Investing With An Edge: AgroFresh

| About: AgroFresh Solutions, (AGFS)

Summary

Results since coming public have been a disaster.

Management badly mismanaged their Q3 earnings call.

Shares today are very cheap. While there are significant risks, they are well known and the upside here is large.

This is the latest in my "Investing with an Edge" series. For more on the series, please see here.

Company: AgroFresh (NASDAQ:AGFS). Reasons for opportunity: insider purchases; weak results; poor communication

AgroFresh makes chemicals that improve the freshness of produce. Their key chemical is SmartFresh, a gas-based molecule that delays the ripening of fruits and vegetables. It is most widely used on apples (~85% of apples in North America are treated with SmartFresh).

Until last year, AGFS was a subsidiary of Dow Chemical (NYSE:DOW). The company was split out of Dow last year via a Special Purpose Acquisition Company (SPAC), which purchased AGFS from Dow for $635m in cash and 17.5m shares in the new company (~36% ownership).

An SPAC is basically a vehicle where investors put some money in a bank account and tell a manager "find me a deal I like". The manager then goes out and finds a deal. If investors like the deal, they will give the manager the money and receive shares in the company in return. If they don't like the deal, they can demand all of their money back and the manager has wasted a bunch of time and expenses on attempting a deal.

In order to convince investors that the deal they have found is a good one, an SPAC will go on a roadshow after they have found a company to buy and convince shareholders that the investment is a good one and they should approve the deal. During AGFS' roadshow, the company guided to $177m in revenue and $100m in EBITDA in 2015. Results since the deal closed have been a disaster. After the deal was completed, AGFS announced Q3 results in November and had to revise their guidance down to $87-93m in EBITDA for 2015. While it's always disappointing to see a company revise guidance so soon after issuing it, possibly the most concerning aspect of the guide down was how poorly management handled it. On their Q3 call, management initially refused to provide any full-year guidance. Given the company had just provided guidance during their roadshow, this refusal caused a market panic that saw shares decline by ~30% in a day (from ~$7 before the report to ~$5 after), and AGFS provided their guidance in response to that panic. While shares rallied a bit after the guidance was provided, shares have continued to decline since then to today's price of ~$4.50.

So yes, management goofed when it came to handling the guide down. But there are a lot of signs that AGFS represents significant value at today's prices.

First, it's important to remember AGFS is a fundamentally good business. The business generates terrific free cash flow (EBITDA is >50% of revenue and capex ~1% of revenue) and SmartFresh represents a terrific investment for their customers (the company estimates an investment in SmartFresh produces a 6x ROI for farmers). The company's roadshow notes they have ~97% market share for apple treatment and are applied to ~85% of North American apples. These are all very impressive metrics that suggest SmartFresh is a very valuable product and indicate AGFS should have some pricing power going forward. It's also worth remembering that, poor guidance aside, the company is performing well. YTD sales are up 5.6% YoY after factoring our foreign exchange headwinds, and the company's annual organic growth rate in the years leading up to the transaction was well above 10%.

Second, AGFS is downright cheap at these levels. Assuming AGFS hits the low end of their guidance ($87m), the company is trading for just over 7x EBITDA. With most of their EV coming in the form of relatively cheap debt (a $425m term loan at 5.75% interest rate) and minimal capex needs, AGFS will generate significant cash flow going forward. At the low end of their guidance, I estimate AGFS would generate ~$50m in after tax free cash flow per year. That would be enough to buy back more than 20% of their shares each year at today's share prices; alternatively, the cash flow could fund some small bolt-on acquisitions that leverage their extensive distribution network.

Finally, AGFS insiders are indicating their belief that the company is cheap. The CEO, CFO, and a bunch of directors (director one, director two, director three, director four, director five, and director six) all bought shares on the open market in November at prices ranging from ~$5.50 to ~$6.50. In addition, AGFS retired $2.5m worth of their warrants last year, and the company announced a $10m share repurchase program after shares tanked in the wake of their botched guidance. AGFS also announced a modification to their warrant repurchase agreement with their sponsors that was designed to allow AGFS more financial flexibility for share repurchases. This agreement suggests both the sponsors (Dow and Avenue Capital) and AgroFresh see today's share price as attractive and would prefer AGFS have as much capital as possible available for repurchasing shares.

Are there risks? Absolutely, but the three main risks to the company have not changed as the company's share price has gone from $10 to ~$4.50. The three biggest risks are:

  1. AGFS has clearly indicated they want to do acquisitions going forward. That may not be feasible given where their stock is trading today, but any acquisition carries execution risk.
  2. The reason AGFS wants to do acquisitions is they are basically a one company product. Their key SmartFresh patents begin to expire in 2018. AGFS argues that their margins do not vary in countries without patent versus countries where they still have patent protection (~25% of sales are from countries without patents) and they should be unaffected by the patent expiration, but there's still a risk that the patent expiration hurts their sales/margins or introduces new competition.
  3. Speaking of competition, Pace received EPA approval for FYSIUM in 2015. FYSIUM is very similar to SmartFresh - it's a 1-MCP technology for improving quality and value of apples. AGFS argued in their Q3 call that the new product isn't having any impact on them. However, with 50%+ margins, SmartFresh will make a juicy target for competition, and any successful competition could rapidly cut into AGFS' margins and cash flow. In fact, it's possible the Q3 weakness and reduced guidance was actually caused by FYSIUM making quicker inroads against SmartFresh than AGFS had contemplated.

All of these risks are real and within the realm of possibilities. However, at today's prices, it seems like investors are well compensated for taking those risks.

Disclosure: I am/we are long AGFS.

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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