Heckmann Corp. And Power Fuels Merger Turns Overpriced Spec Play Into Undervalued Name


On Tuesday of last week, it became apparent that Heckmann Corp. (HEK) would be acquiring Power Fuels to create what management calls the "largest, nationwide dedicated service provider of comprehensive shale focused environmental capabilities." As CEO Richard "Dick" Heckmann said recently on Jim Cramer's "Mad Money" program and in the investor presentation regarding the merger, this was done to satisfy customer demand for a nationwide company that is an expert in compliance with state and federal regulations regarding wastewater from hydraulic fracking activities. Mission accomplished it seems, as it is now the evident name to turn to for all oil and gas water and wastewater needs.

This news has been greeted with warm enthusiasm, as HEK traded as high as $4.26 intraday on Sept. 6, 2012, from lows of well under $3.00 earlier this month. There are some good reasons for the enthusiasm, not the least of which is the fact that this skews shale-based revenue to oil and liquids-rich plays (70%), which should help margins. Management has also been vocal in proclaiming the deal will be immediately accretive to earnings for HEK.

However, let's take a closer look into the financials and potential of the combined company to determine how much value could potentially be added for shareholders. First, let's review the terms of the deal: HEK will pony up $125 million in cash, 95 million shares of HEK, and will assume $150 million in debt. Based on company presentations, this places a price tag of approximately 3.4 times EBITDA on power fuels. That does not seem an unreasonable price on the surface.

But after taking a better look at Power Fuels' recent financial reporting, I get a bit more excited. Broken into the three most recent half-years, beginning January 2011, Power Fuels' net income has gone from $35.7 million, to $49.3 million, to $63.7 million in the first half of 2012. In other words, earnings increased at an average rate of 33.7% in each six-month period. I know this is not the conventional method, but it bears looking at. This would suggest net income of $85 million for the second half of 2012 (when the deal is expected to close), or a 2012 total net earnings approaching $150 million.

What makes this interesting is that even with new shares issued as part of the merger (totaling 247 million shares outstanding), this suggests potential EPS of up to $0.60 from Power Fuels alone for full fiscal year 2012. Assuming a stock price of $4.25 and EPS of $0.60 (P/E of 7), one can see where value bugs may become quickly interested.

This is all great in theory, but management is still declining to provide earnings guidance at this time. Despite lacking guidance, the combined fundamentals of the two companies looks much better than the fundamentals of HEK without Power Fuels. Margins are greatly improved to 33% for the combined entity from 21% for HEK previously. Power Fuels adds an established earnings ability to a company that was previously struggling to break even.

To summarize in a few brief points:

Heckmann has demonstrated success in the past, successfully managing U.S. Filter through a similar series of acquisitions. The following is quoted from the management section of Heckmann's website:

Mr. Heckmann founded United States Filter Corporation in 1990 and was its Chief Executive Officer. Through a series of acquisitions, United States Filter Corporation grew from annualized revenues of approximately $17 million in 1990 to over $5 billion in 1999, when it was acquired by Vivendi S.A. of Paris, France in March 1999 for approximately $8.2 billion.

Revenue growth of nearly 30,000%. Compelling, no?

Power Fuels operates at nearly twice the margin capability as HEK managed previously, and adds immediate earnings power to the company. Yet it was attained at what appears to be a fair price. The combined company will be the first nationwide complete water care company for shale play activity, and is easily the largest pure environmental service name to call upon.

Also worth noting is that HEK had a short interest of 29.6%, according to Yahoo Finance on Aug. 15. I would not be surprised to see some covering continue to drive the price up in the near term.

These are but a few quick points, and I would advise anyone to do his or her own homework on the companies discussed here prior to making an investment decision. I have presented a very brief positive case for the merger, and would welcome all commentary both positively and negatively skewed to promote informed investment decisions. Heckmann Corp. provides PDF-formatted investor presentations at its website for further diligence.

Disclosure: I am long HEK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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