$IEA - The One to Average Down

Deeper Dive into Recent Developments

Introduction

Dear subs, I hope everyone is doing well and keeping well away from any mutations – Omicron or otherwise. I received numerous emails and private messages over the past few weeks regarding IEA, and I felt it was appropriate to get a quick update post out to answer all questions in one fell swoop. My expectation is that this saves time on both ends – as I can hopefully address all subscriber FAQs.

Bottom line, I think the suboptimal stock performance since my original writeup ($11.36 vs. $9.50 today) is largely unwarranted. I felt that the story was becoming more widely appreciated at the time of the post-earnings rally in September (reaching ~$13.50/share) as the market digested the positive catalyst of the global refinancing. Needless to say, it’s all been downhill since then – but I still strongly believe in the long-term potential of this investment. Further, I wanted to spell out some very positive developments since the last update too. Full disclosure, I think the stock at $9.50 is a gift, and added aggressively below $10/share.

My rationale for adding to my position is as follows:

• Substantially better r/r at current prices as the longer term story is unchanged

• Quanta’s buyout of Blattner, a direct competitor, is highly confirmatory of IEA’s deep discount to fair value

• 3Q earnings were better than feared, and forward guidance is reasonable

• Evidence of smart capital allocation framework from management & BoD

• End-game is reasonably clear from Ares’ involvement

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Longer Term Thesis is Unchanged

At its core, the IEA investment is predicated on a very cheap valuation for a Company that should enjoy macro tailwinds for a long time. At today’s stock price, IEA only trades for 5.5x EV/EBITDA based on latest 2021 guidance, and a 12% LFCF yield on market cap, when earnings and FCF should compound at double digits annually for many years to come. And please bear in mind, I am using the share count inclusive of all potential forms of dilution (Options/RSUs, warrants and anti-dilution shares) – so the metrics are presented in the most conservative way possible. The Company will be a huge beneficiary of the Infrastructure Bill, as well as any ESG related tailwinds – how many better ESG stories can you think of, than the Company that builds windmills and solar farms?

Furthermore, IEA was smart and lucky enough to pull off a global refinancing much earlier than I initially suspected, at very reasonable terms ($300mm HY notes at 6.625% rate, with a 2029 maturity). This cleaned up the capital structure by getting rid of all the expensive Preferreds, which in my opinion was the biggest overhang for the stock before it could achieve significant multiple expansion. At 5.5x EV/EBITDA, I believe IEA is the cheapest US-based EPC company in the public markets (with the exception of Limbach), which I feel is a gross mispricing.

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Quanta’s Buyout of Blattner

As you may know already, Quanta Services closed the acquisition of Blattner in mid-October. For context, Blattner is the largest renewables focused EPC, with estimated 2021 revenues and EBITDA of $2.6bn and $315mm (12.1% margin) respectively. Inclusive of the earn-out, Quanta is acquiring Blattner for 9.5x on 2021 numbers, and 11.1x on preliminary 2022 numbers (sandbagged in my opinion). Regardless of where you want to anchor, this is a giant valuation gap between IEA and its best comp in the market.

Now let’s be fair – Blattner is more than 2x the size of IEA in terms of EBITDA, and sports higher EBITDA margins at 12%+, so we should absolutely expect Blattner to go for a higher multiple. However, is 4-5x turns of EBITDA discount really justified for IEA? I really do not believe so – especially because there is no real “secret sauce” in this industry. The renewables EPC market is dominated by a small number of scaled competitors, and customers like to have diversity in their contractor base, which means that market share typically tends not to fluctuate wildly. Again, I do expect Blattner to be a better company in terms of scale benefits and stronger relationships – but this data point suggests that IEA is undervalued, rather than Quanta overpaid for the acquisition.

And let’s not forget what happened to Quanta’s stock price on the day of the announcement – the stock jumped ~15% on the news, which surprised me as the market is giving a ton of credit for future value creation, even at this acquisition multiple. This screams to me that assets like IEA are highly valuable in today’s market, and I have no doubt that someone (mostly likely a strategic) would gladly pay a hefty premium if IEA was up for sale. In other words, I believe the intrinsic value of IEA to be significantly higher than where it is trading today.

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3Q Earnings Commentary

I viewed 3Q earnings favorably for the most part, because I was quite worried into the print that IEA was suffering from several headwinds, such as labor shortage/inflation, subcontractors pushing back on price, as well as various cost escalations in the supply chain that may eat into IEA’s margins. I thought it was within the realms of possibility that IEA may have to reduce guidance substantially – but to my delight, the Company is doing a very good job of mitigating the headwinds, and only brought down the upper bound of 2021 EBITDA guidance by $5mm (i.e. reducing midpoint from $135mm to $132.5mm). I thought this was a very meaningful development, as the Company’s earnings power is proving to be more defensive than I had previously feared.

In addition to that, let’s not forget the Company is almost immune from the impacts of COVID, other than labor pressures and any delays in customer RFPs. I vividly recall during the thick of COVID, in the middle of 2020, when the Company clearly communicated to the market that COVID has little impact on their business, yet the stock and the warrants sold off endlessly – only to recover and then some when the market finally woke up, sending the stock from $2 to $24 (yes, a 12-bagger) in the span of 6 months. So when Omicron is rocking financial markets, my pattern-seeking brain immediately focused my attention back to IEA – I need to buy all big dips!

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Smart Capital Allocation

Among other things, this particular section of the 3Q earnings release really caught my attention:

I think this is a fantastic move – after pulling off an excellent refi, the Company is wasting no time cleaning up the remaining inefficiencies in the capital structure – namely the original SPAC warrants. Granted, the strike is $11.50 and warrants are OTM right now, but opportunistically repurchasing them in the open market at cheap levels fixes the dilution problem – of up to 8.5mm shares that could potentially be issued. It is highly accretive to take out the warrants at current prices, and this will do wonders for longer term value creation.

I think IEA has a strong CFO and an incentivized Board, with two directors from Ares. No doubt they were heavily involved in Boardroom discussions about the best ways to allocate capital. And these types of savvy decisions give me confidence for further value creation, which is just gravy on top of earnings growth and multiple expansion.

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Endgame

As a long-term minded investor, the involvement of Ares as an insider and the largest shareholder gives me a lot of confidence. Not because I think Ares is smarter than anyone else (top investment firm though, no doubt) but because the incentives at play make the end-game very obvious in my mind. Ares owns almost 40% of the company on a fully diluted basis, so the only natural way to exit this investment is to sell the Company – unless the liquidity and stock price improves dramatically, open market sales or secondaries will be challenging in terms of getting a good execution.

I believe that Ares will put the Company up for sale in the next handful of years, depending on market conditions and fundamental business performance. I believe a lot of earnings growth is possible over the next couple of years so do not expect a sale in the near term, but I wouldn’t rule out anything – the great thing about PE firms is that any and every portfolio company is up for sale, if the price is good enough. Natural buyers could include Quanta, to merge IEA with Blattner’s operations, or any other EPC company that wants to diversify into renewables, or could be another PE firm that wants to milk out a few more years of growth. Frankly, I would think it would be a very competitive auction with many potential suitors, yielding a very satisfying outcome for investors with a cost basis at current prices.  

The final point here is that the stock is trading at a significant discount to where Ares last purchased shares – at $11/share back in July:

So how might all this play out, if the Company is sold, say after 2 years? I have an ultra-conservative straw-man model below:

As can be seen from the commentary, I believe the assumptions are highly conservative and see this as the “worst case scenario” – yet this can generate 60% return in two years. If you tweak the assumptions slightly, it is not difficult at all to arrive at 100%+ returns. And this can compound even further through smart capital allocation (e.g. share buybacks in the future, beyond the current warrant authorization).

When all’s said and done, I see little further downside from current prices, and will be looking to scoop up more shares if the market jitters continue – I expect further COVID variants to have little to no impact on the business fundamentals, so IEA is one of the easiest names in my portfolio to average down on.

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Disclosure

Plum Capital is long IEA Common Stock