already started to return cash to shareholders. Official initiation of dividends will serve as a catalyst with potential upside remaining from other bits and pieces.

Admittedly I have limited understanding of refined coal tax credit industry or regulation, so I am a bit handicapped in assessing any risks that might come from cancellation of existing contracts, volatility in payments or changed regulation. My baseline assumption is that currently leased facilities will continue to generate cashflow till expiration in 2021, as per management’s projections. I am also not able to judge how much value could the chemicals business or patent portfolio generate, so my main thinking here is that I get these two parts of business for free so exact value is not that important.

50 COMMENTS

  1. slow

    How you plan to trade?
    Buy and wait for high price to sell or take the tender offer?

    Thanks

    1. dt

      I intend to wait for official dividend announcement or even keep ADES as a LT investment. I will tender at the upper limit, but I doubt my shares will be accepted.
      Currently still researching further bits and pieces to have full comfort with this position.

    1. dt

      R S, that is for you to decide. If you are interested participating in the tender and avoiding proration, then buying 99 shares and submitting these to the tender would be a away to go. If you are interested in longer term perspective or believe that dividend initiation might serve as a catalyst, then holding on to your shares instead of tendering might appear better.

  2. greg lia

    To state the obvious you also need to choose a tender price that is at or below the price that is arrived upon. Unless this tender has a provision to tender without selecting a price and accept the price that is arrived at when 4% of the shares are accounted for. If you are buying at current levels, above the minimum floor, there is much more risk and uncertainty than participating in a “no proration” tender and buying in below the min tender price. (See Great Elm….GECC)

    1. dt

      Jinfeng, I would not be surprised if the tender is priced at $9.4, so if that is the case and if you are in ADES only for the tender, you would still loose money by buying at $9.52.
      I have a slightly longer perspective and expect dividend initiation to serve as a first catalyst.

  3. FM

    “ADES@NASDAQ (Name: ADVANCED EMISSIONS SOLUTIONS) is the subject of an announced merger effective 20170606.
    ISIN : US00770C1018
    Please note, allocation from either a voluntary or mandatory merger offer will be made upon receipt from the Depository / Clearing House.”

    Who is ADES going to merge with? Didn’t see any news about the merger.

    1. dt

      I assuming this is a mistake on IB system. They are mixing up tender with merger. Probably will get corrected this week.

  4. over2u

    Hi dt, a little bit puzzled with the math on this one:
    - while we all agree that one RC generates c.$5m CF for ADES, but then we should dedact income tax of c.35% to come up with the net cash flow available for shareholders
    - Tinuum business is obviously cash cow, but core operation business of ADES generate negative CF: -$2.8m for 3m 2017, so if management don’t put it on breakeven point ADES may worth less than share in Tinuum
    - Each new RC adds c.$1 per share only if undiscounted – if we assume 15% rate, only 58 cents per share

    Please let me know what you think.

    1. dt

      My thoughts below:

      Taxes – ADES still has $113m of NOLs and tax credits, so it will not need to pay taxes for at least couple of years. If it so happens that the tax credits get fully utilized, then ADES might be able to retain (i.e. act as tax equity investor) one of its facilities and generate further tax credits. So if my understanding is correct, ADES should be able to avoid paying taxes on majority of the forecasted profits.

      With regards to business outside of Tinuum, there are couple of points worth mentioning.
      (1) Q1 saw low levels of equipment sales and this number will be far higher in Q2 (as per conference call at $20m), whereas opex is probably spread quite equally over the year. At 20% gross margin, equipment sales would probably generate $7m in gross profits this year and chemicals business would add another $3m in gross profits. So in total we should have roughly $10m of gross profits (excluding any royalty revenues) and c. $13m-$15m of cash operating expenses (from Q4 presentation). Thus I would call cash burn from equipment and chemical sales businesses to be relatively immaterial for 2017 (even after assuming that these segments carry the burden of the whole company wide Opex).
      (2) Equipment sales business is in run-off mode (company is only delivering on previously signed contracts) and management expects it to taper-off fully in 2018. Thus I would expect further cost reductions after equipment sales business is closed.
      (3) Chemicals business currently is growing at a really fast pace and is likely worth more than 0 even if it does not fully cover the company wide Opex. From the latest conf call:
      “Chemical revenues were up 400% year-over-year, which validates the continued commercialization and monetization of our chemical technologies as well as the depth of our IP portfolio. Based on the strong revenue growth and growing pipeline, we remain confident in our ability to attain the 20% to 40% share of the $100 million market opportunity, the goal we laid out on previous earnings call.”

      - Re contribution from new facilities. Agree that $1 is undiscounted and this figure is getting lower with every subsequent quarter that these facilities are not leased. I arrive at $0.7/share if discounted at 15% (using lower end of management’s projections of $5m-$7m of ADES cashflow per newly leased facility).

      My key investment point here is that the downside seems to be well protected by the contractual cashflows + royalties from RC business (worth more than the current market cap). And at the same time I get free upside from potential extension of tax credit regime, further growth in chemicals division, potential leasing of the remaining 14 facilities or any cash distribution announcements.

      Hope this makes it clearer.

  5. Makarid

    Thank you dt for this interesting idea!

    I would like to ask you about the investors that lease these facilities.Must these investors have some specifications in order to lease these facilities or any investor can do it? I am asking this because if there was something like this in my country i am sure that Tinuum will construct everyday a new facility in order to serve the demand!Ofcourse management plays a huge role in promoting these operations(which are complicated) to investors that want to decrease their taxes.Do you believe there is any other reason that there are so many facilities idle all those years exempt from management?

    Thanks a lot!

    1. dt

      I am definitely not a tax expert, but my understanding is that any federal tax paying entity with a large tax bill could get involved in operations of these facilities and get the benefits of the tax credits. However, approvals take time and involve a lot of paperwork. Also certain corporate structures need to be setup in order to get IRS approval (https://www.chadbourne.com/refined-coal-transaction-nixed-project-finance-april-2017) – some companies might simply find this not worth the hassle or risk.

      The largest owner of these refined coal facilities is insurance company Arthur J Gallagher (AJG). They own 34 RC plants and 31 of them has long term production contracts, with the remaining three in early stages of negotiations. So there is clearly a demand for such tax saving vehicles. But the legal aspects and IRS approval/audit might be troublesome – from the AJG 2016 annual report:

      “On February 10, 2017, one of the refined coal partnerships in which we are an investor received a notice from the IRS setting forth its view that certain of our co-investors are unable to claim tax credits based on the structure of their partnership interests. The IRS notice does not challenge the validity of the tax credits or our ability to utilize tax credits. Our co-investors have the right to appeal and defend their position in tax court. While it is not possible to predict the ultimate outcome of any such appeal, an adverse ruling would likely make it more difficult for us to reach satisfactory arrangements with new coinvestors. We could also be subject to claims against us from the co-investors affected by this IRS notice”.

  6. Makarid

    I would like to ask you about the Trump’s decision to not be part of the Paris Green Agreement.Is this a positive event in respect with the RC business?Will this means that the coal industry in US will not have so much regulations? I am not a US citizen and i don’t know anything about regulations or laws in the US.
    Thanks a lot!

    1. dt

      Makarid, I know too little about politics and coal regulation to be able to give any kind of informed opinion on this, so I simply consider this to be a non-event from ADES perspective. Also with Trump, you never now what is going to happen next.

      1. Makarid

        Thanks a lot for your reply! I really like the potential that this company has as a long term investing desition. I am trying to find the biggest risk that this company has in order to understand the downside better.As i can undestand until now the biggest risk is the regulation change or a really big tax cut as Trump has promised. If these are the most importand risks, i am willing to take that risk.We will see how things will unfold.

        Thanks again for this idea!!!

        1. dt

          Makarid, there are other risks as well:
          - ADES could wasted or burn through cash generated by RC facilities.
          - Leases on existing facilities might get cancelled (not sure if lessors have that option).
          - I do not think regulatory change is likely to impact the cash-flows from existing facilities, but clearly regulatory environment plays a role in here, specially with prospects for remaining unleased facilities and other segments of the company.

          There might be a better entry opportunity after the tender expiration on Tuesday, although I have seen a number of times shares rallying after the tender when unexpectedly the tender is priced close to the upper limit.

  7. FM

    “Based on the preliminary count by Computershare Trust Company, N.A., the Depositary for the tender offer, a total of approximately 2,958,900 shares of the Company’s common stock were validly tendered and not validly withdrawn at the price of $9.40 per share, the minimum price in the price range specified in the tender offer. This amount includes approximately 208,165 shares that were tendered through notice of guaranteed delivery.

    Based on the preliminary count, and accounting for the effect of odd lot priority on the proration factor, the Depositary has informed the Company that the preliminary proration factor for the tender offer is expected to be approximately 45.4% of the shares of common stock validly tendered at the price of $9.40 and not validly withdrawn based on the total number of shares reported to be tendered at $9.40 and not withdrawn prior to the expiration of the tender offer and accounting for “odd lot” priority and the conditional tender provisions of the tender offer.”

    For those who bought 99 shares, a loss is made. For those who want to buy and hold, this should be a good entry opportunity, do you agree?

    1. dt

      All as expected so far – tender was oversubscribed and ended up priced at the lower limit.

      Based on my calculations shares were bought back below the intrinsic value, which means that the value of the remaining shares increased further. Thus for those who consider ADES shares to trade below the intrinsic value, this is a good entry point.

      Official dividend announcement should come shortly, will be interesting to see if this will have any effect on the share price.

  8. Sylvain J.

    Thanks for idea,

    Does anyone has an insight of effects of a potential corporate tax decrease in the US?
    With a (potential) 15% corporate tax instead of 39,3%, I have the feeling the tax credits may loose interest for the third party investor.

    1. dt

      My understanding is that these tax credit simply reduce the tax bill, disregarding the tax rate the corporation is paying. So as long as the corporate taxes that corporation pays are larger than the tax credit it receives from operating RC facilities, the scheme appears to be worthwhile. And these tax credits are comparatively small, even at a lower tax rate there will be plenty of companies which could utilize them.

  9. Makarid

    I don’t believe that tax credits will ever loose interest for corporations or individuals unless the taxes will be 0%.Maybe the interest will be reduced and instead for example there are 10 interested investors there will be 7 interested investors. Every self-respected person/corporation will do what ever it takes in order to not pay taxes-reduce taxes because these money belongs to them.Also this industry is for the wealthy or the very wealthy individuals or corporations and this mean that you have the smart money on your side. I don’t know how things are in US, but in Greece if there were these facilities, all of them will be reserved.This is my opinion and maybe i am wrong.

  10. greg lia

    Interested to watch price action on ADES today and tomorrow. I sold at 9.83, (no idea what caused big up day) yesterday as soon as shares were back in my account. Wondering if there will be selling pressure with all these returned shares to unsuccessful tender participants and whether it might provide an attractive point to reenter.

  11. Makarid

    The dividend has been announced! Let’s see where the stock price will go.

  12. Michael Reagan

    The $.25 quarterly dividend is finally official. 10% yield…wonder how long it remains that level

  13. dt

    Seems like the market is not overly excited about the dividend – as Michael suggested it might take some time before this new dividend gets reflected in the share price.

    I am happy to continue holding ADES – 10% dividend yield + contractual cashflows valued (undiscounted) at 30% above the current market price. In addition to receiving a very safe 10% dividend, I am exposed to potential upside that might come from new RC leases, extension of RC tax credits, patent portfolio, or further growth in emission controls chemicals business.

  14. greg lia

    !.7 million shares traded today vs an average 100k. Most of which, (over a million shares, 5% of the float) occurred in the last 30-45 minutes. I am assuming Russell re balance as opposed to some kind of news event given the stock took a similar dive the day before. prior to recovering. I was expecting strength going into ex dividend Monday. Additional insight appreciated

    1. Freedomist

      I’m not familiar with Russell re-balancing. Why the inclusion of both Russell micro-cap and Russell 3000 had such a big selling pressure on ADES? I thought the impact should be positive for inclusion and negative for deletion?

      1. dt

        I do not have any info on what caused the selling pressure on Friday – as Freedomist suggest inclusion in Russell indices should have had an opposite effect. Someone might be exiting the position and using liquidity created by Russell rebalancing to do that.

    1. Makarid

      Maybe someone knows something about earnings report on August 7.

  15. over2u

    Advanced Emissions Solutions, Inc. (NASDAQ:ADES) (the “Company” or “ADES”) today announced that Tinuum Group, LLC (“Tinuum Group”), jointly owned between the Company’s subsidiary ADA-ES, Inc. and an affiliate of NexGen Resources Corporation, has sold a 49.9% interest in a Refined Coal (“RC”) project to a new third-party investor. The Company and Tinuum will maintain ownership of 0.1% and 49.9% of the project, respectively. The RC facility is located at a coal-burning power plant that has historically burned in excess of 3.5 million tons of coal per year and is royalty bearing to ADES. With this addition, Tinuum Group has 15 invested RC facilities in full-time operation.

    Positive news re new management abilty to lease RC facilities.

    1. Makarid

      Does this means that the tax credits will go 50-50 between our company and the third-party or is this the default structure of every invested RC facilities?

  16. dt

    ADES reported Q2 earnings:
    http://s21.q4cdn.com/799184823/files/doc_presentations/2017/aug/Q2-2017-Investor-Deck_FINAL.pdf

    Three points to note:
    1) Future expected cashflows from RC facilities have been lowered from $275m-$300m in Q1 to $225m-$250m in Q2 even though only $12.5m of distributions and royalties were received during the quarter. In the press release management did not provide any explanations for the change. Hopefully conference call will shed some more light on this.
    2) The latest (July 2017) RC facility leasing seems to be done on different terms than the previous ones, with Tinuum retaining 50% ownership. Not sure whether this was done on purpose to gain tax credits for Tinuum shareholders (including ADES), or whether this indicates changing market where that tax equity investors are unwilling to take the full 100% position. Again, conference call might shed some more light on this.
    3) There is a nice chart of slide 9 depicting the RC business model and the benefits for the involved parties.

    1. Freedomist

      How did you get $12.5m of distributions and royalties? I saw 4m royalties + 10.5m distributions. Thanks.

      1. dt

        Where did you see $4m in royalties?

        From the press release:
        - Tinuum distributions to ADES were $10.5 million during the second quarter of 2017;
        - Royalty earnings from Tinuum were $1.9 million for the second quarter of 2017.

    1. dt

      No, the call did not clear up anything. From the call:

      Q2 2017: “Slide 16 shows an update on our expected cash flows. This slide has been updated to reflect the distributions that received in the first half of 2017 and it shows that moving forward, as of June 30, we are expecting $225 million to $250 million in consolidated cash flows through the end of 2021.”

      Q1 2017: “First, on Slide 16, you can see what supports our future capital allocation program. With the addition of Tinuum’s 14 leased facility and the contributions from the EC business, we are projected between $275 million to $300 million in future cash flows ADES.”

      During H1 2017 ADES received total distributions of c. $27m, however the change in projected cashflows is -$50m, so half of the change is not really explained. Also the amounts projected to be received in 2018-2020 have declined, so clearly the forecast change is not explained by the distributions received so far.

      Nobody asked this seemingly obvious question during the call – so maybe I am missing some kind of logical explanation?

    1. dt

      Based on NASDAQ info, 2m shares are short, which is 10% of all outstanding shares:
      http://www.nasdaq.com/symbol/ades/short-interest

      Even more interestingly, the number of shorted shares doubled during the summer from 1m to 2m – this happened at a time when company announced and started paying dividend yielding almost 10%.

      Company generates strong cashflows from existing assets (which will end after 5 years) and has optionality from unutilized capacity and other parts of business. Couple this with 10% yield and I struggle to see any strong arguments of why ADES is a good short at current levels, unless the dividend cut would be imminent (as far as I aware this is not the case).

      In any case, this is definitely concerning and suggests I might be missing an important piece of the puzzle.

  17. Michael

    I didn’t study this business in detail. But maybe the current price (and possibly the short interest) reflect the fact that
    - the $13 original cash flow estimate is “undiscounted”
    - the 10% yield will of course reduce principal, if I understand it right – they are not yearly “earnings”
    - very limited growth prospect, as most capital will be returned within 5 years
    - general business and market risk still apply, until the capital is returned
    These factors have to be considered when estimating the risk/return characteristics in comparison to alternative investments.
    On the other hand, at $10.58, and $0.50 dividends, the investment returned already 12.5% based on your posted “current price” of $9.85. Your original posted upside was 20%. Do you think the investment is still worth holding at the current price?

    1. dt

      Michael, I was also considering liquidating part of the position, but so far have not done this. As you suggest the return has already been significant.
      In the above you correctly outline the risks, however you have also to consider material upside and value from the other parts of the business outside the RC part.

      From the initial write-up:

      “At the same time the upside remains from:

      - Still unleased RC facilities (14 remaining). One additional has already been leased during Q1 2017, proving that there is still demand for it. Presidential election and resulting uncertainty regarding reg environment for coal and taxes in general has caused hesitation among potential facility operators to start using these for tax purposes, but management believes the skies have cleared now and mentioned being in active discussions with potential RC investors (to be fair similar discussion have also been mentioned on the previous conference calls, but so far resulted only in one incremental leased facility)
      - Any extension of refined coal tax credits beyond 2021. Currently tax benefits expire on 2021, but keeping in mind Trump’s rhetoric regarding coal industry, these could be extended allowing ADES to continue its tax credits business beyond 2021.
      - Value of the growing emission controls chemicals business;
      - Value of the patent portfolio.”

  18. Michael

    There is an article on seekingalpha “Advanced Emissions Solutions – Avoid This Coal Dependent Company”. Unfortunately I don’t have access to it. Maybe it would shed more light on potential risks.

    1. dt

      The article is from Aug 2016 – quite a few things have changed since and obviously the author has been quite wrong so far as share price (including dividends) is 40% higher already.

  19. M P

    Do you see new GOP tax plan having a large affect on company? Looks like Investor’s receive $2.28/ton assuming 35% tax rate but if tax rate does drop to 20% wouldn’t that reduce the incentive to invest in the RC facility?

    1. dt

      Agree that with lower corporate tax rates the incentives for third parties to ‘invest’ in RC facilities is somewhat reduced, because the same expense amount would produce lower tax savings. However the incentives to setup these vehicles would still remain, especially keeping in mind that the third party does not really need to invest anything – simply do the legal work and start leasing the facilities (in reality probably far more complicated).

  20. dt

    I have closed ADES position. Price has increased significantly over the last month and I am taking the opportunity to cash-out. I am already above the initial $12 price target (if dividends are included) having realized 23% return in 5 months.

    The upside optionality (unleased RC facilities, chemicals business, patent portfolio and etc) remains high and the stock could easily continue to outperform – I still have no idea why it is doing so well over the last month. However, my key thesis at the time was that ADES was trading below contractually secured cashflows. With share price approaching $12/share, this part of investment thesis has played out.

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