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.
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 unlikely – The 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:
- 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.
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.
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.