Since being introduced to Abtech (ABHD.OB) earlier this year, we have considered the company not only a direct play on stormwater, but also a back-door way to benefit from partner Waste Management's (WM) efforts at moving into a new multi-billion dollar vertical. While progress has taken longer than expected, the facts speak for themselves. Waste Management has begun to move aggressively in the stormwater sector. Contracts from its customer base should begin to flow in a meaningful way this fall to Abtech.
Because there is no competition to the total solution set being offered to municipalities by the Waste Management/Abtech partnership, we believe that it is just a question of when, not if, these contracts begin to roll in. Perhaps just as importantly, not only are municipalities ready to act, but it also now appears that large cities and corporations are ready to utilize Abtech's solutions. Taken together, the stage has been set for a flurry of new contract wins that will position the company for both an extremely strong finish to 2012 and a breakout year in 2013.
Efficacy Of Abtech's Smart-Sponge Verified By Third Party
Last week, Abtech announced a contract win with the Long Island village of Babylon, along with the results of an independent third-party 5-year study examining the efficacy of Abtech's Smart-Sponge product.
The study results demonstrated Babylon's existing installations captured approximately 1,600 pounds of total contaminants from stormwater annually, including 1,400 pounds of toxic hydrocarbons. These study results are significant for two reasons. First, they detail the efficacy and cost-effectiveness of Smart-Sponge to a municipality. Second, the results will spur other municipalities to follow Babylon's lead and act on their stormwater issues.
According to Bjornulf White, VP of Business Development for Abtech, municipalities want to see that Best Management Practices (BMP) solutions such as Smart-Sponge have already been owned and operated by other municipalities. White stated that it is always difficult to be the first municipality to employ a new BMP. With Babylon poised to "smart-sponge" their entire village, the stigma of being the first municipality to act has been removed. In addition, Babylon is widely considered to be at the forefront of Long Island water issues, so that as Babylon goes, so will the rest of Long Island. The words of Babylon's mayor, Ralph Scordino, are quite encouraging for Abtech:
When we set our stormwater management plan in motion, we hoped it would serve as an attainable model for our neighbors throughout Suffolk County...But after seeing these results, we are confident that our model will be employed throughout the country.
Municipality Proposal Growth Begins To Mushroom
Since the launch of its public-private partnerships earlier this summer, Abtech's partner, Waste Management, has spent the past few months refining this new business model. Because the business model was new for them, Waste Management took additional time to iron out the kinks. Now it is easy to understand and customizable for any city. As a result, municipalities have given positive feedback and are excited about it.
As a testament to this, municipality proposal growth has begun to mushroom. While many investors choose to focus on the lack of contracts so far, we are more focused on the dramatic growth in proposals this summer. To wit, in the early spring, there were only a dozen proposals in place. This number moved up to 20 by mid-May. Three months later, the number of proposals has increased by 150% to over 50.
On Abtech's conference call last week, Abtech's White stated that "things continue to accelerate on a weekly basis with new territories being opened up." With a complete offering that promises to "design, build, and operate" their stormwater remediation, Waste Management and Abtech have become "the only game in town offering this total solution set," according to White. With up to six municipalities in the final round of contract talks and scheduling negotiations, no proposals rejected so far, financing available to those that require it, and the stigma of being the first municipality to act recently removed, we expect to see contract wins materialize for Abtech after Labor Day.
Expecting An Avalanche Effect After First Movers Engage
Leading experts within the stormwater space brought on as consultants by Abtech have informed the company that when the first few municipalities act, they expect to see an "avalanche effect" occur shortly thereafter. With early adopters validating this new business model, a number of other municipalities should quickly follow suit and approve many of the pending proposals. This "avalanche effect" would quickly provide a multi-year pipeline of projects entering 2013, projects that will not only be measured in years, but also potentially in the tens of millions of dollars.
As Abtech begins to gain traction from this expected "avalanche effect," not only will it result in orders for its Smart-Sponge products, but the company will also receive a surge in design activity. With each additional municipality that signs up, revenue will, therefore, be front-end loaded for Abtech these next two to three years, with these two layers of revenue opportunity. This is one of the reasons why we expect to see "hockey stick" type of growth materialize late this year and especially in 2013.
Above all else, the public sector needs the private sector's help with its water infrastructure needs. Growing fiscal duress throughout California has already resulted in three cities filing for bankruptcy. Moody's expects others to shortly follow suit.
Echoing this epidemic, in Congressional hearings earlier this year, Chairman Bob Gibbs (R-OH) of The Subcommittee on Water Resources and the Environment stated:
A large portion of the Federal, not to mention State, regulatory mandates are going unfunded by the Federal and State governments. Rather, local governments are being forced to pay more and more of these costs of these mandates. 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.
Former Governor Rendell Plays A Key Role
As one of the leading Democratic authorities on the environment in the country, former Pennsylvania Governor Edward Rendell is all too familiar with the fiscal challenges cities and municipalities face confronting their water infrastructure needs. During his eight-year tenure, Governor Rendell pushed through hundreds of millions in funding for numerous PA counties for their water infrastructure needs.
Governor Rendell was recently appointed to Abtech's Strategic Advisory Board, joining Robert F. Kennedy Jr. and Congressman James Saxton. Governor Rendell had this to say about Abtech and his selection to the advisory board:
Abtech's products and services address a growing need for effective ecological solutions that create jobs while restoring environmental health quickly and cost effectively. I am honored to be associated with such an innovative group of water treatment experts who are laying the groundwork for a greener future.
Adding such a prominent political figure to its advisory board is significant for a number of reasons. First, as the current co-chair of Building America's Future, an organization he created with NYC Major Michael Bloomberg and Governor Arnold Schwarzenegger to highlight the need for investment in American infrastructure projects, Governor Rendell should offer important counsel and an impressive rolodex of important contacts, which Abtech's CEO, Glenn Rink, can tap into. Moreover, it would seem only logical that a few well-timed phone calls by Governor Rendell could get a host of municipalities to act in the near-term.
We also feel confident that Governor Rendell can act as a gatekeeper for one of the most important water infrastructure projects in the country: Philadelphia's already funded $2-billion, two-decade initiative. Abtech is in a great position to land a part of this contract, considering the City of Brotherly Love has allocated almost $100 million a year to what may be our nation's most progressive large city stormwater program. This would be a game-changer for the company.
With one of the oldest sewage systems in the country, such a contract could potentially mean $10-$15 million a year in Smart-Sponge product. Perhaps Philadelphia is the large city which was referenced on Abtech's conference call, the one that they have already begun design work for? Should the company ever announce such a deal, it could send its stock up 50% in short order. After all, a 4-year, $40-$60 million contract would just about equal Abtech's current fully-diluted market capitalization.
One final note on what Governor Rendell's involvement could mean for Abtech: With the company on the cusp of securing its first fracking contracts, Governor Rendell could also make some important introductions to the bigger players in the Marcellas Shale region. Already an advocate for treating wastewater in fracking in PA, companies who have worked with Governor Rendell on environmentally-friendly solutions for fracking could suddenly warm to the idea of integrating Smart-Sponge into their on-site efforts for produced water remediation.
Facility Opportunity About To Hockey Stick in 2013
As Abtech prepares to make headway with companies in the fracking space, the company has already begun to make important progress with large corporations for their facility stormwater remediation plans. In addition to announcing a contract with the Department of Defense in June, in its most recent earnings release, the company announced a new contract win with a Fortune 500 company. While still in its infancy, this contract should morph into a material revenue contributor for the company in 2013.
The facilities opportunity is a uniquely exciting one for Abtech with large corporations having hundreds, if not, thousands of sites to remediate. During the conference call, White detailed how corporations have been facing increased regulations and enforcement actions over the past few years, many of which are not publicized. Stormwater management is the top environmental issue facing the facilities management divisions at many large corporations. With companies focused so intently on their bottom lines, Abtech's cost-effective solutions make sense, particularly with how easily they can be retrofitted into the existing facilities infrastructure.
During the call, we asked White how significant the Fortune 500 company opportunity could be for Abtech. He stated that the company was targeting only a few facilities at first. From there, however, it would then expand to a full service offering. Think about that. Over the next few years, this company could very well "smart-sponge" all of its facilities. If this were to occur, in and of itself, this opportunity could total in the hundreds of millions over the next five years. Let's do some quick math to explain how we came to these figures.
While Abtech would not reveal who the company was and what business they were in, since this is a Fortune 500 company, odds suggest that each site in need of remediation is very big and in need of significant work. With this being the case, we could probably assume a $500,000 ASP per site. This would include design, materials, and installation costs per site. Since the company would not provide us any color here, we are going to be conservative and assume that the ASP will instead be $250,000 per site.
Based on these figures, if the company were to remediate 50 sites next year, that would be a $12.5 million revenue opportunity for Abtech. One hundred sites would equate to $25 million. If all 1,000 sites were eventually completed, this would translate into a $250 million opportunity for the company over the next five years. As you can see, the numbers get very big, very fast.
We consider White to be one of Abtech's most valuable resources. In short order, he has become one of our nation's leading experts on stormwater remediation. Investors should listen carefully to what he has to say. We urge investors to listen to the conference call to see what we mean.
$50 Million In Revenues Very Achievable In 2013
With only three confirmed orders for the company and the actual size of them still to be determined in the next few months, the market is understandably concerned about whether the company will be able to make 2012 guidance of $17-$20 Million. We think these investors are being short-sighted. Because three to four months were lost to creating the public-private partnership structure and to then perfecting the business model, the initial roll-out by Waste Management did not go as quickly as originally planned. Waste Management has now begun to move aggressively -- this is what investors should key in on.
With an avalanche of orders expected to occur between now and year-end, we expect Abtech to enter 2013 with tremendous momentum. Hoping to quantify the 2013 opportunity, we spent considerable time creating a model for next year. The numbers are impressive. Let's take a look.
Municipal Opportunity: $15 Million
Based upon a number of proposals being in very late-stage negotiations, we expect Abtech to sign up five municipalities this year and another 15 in the first half of next year. This would equate to a 40% win rate for the 50 existing proposals in place. With no competition in sight, financing being provided by WM, and interest levels very high, we feel that a 40% win rate will prove to be conservative.
Abtech's subsidiary, AEWS, will be responsible for the design work for these contracts. Abtech would, therefore, stand to garner two pieces of revenue contributions from the first wave of municipality work. We feel that the engineering subsidiary could do $3 million in design work next year, with the Smart-Sponge bringing in another $12 million. Therefore, $15 million seems to be a reasonable target for this vertical next year.
Facility Opportunity: $15 Million
In need of remediating 1,000 sites, it seems more then reasonable to expect the Fortune 500 company to remediate 50 of their facilities next year. Abtech would garner $12.5 million from this one client alone. During its earnings call, they stated that they were working with a few large corporations, so let's assume these other companies give Abtech contracts totaling $2.5 million. These additional contracts would bring us to a $15 million revenue estimate for the facility opportunity in 2013. This seems very doable.
Large City Opportunity: $10 Million
Philadelphia should begin to spend in earnest on its stormwater program beginning next spring. With Governor Rendell on board, we feel that Abtech will get $10 million of this contract. This leaves plenty of upside for this vertical if Governor Rendell convinces Major Bloomberg to Smart-Sponge in New York.
Fracking: $8 Million
We estimate that the fracking vertical will bring Abtech $8 million in revenues next year. We feel that this number could be exponentially higher if large oil and gas companies begin deploying Smart-Sponge on multiple sites. As it stands now, it would only require four large well-sites to use Smart-Sponge to reach $8 million in revenues next year.
Nuclear: $2 Million
We have not heard much regarding this vertical at this point. Therefore, we are not expecting more than one or two small contracts to materialize. This gets us to $2 million for 2013. Please note: with the recent addition of one of our country's top nuclear experts, Michael Shea, to its Technical Advisory Board, Shea's connections could help the company garner much more than $2 million from this vertical next year.
2013 Totals: $50 Million in Revenues, 55% Gross Margins, 25% Operating Margins
If we are correct, 2013 should be Abtech's breakout year. $50 million in revenues seems very achievable. If an "avalanche effect" does occur and the company's win rate is higher than 40%, it is very possible that Abtech could do over $60 million next year.
Using $50 million as our run-rate, we feel that gross margins should scale to 55% at these levels. Amazingly, the company's current gross margins are already 36% on only $250,000 in revenues last quarter. This is going to be a tremendously profitable business as revenues scale. Even with additional hires expected, additional R&D testing for its heavy metals initiative, and further capacity expansion planned, we see the company achieving 25% operating margins next year. Fully diluted earnings could be $0.15, depending on share count and tax rate.
Final Thoughts: Near-Term Overhangs Will Be Overcome
In the very near-term, there are a few overhangs on the stock. First, as we see it, the company needs to announce at least two to three municipal or large fracking contracts this fall. This will validate the company's business model, and should convince most of the convertible holders to convert to common stock this fall/early winter.
With 2012 guidance a continual overhang, the company will need to convert on a number of contract wins before the market sees what we see -- a breakout 2013. While we are fine with looking toward 2013, other investors are not.
Notwithstanding these near-term concerns, we remain resolute and are highly confident that we will only need to wait a few more months until lift-off occurs. Waste Management has begun to move aggressively. The evidence is there to support this. As their municipal customers engage and large corporations and large cities begin to also place orders, Abtech's stock will quickly gain traction. We believe the wait will be worth it.