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KHD Post Spinoff Valuation is Dirt Cheap

|Includes:KHDHF, MFC Bancorp Ltd. (MFCB)
Conservative Fair Value Estimate: 15 euro
Current Price: sub 6 euro
Strategy: Buy 2% allocation, double down at 5 with rising Euro volatility


All #'s below are Euro!


I obviously have developed a sort of fascination with Michael Smith and his portfolio co's - only because they are some of the best managed companies in terms of 1) efficiency 2) profitability 3) truly maximizing book value, not even to mention the management teams in place.

So, as most of us know by now, KHD has split itself into 2 entities, Terra Nova Royalty and KHD International (German exchange, symbol: KWG). My discussion here will be on the KHD part of the business. I believed previously this was the main attraction of the company and I still do today. I have previously written a valuation of the original KHD so please check that out if you can, as the explanation below is an update of that Article. One extremely important note of importance, is the fact that backlog now stands at about 200 million, with the company expecting nominal net income over the next 1-2 yrs.

Recap on Margins
In 2008 they incurred costs (directly related to progress billed or how much they charge for percentage of completion) of $170 million and earned nothing, I'm assuming this is because of cancellations and other charges they took on their income statement.. In 2007 they incurred costs of $390 million and about $100 million in profit, about a 25% earnings rate on billings.. Taking these into account, I believe that going forward they can earn 20% on future incurred costs

- Looking at their current operations I estimate $100 million in incurred costs per year

- Backlog is now 200 million, so the life of their backlog is 200mil/100mil which is 2 years. All my valuations will be projected based on 2 years (I won't discount them back to today)

- Take 20% of $100 mil for 2 years and that totals $40 million in additional book value from their backlog.

- With current book value at $170 million, book value is expected to be $210 million in 2 years

- I am disregarding any valuation from maintenance service contracts, so my minimum valuation for this company is now 210 million
.

At this conjecture, KWG is trading at 5.75 euro. No doubt there is some volatility since the spinoff but this price is 100% absurd. At 5.75 and just under 16.5 million shares outstanding, gives it a market cap of 100 million euro. Against 226 million in net cash, Enterprise Value is a negative 120 million. At minimum shares should be trading at 10, where market cap would be on par with Book Value. Account for an additional 40 million in book value over the course of 2-3 years, and they should trade closer to 12-13 euro a share. Account for new orders to start flowing in 2011-2012 generating a positive 10 million in cash flows, and shares can hit upwards of 20.

For this reason I have sold my TTT and held on to KWG and plan on building that position.


Disclosure: Long KWG (german equity, listed on Frankfurt)
Stocks: MFCB, KHDHF