While moving forward on its first two municipalities in the form of its Public-Private Partnership (P-3) initiative last week, Abtech's (OTCQB:ABHD) long-awaited penetration into the municipality storm water market has begun. This breakthrough has important implications for the company. Above all else, this "proof-of-concept" will allow the company's contract wins to accelerate steadily throughout 2013. As these contracts materialize, the company will build a very robust multi-year backlog, setting the table for a massive J-curve in revenues and earnings over the next 3-5 years. Based on information provided during the company's most recent conference call, we not only expect a breakout year in 2013, but also a sizeable ramp-up in revenues to $100 million in 2014.
Abtech's Growing Pains Will Be Quickly Forgotten
First things first: we were premature to be overly bullish on Abtech earlier this year. After removing guidance for 2012 last week, Abtech's management team has a clear mandate - it must now execute in a timely and consistent manner going forward.
For those investors wondering why things have been pushed back, we have some important feedback. First off, the P-3 model is new. Because of its newness, municipalities have been reluctant to commit to the offering just yet. This concern should shortly recede and eventually disappear after the first two municipalities finalize contracts with Abtech in the next few weeks.
Public-Private Partnerships: The Remedy For Cash-Strapped Municipalities
While it has certainly proven to be a very bureaucratic process to break into the municipal sector, importantly, the P3 structure has been endorsed by both sides of the political aisle. At a Congressional hearing in early February reviewing financing tools for water infrastructure, Chairman Bob Gibbs (R-OH) of The Subcommittee on Water Resources and Environment stated:
"Increased investment needs to take place, which leads to the question - where is the money going to come from? There is no single answer to that question. Rather, we need to make a variety of financing tools available for the infrastructure financing toolbox."
After being espoused by the EPA's Lisa Jackson, the Public-Private Partnership offering being presented to municipalities by Waste Management (NYSE:WM) and Abtech should gain material traction, especially given Waste Management's formidable balance sheet.
Why We Expect Sizable Market Share Gains For Abtech
We expect the Waste Management/Abtech partnership will grab significant market share in the municipal storm water sector over the next 3-5 years. In addition to being the only entity currently capable of offering a "Design, Build, Operate and Finance" solution for municipalities, the partnership offers municipalities a number of advantages that should not be overlooked.
In addition to its aforementioned balance sheet, WM brings 34,000 customers for Abtech to potentially plug its solutions into. Assuming that Abtech will eventually garner a 3% market penetration over the next 5 years, this would equate to a $4 billion opportunity.
Moreover, in a highly politicized arena, Abtech's advisory board members Robert Kennedy Jr. and Governor Ed Rendell, highly influential thought-leaders, could offer strategic guidance for traversing the bureaucratic red tape.
On a final note, Abtech's technology is being offered to customers in a vault-like system that is highly upgradeable. Recently, L.A. County increased the number of contaminants that municipalities will need to address in their storm water permits. This was the first update of storm water regulations since 2002. Expect others around the country to follow L.A. County's lead. Amid this backdrop, considering that Abtech's solutions will immediately remedy a number of these contaminants and will over time be adding new technologies targeting heavy metals removal, this will go a long way to solving not only municipalities' near-term requirements, but also their future ones.
80 Outstanding Proposals Equate To A $320 Million Pipeline
In its recent earnings conference call, Abtech's management provided investors with what the average deal size would look like for a small city win: $4 million over 5 years. Perhaps the most important kernel of information was this: 60% of the contract revenue will be realized over the first year. While Abtech's Smart Sponge will account for a large majority of each contract, design and installation revenues will help to front-end the dollar value of each 5-year contract to the first year.
During its earnings call, Abtech's Sr. Vice President of Business Development, Bjurnolf White, stated that the company is expecting a win-rate of 75% on the existing 80 proposals in place. With the average sales cycle for municipalities lasting 9-12 months, Abtech's visibility will increase dramatically as the company builds a steady series of contract wins in 2013. Let's run some numbers to see how they get very big, very fast.
2013 Revenues Should Ramp To $40 Million
If the company can close on 12 municipal contracts by the first half of next year, this would equate to $48 million in revenues over 5 years. With 60% booked within the first year, this would mean $29 million in revenues by the first half of 2014. Let's assume $20 million is booked by the end of next year, with the remainder carrying over into 2014.
Abtech has also begun to see a dramatic increase in activity within its fracking vertical. On the heels of winning The Best Technology Innovation Award, the company has expanded its marketing efforts by hiring a seasoned oil and gas executive with 25 years of experience. With 54 proposals outstanding and 10 in advanced stages, we feel that Abtech's fracking division is also poised for a breakout 2013. Let's assume the company can garner $10 million in revenues from this division next year, with another $10 million from its industrial and commercial opportunities - this gets us to $40 million in total revenues for 2013.
2014 Revenues Should J-Curve To $100 Million
By the end of next year, the company should be able to land an additional 33 contracts. This would imply a total 55% win-rate over a 12-month period on the existing 80 proposals in the queue, a level that we view to be very conservative. At $4 million a clip, this would give the company another $129 million in a 5-year backlog, with $78 million of this realized in 2014. Combine that with the $9 million that will get carried over from the first 12 wins in the first half of 2013 and you get immediate visibility to $87 million in revenues for 2014. A $100 million baseline estimate for 2014 would therefore be considered very conservative when you consider the various other initiatives that the company is currently pursuing within fracking and other large city opportunities.
At $100M, gross margins should be 55% for the company, implying gross profit of $55 million and operating margins of 25-30%. This would equate to $0.35 in un-taxed earnings for 2014 on 100 million shares outstanding. We are using 100 million shares outstanding, as we feel that the company will need to do at least one more equity raise in the summer of 2013, with it burning through $1 million a quarter.
Ironically, such a raise would actually be a welcome catalyst for the stock. In addition to expecting analyst coverage shortly on the company, we feel that the involvement of two mid-tier investment banking firms would help lift the price of the stock to levels where it would be able to up-list to an exchange in late 2013.
An Organic Growth Story That Balances The Remaining Risks In Abtech
As for what could go wrong, we see three risks of which investors should be cognizant. First, the shares reside on the bulletin board. Therefore only those investors with a tolerance for liquidity risk should consider Abtech's shares. We also see the potential for further delays in landing contracts from municipalities. Investors should also be mindful of execution risk, as the company will need to scale manufacturing 10X from here in order to achieve our revenue projections for the next few years.
Risks aside, in an economy bereft of many organic, secular growth stories, we believe Abtech's stock will be embraced by new institutional investors as the company lands a steady stream of contracts and also demonstrates effective execution. Inflection points like this do not occur that often. We therefore remain very bullish on the potential for Abtech's shares over the next 3-5 years and remain buyers of the stock at current levels.