Description

Description/Opportunity

Infrastructure and Energy Alternatives (“IEA”) is a renewables-focused E&C company trading at over a 3-EBITDA turns discount to E&C peers servicing the utility industry. In addition, the company trades at an exceptionally low valuation on an absolute basis at just 4.9x EV/EBITDA (which includes the distribution of earn-out shares) and has 20%+ FCF yield.

We believe the company is on the cusp of a massive growth and earnings inflection which should become evident when the company reports 2Q results on August 9th. Revenue should increase more than 3x from 1Q, and revenues and EBITDA should experience accelerating y/y comps over the next 3 quarters, averaging more than 90% y/y.

IEA exited 1Q with record backlog ($1.1bn) and visibility into the out year – a trend that we believe continued in 2Q. Additionally, the company was on the road in June and reiterated confidence in full year revenue and EBITDA of $805mn and $80mn (both at mid-point) versus $454mn and $52mn, respectively in 2017 (also see June investor presentation http://bit.ly/2Mp7kC2). We note this is a low capital intensity business (2% of revenue), with significant structural barriers to entry, and only 3 major domestic players.

The utility-scale wind energy sector is poised for record growth over the next several years, including a forecast of 31% y/y from MAKE Consulting for 2019 (11GW versus 8.4GW in 2018), well below the 13% revenue growth modeled in 2019 from the sole sell-side analyst covering IEA. Notably, we also expect solar (6% of revenue) to grow faster than IEA’s corporate average in 2019.

Why this opportunity exists

SPAC heritage – IEA became a public entity via a SPAC through its merger with MIII in March. Investors frequently have a negative view towards SPACs and therefore largely ignore them when mergers occur. Additionally, SPACs, unlike IPOs, fail to have significant price discovery through a traditional roadshow, resulting in potential mispricings. We note that IEA was “sold” by Oaktree, which was in the 8th year of the PE Fund that owned IEA. While Oaktree took some cash off the table, they also rolled an equity stake which represents 48.3% of the company. Assuming IEA achieves EBITDA targets in 2018 and 2019, Oaktree stands to receive an additional 9mn shares (we are confident IEA will hit the targets and have included earn-out shares in our valuation) increasing their stake to approximately 67% of the company. As such, Oaktree remains a highly invested and motivated partner to MIII and IEA, and is actively using its significant network to help source and diligence potential M&A transactions (we would be surprised if a transaction is not announced in the next 3 months).

Small-cap/limited coverage – IEA has a market cap of just $220mn and a single sell-side firm following the company. Assuming Oaktree receives its 9mn earn-out shares and the stock appreciates, resulting in additional Founder shares vesting (at $12 and $14) as we anticipate it will, the market cap would be approaching $500mn, making the company relevant to a larger investor base. IEA recently appeared at a Stifel conference and we suspect that they and others will pick up coverage of IEA in coming quarters.

Wait and see following tepid 1Q – We believe that many institutions that have looked at IEA are taking a wait and see approach following a tepid 1Q. Revenue declined 4% y/y to $50.1mn while adjusted EBITDA was a loss of $8.9mn versus a gain of $4.1mn in 1Q 2017. These results reflect delays in projects due to uncertainty regarding the Trump tax policy on renewables, worse than expected weather, and delays in solar due to tax changes. Despite a soft 1Q, management reiterated full-year guidance on its 1Q call. We believe that when it becomes evident that IEA’s business is very much on track, and poised for significant growth in 2019 as well, the stock should move dramatically higher.

Thesis

Wind at IEA’s back – IEA is poised to experience dramatic growth over the next several years, buoyed by a strong move to renewables in the United States, coupled with favorable tax policy. IEA currently generates approximately 88% of revenue from utility-scale wind, 6% from solar, and 6% from civil/other. In the wind sector there are more than 60GW of projects safe harbored as of 12/31/2016 to receive the full Federal Production Tax Credit (PTC). The clarification regarding the Administration’s policy regarding the PTC is reflected in the American Wind Energy Association’s (AWEA) May estimate that the US’ full wind pipeline now totals 33.5GW at the end of 1Q, up 34% versus a year prior. This pipeline represents 37.5% of all the wind currently in operation in the US.

More recently, MAKE Consulting provided a forecast for 8.4GW of wind construction in 2018, 11GW in 2019 (31% y/y growth) and 13GW in 2020 (18% y/y). Considering the sole sell-side estimate has 12.5% revenue growth forecast for IEA in 2019, we believe there could be substantial upside to 2019 estimates, particularly since we expect solar, which has been a drag year-to-date due to import taxes (but has not lost any projects – and has a solid funnel of opportunities), to grow substantially next year.

While PTC tax benefits begin rolling off at a rate of 20% per year post 2020, it’s important to note that in many geographies wind costs are already at or below parity with conventional energy sources.

Source: IEA June Presentation

Moreover, technology improvements are ongoing, and significantly improved battery storage in the 2022/3 timeframe, should dramatically increase wind efficiency and position it for sustained growth even without tax benefits. In addition, 26 States in the US have established Renewable Portfolio Standards (RPS), mandating the use of renewable energy in coming years, which should further bolster demand. Finally, many large corporations including Adobe, AT&T, Bloomberg, Facebook, Nike, T-Mobile and others have entered into power purchase agreements (PPAs), which we believe will be an ongoing trend.

While solar is currently just 6% of IEA’s revenue, we expect it to be a significant growth engine for IEA over coming years. In 2017 the company hired teams to build out its solar capabilities, which increased SG&A in 1Q, but had no commensurate benefit to revenue. We think that will change. IEA has guided that solar will grow organically and via M&A over the next several years and has noted that many of its existing utility-scale wind customers are strong prospects for solar.

Source: IEA June Presentation

Diversification via accretive M&A – We expect IEA to make at least one sizable acquisition in 2018 at a purchase multiple of 4-5x EBITDA. While the company is currently trading at the high-end of this range, we expect that IEA will use cash from its current borrowing capacity of $80mn at ~5.7%-5.8% interest, which would prove meaningfully accretive. Management has noted that they have an actionable pipeline of acquisition candidates. Importantly, the company has commented that it will not issue equity at current prices to finance an acquisition.

Source: IEA June Presentation

We believe that an accretive acquisition will be viewed favorably by the market, and diversification should be significantly multiple enhancing. As noted previously, we believe Oaktree is an active participant, working closely with IEA management to source, diligence, and ultimately, structure deals.

Solid business model: low cap-ex, high barriers to entry – We view IEA’s business model favorably as the company participates in what is essentially an oligopoly as one of 3 major players in the US in the E&C sector for renewables (the other 2 are Blattner Energy and Mortenson). We note that conventional E&C players, such as Bechtel and Kiewitt, have struggled in their attempts to enter the sector. IEA is well-positioned, with both union and non-union employees and a national presence. IEA has a diverse, whose-who of customers, and as such, we believe they represent an excellent platform company.

Source: IEA June Presentation

We also view the company’s low-capital intensity as a very favorable aspect of the story. We expect cap-ex to be less than 2% of revenue, barring an acquisition with a significantly different capital spending profile. Coupled with a negative working capital cycle, we expect IEA to throw off significant cash in coming years, including $50-$60mn of free cash flow in 2018, which we expect will largely be used for further additional accretive acquisitions. We believe that between cash generation, and a higher multiple stock, IEA’s opportunity set for accretive acquisitions should expand, further bolstering the medium and long-term growth story.

Compelling valuation – We expect significant share price appreciation if IEA hits 2018 guidance and enjoys solid growth in 2019. At current prices, shares trade at 4.9x EV/EBITDA, including earn-out shares (3.9x excluding), representing a dramatic discount to utility E&Cs despite faster anticipated growth, higher EBITDA margins, and better cash conversion. In our opinion, as the company proves itself over coming quarters, with its superior growth profile, IEA could go from the low-multiple player in the sector to the high multiple player. Management has commented that it is targeting becoming a $2bn in revenue company in the next few years via organic growth and M&A. We believe that assuming IEA achieves this goal, both Oaktree and the team from MIII could eventually be willing sellers to are larger player, as we view both groups as value-maximizers.

Source: IEA June Presentation

Valuation

As noted previously, we anticipate exceptional growth in revenue and EBITDA in 2018 and 2019, with a massive inflection beginning when the company reports on August 9th. Importantly, we expect that despite significant revenue growth in 2Q, the company’s backlog and opportunity funnel to remain exceptionally strong (if not up further accelerated)

IEA’s valuation is a somewhat of a moving target as warrants, earn-out shares, and Founder shares kick in at different prices. In the table below, we show the share count and implied EV at various prices, and value the warrants using the treasury method. We have attempted to be conservative in our assumptions, including the full inclusion of earn-out shares in our share count, although only half would vest in 2018 and the remainder 2019. We also include capital leases in our debt calculation. Applying an EV/EBITDA of 7.5x-9.5x 2018 EBITDA (in-line with peers), we arrive at a price target of $15-$19. We believe that with accretive M&A, run rate EBITDA exiting 2018 could approach $100mn. We are modeling $102mn of EBITDA in 2019 based solely on organic growth, however we believe M&A could drive this number significantly higher.

Source: Our estimates, company filings

Catalyst

Massive growth inflection when the company reports 2Q on August 9th, coupled with strong outlook and exceptionally low relative and absolute valuation.

Algo buying based on screening of acceleration on y/y and q/q basis.

Accretive M&A.

More investors taking notice of story, with low public float.

2019 guidance above current estimates.

Additional positive research coverage.

Risks

Meaningful negative revision to guidance.

Inability to achieve historic win rate on new business opportunities.

Failure to close M&A, or poor execution upon closing M&A.