Private equity firms and long-term value investors should examine Orion Marine Group (ORN). Here's why:
Low Valuation Limits Risk
ORN has a price to tangible book value of 0.84 and an EV / EBITDA of 4.4. In its Q2 earnings call, management stated that the replacement value of its PP&E, which has a book value of $152.5mm, is $200-250mm "at least." ORN's liquidation value and its EBITDA and cash flow generation support a high floor on investor recoveries.
Powerful Catalysts for Long-Term Growth
Catalysts that could drive ORN's stock price higher include:
The RAMP Act. There is considerable bipartisan support within Congress for legislation providing that moneys in the Harbor Maintenance Trust Fund can only be spent on harbor maintenance; this legislation, if it were to pass, should lead to higher earnings and revenue.
In theory, Trust Fund moneys should only be spent on maintenance of harbors and waterways. But a relatively small proportion of Trust Fund proceeds are being spent as intended. In 2010, for example, the Trust Fund took in roughly $1.3B, but only $830mm was spent on waterway operation and maintenance dredging.
There appears to be a relative consensus that underinvestment in harbor maintenance has led to the deterioration of U.S. ports and that this deterioration raises shipping costs and reduces safety. At a recent congressional hearing, for example, expert James H.I. Weakley testified that "the authorized depth of federally maintained navigation channels is available over only half of their authorized width less than one-third of the time, and this performance is declining." Other experts explained that the consequence of a lack of maintenance is that ocean-going vessels must transport less than their full loads so that their hulls do not scrape the sea floor when they dock at American ports, and that some waterways have narrowed to the point where they are one-way channels. In response, congressional leaders have proposed legislation (the RAMP Act, or H.R. 104, and the Harbor Maintenance Act, or S. 412) providing that all Trust Fund revenue must be spent on maintenance of harbors and waterways.
To be clear, the federal budget deficit and the recent agreement to cut spending will create resistance to measures such as the RAMP Act, and passage of the Act is most certainly not assured. But there is at least a significant possibility that the legislation will be enacted over the next year because the Act has influential supporters and because there are credible arguments supporting the legislation on good-governance grounds and on the grounds that U.S. ports badly need the incremental maintenance.1
Expansion of the Panama Canal. The expansion of the Panama Canal, which should be completed by 2014, should drive incremental spending on marine construction. The purpose of the expansion of the Canal is to accommodate more and larger ships. At present, supertankers and the largest modern container ships are too big to fit through the Canal. When the expansion of the Canal is completed (by 2014), it will again be able to accommodate these larger ("post-Panamax") vessels. Per-unit costs of a fully-loaded post-Panamax vessel are significantly lower than those of the smaller vessels now used to traverse the Canal. But according to David Sanford, Director of Navigation Policy and Legislation at the American Association of Port Authorities, Norfolk is the only port on the East Coast or Gulf Coast of the United States that can currently accommodate post-Panamax vessels.2 Upgrading other U.S. ports appears to be a significant undertaking; among other things, contractors will need to increase the depth of the ports to as much as fifty feet. But if U.S. ports do not make these investments then domestic and Caribbean rivals will poach business and/or shippers will be forced to use smaller, less-efficient vessels.
Growing Maritime Trade. Growing international trade will over the long-term require the expansion, as well as the maintenance, of U.S. ports and waterways. The geometric growth rate of container traffic at U.S. ports between 1990 and 2010 was 5.1%, according to statistics compiled by the American Association of Port Authorities. Approval of free-trade agreements with South Korea, Colombia and Panama could also boost trade. 3
An Optimal Balance Sheet for an LBO
ORN could support additional leverage from a going-private transaction because [i] it has no debt; [ii] it has $0.92 of cash per share (versus a share price of $6.62); and [iii] it has lots of (unencumbered) tangible assets.
A Leading Player in a Fragmented Market
ORN is one of the four or five largest contractors in the United States serving the marine infrastructure market. This market is highly fragmented. It appears that the industry as a whole is facing headwinds because among other reasons government budget deficits have placed downward pressure on discretionary spending by public-sector bodies, housing contractors desperate for business during the real estate downturn have placed low-ball bids on marine construction projects, and uncertainty about the economic environment has made businesses hesitant to invest. ORN has the balance sheet and scale to be one of the last men standing, and an acquirer of distressed rivals, in the event that the industry downturn continues.
ORN Is Already a PE Success Story
PE firms TGF Management Corp. and Austin Ventures invested $31.5mm to acquire ORN in 2004 and received $213.7mm upon exit in 2007.
Insider Buy Signals
Insider buying and the board's authorization of a robust stock repurchase plan signal that management views ORN as undervalued. In mid May 2011, CEO James Michael Pearson bought 4,900 shares, CFO Mark Stauffer bought 1,000 shares, and Director Richard Daerr bought 1,000 shares. On May 4, 2011, the board authorized the repurchase of $40mm of common stock over the following year.
ORN warrants study by buyout firms and value investors because among reasons [i] it's a cheap company that generates large operating cash flows and would have a high liquidation value; [ii] there are several catalysts including federal legislation that would drive higher earnings and revenue; [iii] it has an optimal balance sheet for an LBO; [iv] it's a big player in a fragmented market; and [v] management appears to view the company as undervalued. Whatever the severity of our budget deficits and economic challenges, the United States will still need to maintain its harbors in order to participate in international trade.
There are many problems and risks. For example, analysts may have lost confidence in management following earnings misses. As another example, the problems that contributed to lower revenue and ugly margins in Q2 - such as low-ball bids by "land-based" contractors, businesses' lack of confidence in the economy, public-sector budget deficits, and lack of clarity respecting how the federal government will address deficit-related issues - could continue. Relatedly, ORN's order backlog has decreased from $194.5mm to $119.8mm over the past two quarters. Management believes that over the medium-term there is now pent-up demand for its harbor maintenance services. I have not reviewed sell-side research, do not have expertise respecting the marine infrastructure industry, and have not communicated with any contacts in this industry; therefore, it's hard for me to form more than a tentative view.
1. A video of a recent congressional hearing on the RAMP Act is available at http://transportation.house.gov/hearings/hearingdetail.aspx?NewsID=1330.
2. See "US Ports Unready for Larger Panama Canal, Say Officials," DredgingToday.com, May 16, 2011, available at http://www.dredgingtoday.com/2011/05/16/us-ports-unready-for-larger-panama-canal-officials-say/.
3. Still another possible catalyst would be an upturn in the U.S. housing market. This upturn would presumably diminish competition from contractors that have traditionally focused on non-marine construction.
Disclosure: I am long ORN.