NV5, Inc. (NVEE) Investment Thesis At the current price of $10 per share, NV5 is an attractive investment because 1. NV5 is a low capital-intensity, consistently cash flowing business exposed to an end market at trough levels. 2. NV5 is cheap on a run-rate cash flow yield basis, while being a very attractive growth company. 3. NV5 is pursuing a roll-up strategy, acquiring small to mid-sized bolt-on acquisitions in a highly fragmented industry that has been consolidating for years. Despite years of consolidation, M&A activity continues to be strong and there are still over 500 targets out there, many of which are small mom and pops. 4. As NV5’s revenue becomes more diversified among customers and geographies, the multiple it deserves increases, and NV5 becomes a more attractive target for acquisition itself. 5. Finally, NV5’s CEO, an owner operator owning 40% of the company, has a long and distinguished 30+ year track record of successfully executing on the same roll-up strategy. He has proven himself adept at both the financial and operational nuances of the strategy and has done a multitude of accretive acquisitions throughout his career. Business Overview NV5 provides technical and professional consulting/certification services for engineering projects. They group their offerings into five verticals: Construction Quality Assurance, Infrastructure Engineering, Energy Services, Program Management, and Environmental Services. They currently derive the majority of their revenue from public costumers (>65%), but aim to target more higher-margin private projects going forward. Below is an example of what their services might entail: “We provide services from conception to completion of a building project to verify that the project conforms to construction specifications. We analyze the soil to determine whether it can hold the proposed structure. We also analyze the structural strength of the concrete, masonry and steel materials to be used during construction. We use universally recognized testing procedures and laboratory equipment to perform our analyses. Our employees, that are licensed inspectors, inspect all construction in the field.” Engineering & Construction engagements happen with two different payment schemes – fixed price or cost plus. Fixed price projects are negotiated on a lump sum basis. They typically involve an auction, where multiple contractors offer competing bids. The winning bidder takes on the risk that the cost of executing the project exceeds the lump sum paid for the project. Fixed price projects only made up ~10% of NV5’s revenue over the past two years. The bulk of NV5’s business is cost plus, also known as cost reimbursable contracts. These contracts are paid on a time-and-materials incurred basis, and are typically lower risk for the contractor. The majority of NV5’s activities are focused around consulting. For example, in Quality
NV5, Inc. (NVEE) Assurance, another engineering & construction company is brought in to do the construction, and NV5 is brought in to monitor whether engineering and project management best practices are being followed. Therefore NV5’s business model is one of billing the hours of their employees, and is less exposed to project execution risks than fixed price business models. NV5’s clients include University of San Diego, Miami Art Museum, Bechtel, Hyatt, etc. They have done projects for multiple international airports (San Diego, Ft. Lauderdale, and Miami), colleges, museums and power plants. Up till 2013, over 65% of NV5’s revenue comes from California, and ~20% of their revenue came from one customer – these facts are both risks and opportunities for the company, which I will address below. The Strategy NV5 was created to be a platform company from which the owners can perform several bolt-on acquisitions. As a company with $68M revenues in 2013, NV5 has the aggressive growth targets of $140M of revenue by the end of 2014, and $300M by the end of 2016. The bulk of NV5’s strategic framework for growing revenue is through acquisitions. The field is attractive for acquisition because even small firms build execution track records with individual customers – creating repeat business and switching costs. Being acquired by a larger firm allows each small business to continue doing business with existing customers, while being able to provide more services and cross-sell. To provide context, the E&C consulting space has been consolidating for several years:
NV5, Inc. (NVEE)
NV5, Inc. (NVEE)
A few data points to highlight: 1. 2. 3. 4.
>100 acquisitions per year have been made over the past 9 years The US space is still highly fragmented, with over 3,000 firms in 2011, and less than 200 firms had revenues over $20M 18.6% of gross revenues in the US industry in 2011 was generated by firms with less than $20M of revenue The number of firms doing acquisitions have trended up over the past decade
NV5 targets firms with $3M to $30M revenues. Given the data from Environmental Business Journal presented above, there are at least 500 firms in the US that fit this criterion. NV5 avoids turnarounds and looks for acquisitions that are immediately accretive to earnings. NV5 finances each deal with cash, new NV5 shares, and notes given to the seller payable contingent on the operating results of the acquired company (essentially an earn-out).
NV5, Inc. (NVEE) Despite there being competition among buyers for attractive acquisitions – NV5 has an advantage in being small. Acquisitions that would not move the needle for a large competitor will be a significant increase in size for NV5. In addition, the management team of NV5 has been around the space for over 20 years doing M&A and has built both reputation and contacts within the space. To achieve attractive acquisition valuations, NV5 targets motivated selling companies with an aging owner who is seeking an exit, and a young up-and-coming team that wants more equity in the business. NV5 provides the owner liquidity in the form of cash, notes and shares to sell. NV5 provides the up-and-coming team members equity in the business in the form of RSU’s. NV5 management describes this process as the method through which they can acquire partners rather than just employees. NV5 creates additional value above the price paid from each acquisition from two sources: operational and financial. Operationally, NV5 has identified 5 functions that the consolidated company can share across divisions. These functions are human resources, risk management, IT (includes integrating new firm into parent firm’s production platform), finance group, and finally the M&A team. These five functions account for a cost of 8% of NV5’s gross revenue and management indicates that the 8% will not grow even as revenues grow. From past experience, management estimates that these five functions cost acquired companies about 10%-14% of their gross revenue. 40%-50% of any cost savings achieved from de-duplicating the functions will hit the bottom line. Accepting these assumptions, we estimate NV5 improves the operating margin of acquired companies by around 80 to 300 bps. Each acquired company also benefits from becoming part of a larger company by gaining more capability to service clients. By offering the combined services of a company with a more diversified expertise portfolio, acquired firms can become more competitive in their offerings to existing companies. Often selling managers are seeking stability by joining a larger company and stay on with NV5, taking advantage of the greater scale to continue operations. Financially, the roll-up makes the whole greater than the sum of the parts. 1. Larger firms have more diversified revenue bases– creating more stable cash flows over time and therefore commanding higher multiples. NV5 becomes more geographically, service line, and customer diversified with each acquisition – and therefore experiences multiple expansion with each acquisition. 2. As a direct result of point 1, NV5 can acquire smaller companies at lower valuations than where NV5 is trading, capturing the earnings multiple arbitrage. 3. Larger firms have greater access to capital markets, either through debt or public equity. The larger the firm, the greater the access.
NV5, Inc. (NVEE)
Management Now the question of “What” the strategy is has been answered, the more important question of “Why” will they be successful comes up. The main reason to have confidence in this management team is that they have done this before, very successfully, and for many years. Despite the company having a limited history, the management has a distinguished and aged track record. “The best judgment we can make about managerial competence does not depend on what people say, but simply what the record shows.” – Warren Buffett, Essay entitled Track Record is Everything The CEO and Chairman of NV5, Dickerson Wright has a 35+ year history of starting, growing and selling E&C testing companies similar to NV5. Starting in 1976, he left his position managing a Civil Engineering Laboratory at the San Onofre Nuclear Generating Station Construction project to start his first company. Western States Testing, started with Mr. Wright as the only employee and $500 of start-up capital, grew to 10 employees by 1979 and was sold to United States Testing Company. At United States Testing Mr. Wright grew Western States to over 200 employees.
NV5, Inc. (NVEE) Mr. Wright left United States Testing in 1987 and acquired a 50% interest in American Engineering Laboratories in San Diego, which grew from 30 employees in 1987 to over 200 in 1990. In 1990, Mr. Wright sold American Engineering to Professional Services Industries, becoming an EVP and member of the operating board. He left Professional Services Industries 3 years later to found U.S. Laboratories in 1993. U.S. Laboratories was the first and only company Mr. Wright has taken public prior to NV5. U.S. Labs went public in 1999 as units that contained both a $5 share and a $1 warrant to buy. The warrants were essentially long dated call options â€“ that when redeemed sent cash into the company in exchange for new shares. US Lab Financials 1996 â€“ LTM June 2002 FY96
LTM Jun 02
Revenue Other Revenue Total Revenue
Cost Of Goods Sold Gross Profit
(0.1) 0.0 (0.1)
(0.1) 0.0 (0.1)
(0.2) 0.0 (0.2)
(0.1) 0.1 0.0
(0.3) 0.0 (0.3)
(0.2) 0.1 (0.2)
(0.4) 0.1 (0.3)
Other Non-Operating Inc. (Exp.) EBT Excl. Unusual Items
Impairment of Goodwill Gain (Loss) On Sale Of Invest. Gain (Loss) On Sale Of Assets Other Unusual Items EBT Incl. Unusual Items
0 0 0.4
0.0 0.0 0.8
Income Tax Expense Earnings from Cont. Ops.
Other Operating Exp., Total Operating Income Operating Margin Interest Expense Interest and Invest. Income Net Interest Exp.
NV5, Inc. (NVEE) Earnings of Discontinued Ops. Extraord. Item & Account. Change Net Income to Company Net Margin
Source: CapIQ U.S. Labs grew both organically and through acquisitions to $80M in revenues in 2002, when it was acquired by Bureau Veritas (BV) for $16.50 a share. The $16.50 price, after taking into account dilution by issued shares, represents a 142% total return for investors in the IPO of U.S. Labs. A >30% CAGR over the years U.S. Labs was public. Dickerson Wright stayed with BV after the acquisition to continue to head U.S. Labs, growing U.S. Labs to over $300M in revenue by January 2008. BV is a highly respectable company and in 2008, when Mr. Wright left, BV had revenues of over $2.5B and industry leading net margins of 8.5%. In 2009, Mr. Wright saw a market opportunity to begin another roll-up effort as an independent company, and took with him many of BV’s North America team. NV5’s current management team and board consist of industry veterans, all with over 20 years of experience. Below are a few examples picked from the team: 1. Donald Alford, EVP & Director of M&A, has been with Mr. Wright since US Labs and has managed over 40 M&A transactions for the firms. 2. Alexander Hockman, COO of CQA founded Intercounty Laboratories, which was acquired by NV5 (which then was part of BV) in ‘03, and has worked with the team for over 10 years. 3. Richard Tong, EVP and General Counsel left BV, where he headed the North American legal & risk management, with Mr. Wright, also having worked with him for 10 years. 4. Ernesto Aguilar, COO of infrastructure, is an exciting new addition to the team. He has almost 25 years of experience in the industry and has done well managing operations of major divisions. “Most recently, Mr. Aguilar served as Vice President, National Business Sector Manager, where he oversaw the Infrastructure Engineering sector for Atkins in North America and turned it into one of the top performing business units in the organization with double-digit increases in profit margins.” Final thoughts on management, Mr. Wright has always had a significant ownership stake in each company that he founds/operates. He currently owns 40% of NV5’s common shares, representing ~$22M of market value, which is equal to 55 times his 2012 salary of $400K, and has only granted himself $50K of stock options. In addition, Mr. Wright has provided personal guarantees for the credit facilities granted to NV5.
NV5, Inc. (NVEE)
Proof of Concept NV5 started as a platform company acquired from BV. The initial acquisition was a construction quality assurance business with 125 professionals and $12M of revenue. Over the next 4 years, the firm made several acquisitions. Most notably in 2010, NV5 acquired the majority of shares of Nolte, a 325 professional firm with $50M of revenue, dramatically increasing the firmâ€™s size. In October 2011, NV5 and Nolte completed a reorganization transaction in which NV5 became an incorporated Delaware corporation, acquiring all the shares of NV5 and Nolte â€“ becoming the publically listed holding company. The firm has an excellent track record with acquisitions already:
NV5, Inc. (NVEE)
BV Deal 57% of Nolte Kaco Sum of all acquisitions in 2013 AK Environmental Average
Total Consideration ($M) 5.17 7.26 3.50 3.26 7
Sales (Annualized) ($M) 14.80 47.40 4.60 6.25 25
Net Income (Annualized) ($M) 1.00 0.50 0.85 0.60 1 (Estimate)
P/Sales P/E 0.35X 5.17X 0.15X 14.52X 0.76X 4.12X 0.52X 5.43X 0.28X 7.00X 0.41X
Source: Company Reports Description of Deals:
July 27, 2012 NV5 acquired Kaderabak Company (Kaco). Kaco is a 30 person engineering firm specializing in development and engineering teams that has projects in south Florida, the Caribbean, and Central America. In 2013, NV5 made a series of small acquisitions including Consilium partners (20-person owner’s representation and project management firm), the Tampa, Florida division of Pitman-Hartenstein & Associates (specializes in transportation infrastructure engineering), and Air Quality Consulting (specializes in occupational health safety and environmental consulting). March 21, 2014 NV5 announced they acquired AK environmental, a young firm that grew revenues 38% over the last 3 years. The firm specializes in inspection, construction management and environmental consulting. AK Environmental primarily services natural gas pipeline companies in the Northeast, Mid-Atlantic and Southeast United States.
As you can see, each deal increased the breadth of services NV5 can offer as well as the number and types of customers NV5 services. For example, the AK environmental acquisition reduced the exposure of NV5’s revenues to Californian customers from over 65% to around 45%. In addition, each acquisition provides growth opportunities from cross selling new services, and through penetrating new geographies. The multiples the deals were done were on average accretive. Combined, they were done on prices of 0.4X P/Sales, and 7.3 P/E compared to NV5’s current .7 EV/Sales and 11.8 LTM P/E.
NV5, Inc. (NVEE) Dilution One issue that must be addressed is the dilution the firm utilizes to finance its growth. The firm went public in April 2013, in units that combined a $5 share with a $1 warrant, and raised $8.1M. In September 2013, the company raised capital again by lowering the exercise price of warrants from $7.8 to $6 for a month, raising $7.2M. This second move was obviously dilutive, but there is reason to think that a similar event won’t happen in the near to medium term. 1. The firm has $10M in cash (after the AK acquisition), and Mr. Wright has indicated that this is enough dry powder to achieve the $140M revenue target by end of 2014. In addition, the firm is cash flow positive, and more cash will build up through the year. 2. Mr. Wright and the current management team are unlikely to dilute in any way that disadvantages them because of their significant inside ownership. Management had shares and as such had warrants that came with the units of the IPO. Management was able to participate in exercising their options at the lower strike price, picking up shares at a discount while contributing money to the business. Now that the company is funded and the majority of warrants have been exercised, it is unlikely a repeat event will occur. The End Market NV5 is exposed to an attractive market at a cyclical trough – US infrastructure. US non-residential spending is well below its long-term averages, but despite that NV5’s business has been strong. Should there be a pick-up in the overall market; NV5’s business will experience strong sales growth.
NV5, Inc. (NVEE)
Despite budget constraints at both state and federal levels, plus the negative effect on spending caused by the Sequester, a country can only underinvest in its infrastructure so long before bridges start collapsing â€“ forcing the topic into the public agenda: http://www.thewire.com/politics/2013/05/bridge-collapse-us-infrastructure-spending-charts/65575/ According to Ernst & Young, State and local governments will take leadership in driving new infrastructure spending. As federal support weakens, state and local governments are increasing sales and gas taxes to pay for bridge replacements and new water treatment plants. There has also been increased utilization of public-private partnership (PPP) financing, as governments partner with private capital to fund public projects. http://www.ey.com/Publication/vwLUAssets/Infrastructure_2013/$FILE/Infrastructure_2013.pdf The sell-side consensus is that US non-residential construction spend is currently in the trough and we should start seeing improvements within the next year or two:
NV5, Inc. (NVEE) “Total U.S. non-residential construction starts totaled 845 million square feet in 2013, well below the 1.67 billion square foot peak in 2007 and approximately 35% below the long-term average of 1.3 billion square feet… Our industrials analyst Julian Mitchell expects improving nonresidential construction as 2014 progresses and acceleration in 2015.” – NCI Building systems Initiation, Credit Suisse. March 24, 2014 “Expect to see an eventual resumption of projects being awarded, which has begun at the federal level, and expect to see the trend continue at the state and local levels… Clear signs of resurgence in commercial construction activity, particularly in major cities such as New York, Chicago, L.A., and San Francisco. In New York, the construction spend is expected to be $37b in 2014, just shy of the 2007 peak. In Downtown Los Angeles, there are over half a dozen major developments being planned and several more in the pipeline including a AECOM Capital project that will develop almost 1,500 high-rise residential units.” – Engineering & Construction, UBS. March 11, 2014 “Clear signs of resurgence in commercial construction activity, particularly in major cities such as New York, Chicago, L.A., and San Francisco. In New York, the construction spend is expected to be $37b in 2014, just shy of the 2007 peak. In Downtown Los Angeles, there are over half a dozen major developments being planned and several more in the pipeline including a AECOM Capital project that will develop almost 1,500 high-rise residential units.” – Americas: Machinery, Goldman Sachs. March 11, 2014 Various companies exposed to US capital investment are also feeling optimistic for the mid-term improvement in the end-market. “The commercial market is roughly a $3 billion to $4 billion market in the Americas. The outlook for 2014, I would characterize as slightly improved to 2013. The institutional market which has been going through a very difficult stage in the last two years has shown signs of bottoming out and in some markets around the country largely driven by improved local tax bases driven by job growth. We actually are seeing some growth in the institutional market.” – Allegion Management “But I think the better news, if you will, really goes on the non-resi side. We saw Otis orders in North America up almost 30% in the fourth quarter. The CCS, the commercial business, orders were up about 5% even though sales were down 5%. So we're starting to see that recovery that we have been talking about in non-res.” – United Technologies Management Valuation NV5 Income Statement
Revenue Other Revenue Total Revenue
NV5, Inc. (NVEE) Cost Of Goods Sold Gross Profit
Selling General & Admin Exp. R & D Exp. Depreciation & Amort. Other Operating Expense/(Income)
14.3 1.1 -
27.6 1.9 -
27.8 1.5 -
29.4 1.5 -
Merger & Related Restruct. Charges Impairment of Goodwill Other Unusual Items EBT Incl. Unusual Items
Income Tax Expense Earnings from Cont. Ops.
0.0 (0.1) -0.3%
0.0 1.9 3.1%
Other Operating Exp., Total Operating Income Operating Margin Interest Expense Interest and Invest. Income Net Interest Exp. Other Non-Operating Inc. (Exp.) EBT Excl. Unusual Items
Earnings of Discontinued Ops. Extraord. Item & Account. Change Net Income to Company Net Margin
Key Stats: Total Revenue Growth Over Prior Year
NV5, Inc. (NVEE) Gross Profit Margin %
EBITDA Margin %
EBIT Margin %
(0.2) (2.5) (2.7)
(0.4) 0.1 (0.3)
(0.6) (1.0) (1.6)
(0.5) (1.6) (2.2)
Cash Flow Statement Excerpt Cash from Ops. Capital Expenditure Sale of Property, Plant, and Equipment Cash Acquisitions Divestitures Invest. in Marketable & Equity Securt. Net (Inc.) Dec. in Loans Originated/Sold Other Investing Activities Cash from Investing
A few things to note: 1. Using the conservative assumption that all CapEx is maintenance CapEX, the free cash flow is very much in line with reported GAAP net income over the past few years – indicating high earnings quality. 2. Net margins improve with greater revenue, indicating operating leverage. At run rate, margins for U.S. Labs were ~9.5% operating and 5% net margins. This seems an achievable goal for NV5 to match or exceed, given its larger revenue base. For FY14, management is guiding $100-110M revenues, driven by 13% organic growth on top of the additional pro-rated AK Environmental revenues for the rest of the year (18-20M). This guidance is strongly supported by a $60M backlog (excluding AK environmental) – backlog historically has been 75% of realized revenue over NTM. Assuming no organic growth, NV5’s annual run rate revenue is $68M NV5 + $25M AK Environmental = $93M.
NV5, Inc. (NVEE) To roughly estimate today’s run rate earnings power without further acquisitions – we estimate the company has current annual run-rate revenue of $100M growing organically at mid to high single digits. Without growth spending, the company should have a FCF margin of >5%. Together this yields cash earnings of >$5M – indicating that at an EV of $47M, the company trades at an >10% FCF yield, while out-growing inflation – very attractive value in today’s high multiple market. What makes the company unbelievably cheap on top of the low multiple for the run-rate earnings of the company is the huge intangible asset of management’s experience. Given their track record of acquisitions, the management can be expected to continue making accretive acquisitions going forward, creating further value for shareholders. What will the company be worth in 2016? The following scenarios assume a low-ball 5% organic growth, and a multiple of .5X revenue paid for acquisitions. By 2016, the company’s existing revenues will have grown organically to ~$110M. If management can achieve their guidance of $300M revenue by 2016 and hit a 9% EBIT margin (guided 8-10% management normalized EBIT margins), then the company will have $27M of EBIT. Using an 8x EBIT multiple, the firm will have an enterprise value of $216M. New shares, cash used, and debt taken on for acquisitions will have been $95M (having bought $190M revenues) of that Enterprise value - $93M after the 2M net cash they already have. So the new “market cap owned by existing shareholders” will be ~$123M, a 124% return over 3 years. [Calculations goes 216M Enterprise value less $95M paid to acquirees Enterprise Value = $123M Market Cap less $2M net cash] I don’t expect them to meet guidance, and rather my base case is $225M revenue by 2016 and an 8% EBIT margin, giving the company $18M of EBIT. Using the 8x EBIT multiple, the firm will have an enterprise value of $144M. New shares, cash used, and debt taken on for acquisitions will have been $57.5M (having bought $115M revenues) of that Enterprise value - $55.5M less the 2M net cash they already have. So the “new market cap owned existing shareholders” will be ~$88.5M, a 61% return over 3 years. [Calculations goes 144M Enterprise value less $57.5M paid to acquirees Enterprise Value = $88.5M Market Cap less $2M net cash] Competitor Multiples (Justification for terminal EBIT multiple calculation): Company name AECOM Technology Corporation AMEC plc
EV/NTM EBIT 10.11X 10.24X
LTM Revenue Multiple 0.47X 0.89X
NV5, Inc. (NVEE) Intertek Group plc Bureau Veritas SA Tetra Tech Inc. TRC Companies Inc. URS Corporation Willdan Group, Inc. WS Atkins plc NV5 Holdings, Inc. Average
15.21X 15.60X 10.19X 7.52X 9.71X 7.24X 10.58X 7.02X 10.34X
2.48X 2.80X 0.96X 0.54X 0.46X 0.38X 0.70X 0.69X 1.04X
The bear case scenario is that they are unable to find attractive acquisitions, and cease acquiring – and we are left with a 10% FCF yield at current prices, which grows organically above the rate of inflation. This should yield a CAGR above 10%. Finally, my worst case scenario involves the value of the stock halving – and there are a variety of things that could cause that to happen, which I will address in the risks portion. However, the probabilities of these worst cases are low, and I will present each risk’s mitigation as well. Risks 1. Poor acquisition discipline – a particularly bad, dilutive acquisition would severely dampen the future value of the company. 2. Poor execution – this could happen in integrating acquired companies, mismanaging operations, losing customers, losing valuable employees through poor treatment, and a variety of other managerial missteps. Risks 1 & 2 are mitigated by the management’s long track record of excellent execution, and their significant personal ownership of the company. My argument is simply if the horse is good (which it is), it is safe to bet on a good jockey especially when the jockey has bet significantly on himself. 3. Dilution – NV5 is run by a management team that has a track record of using equity markets as a source of financing through both public offerings and warrant maneuvers. An outside shareholder risks being diluted by owning the stock. This risk is addressed above in its own section. 4. Loss of large customers – NV5 is fairly concentrated with almost 30% of its revenue coming from two large customers (prior to AK acquisition)
NV5, Inc. (NVEE) 5. California public spending goes down – as roughly over 65% of the company’s revenue comes from California (prior to AK acquisition), if California slows spending because of budget, NV5 could suffer. 6. Large project delay – as the revenue base is small, a large project being delayed could significantly lower a quarter’s earnings. These 3 are actually an opportunity as well as a risk, as mentioned earlier. For example, with the AK environmental acquisition, NV5 gained $25M (~25% of total) revenue of new customers that outside of California. With each acquisition revenues become larger and more diversified – leaving the company safer and deserving a higher multiple. For example, with the AK acquisition, concentration of top two customers is now ~20%, and exposure to California is ~45%. 7. US E&C slows down This last one is possible though unlikely, and has been addressed in “The End Market” section. Warrants The warrants are publicly traded call options with strike price of $7.8 that expire in March 27, 2018. They can be called for redemption if the shares trade over 12 dollars for over 20 trading days. The warrants have traded up with the shares and are less attractive now, but are probably the most interesting way to double down should the stock fall – as a leveraged bet on the strategy succeeding. Catalysts
Acquisitions, acquisitions, acquisitions Multiple arbitrage on the earnings of acquired companies Margin improvement on operating leverage from scale Multiple expansion on NV5 after reaching a certain revenue size o Company becomes less risky as customers become diversified o Removal of geographic discount Sale of the company Increased buying by market participants as the company grows and trading volume increases
Published on Apr 21, 2014