Peter Kennan presented his in-depth investment thesis on Emeco (Australia: EHL) at Asian Investing Summit 2015.
Emeco is the largest mining equipment rental company in the world, formed in Western Australia in 1972 as a family-owned business. It was acquired by a syndicate of private equity investors in 2005 and then floated on the ASX in 2007. Emeco’s business is focused on the major mining houses and increasingly it is working in partnership with the major Caterpillar distributors to service the equipment needs of the world’s major mining houses. In October 2013, Emeco issued a US$355m 144A bond with a 5 year term. The net proceeds were from the bond were used to repay existing facilities. Emeco also has a A$75m asset backed facility which is currently un-drawn. The notes do not include maintenance covenants, the asset backed facility has the following covenants (if drawn above a specified level): liquidity ratio (net debt to net tangible assets of no greater than 65%),interest cover ratio (operating EBITDA to interest expense of no less than 2.25 times).
Investment thesis: The downside is protected by asset values and liquidity of the assets. Strong free cash flow is available if capital expenditures are curtailed. Equipment depreciation rate and disciplined supply of new equipment result in relatively quick re-balancing of supply and demand. Improving utilization drives earnings growth. Surplus cash may be utilized to buy back bonds and equity. Stock trading at 10-12¢ versus net assets backing of 47.5¢.
Where did it go wrong? Management change post investment by Black Crane Capital. Utilization was restored but at the cost of margins. Cost control and reduction have not the number one priority when they should have been. Management is pursuing a large, diversifying acquisition (Rentco) at the wrong time and wrong price (8-10x EBIT). The acquisition uses most of the surplus cash and also includes substantial issuance of shares. Black Crane is pursuing an activist campaign to stop the acquisition and change the Board. Emeco needs to refocus on capital management and potential industry consolidation. A public letter to the Chairman clearly outlines opposition to the acquisition. The letter is jointly signed by Black Crane and one other shareholder with a combined stake of 24%.
About the instructor:
Peter Kennan is Managing Partner and CIO of Black Crane Capital. He has 15 years of corporate finance experience across a diverse range of sectors and transactions with UBS Asia and Australia. With UBS, Peter was formerly the Head of Asian Industrials Group for UBS Asia, a corporate finance sector team covering energy, infrastructure, resources, consumer/retail and general industrial companies. He achieved number 1 team rating in Asia with revenues of US$400m in 2007, grown from just US$20m over a four year period. Peter was also the Head of Telecoms and Media sector team for UBS Australia specializing in M&A, advising on many large, complex transactions. Prior to UBS, Peter spent seven years with BP in a variety of engineering and commercial roles.
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