Shares of Essex Rental (NASDAQ:ESSX) have been beaten down over the past year as one of the subsidiaries was in default and ultimately was wound down by its creditors. ESSX used to operate as a holding company with two subsidiaries: Essex Crane Rental and Coast Crane. Essex Crane Rental has since been divested and is no longer. Going forward the company only owns one subsidiary, Coast Crane. Coast Crane is a solid stand-alone company and the shares are worth a look trading at only $0.16.
Coast Crane was acquired by a partnership between Northwest Capital Appreciation and GE Asset Management in 2007. As we all know, the financial crisis soon followed and the company filed for bankruptcy. Essex Rental was the winning bidder for the assets and business of previously privately-held Coast Crane. On November 29th, 2010 Essex Rental released a press release announcing it had closed the deal and paid $80 million for the assets and assumed $12 million of Coast Crane's liabilities. This represents a purchase price of roughly $92 million. For the twelve months ended September 30th 2010, Coast had generated about $85 million in revenue according to its unaudited financials. Coast was bought at a time when the economy was struggling and the housing market was in shambles, obviously not the best time to be in the business of renting cranes. However, from a value investor's view, a great time to be picking up these assets at fire sale prices.
Essex Rental Corp is currently an attractive speculative value play as it has been beaten down as a result of Essex Crane's failure.
When Essex Rental Corp recently reported its Q3 2016 results, it reported them excluding Essex Crane and restated the prior periods presented to also exclude Essex Crane for comparability purposes and for investors to be able to conduct accurate trend analysis. This allows investors to have a much better idea about the health of Coast Crane so let's take a look.
First, let's look at Coast's net book value. As of September 30th, 2016, book value per share is roughly $0.77. At a closing price of $0.16 on February 22nd, 2017, the stock is trading at roughly one fifth of its net book value. It is noteworthy to talk a little bit about carrying value of assets and depreciation at this point. GAAP wants accountants to carry assets at their historical (purchase price) values and then depreciate them. This helps smooth out earnings, we do not have big one-time expenses, rather we recognize the expense over the useful life of the assets. Another reason that GAAP mandates the assets be reported at their historical value and depreciated is because it is difficult to estimate the fair market value or net realizable value of a lot of assets. For example, it is very difficult to estimate the fair market value of all the cranes Coast owns. However, in this case even if we completely disagree with the depreciation numbers the company is using and think that the assets would actually sell for much less, there is still significant upside. If the stock traded at only half of book value it would trade for $0.38 representing a gain of over 130%. To further this point, if ESSX were to trade at just one third of its book value, it would be trading at around $0.25 representing a gain of over 55% from the current share price.
Free Cash Flow:
While the book value numbers are helpful to show that there is likely some value, a NAV approach is difficult because it is hard to estimate how much a crane can sell for and Coast has a large and diverse fleet. Now, let's look at how much cash the core business is throwing off. The numbers the company reports are a little funky, but the adjusted EBITDA they report is pretty close to a FCFF number. The Adjusted EBITDA number is accounted for by taking EBT subtracting the gains from foreign currency, adding back interest expense, and subtracting other income to derive an income or loss from operations number. The company then adds back depreciation and amortization to arrive at the adjusted EBITDA number. This is a pretty accurate number of the amount of cash the core business is generating. For the nine months ended Sept 30th 2016, that number was just short of $5.5 million. From December 31st 2015 to September 30th 2016 net working capital decreased by about $6.3 million which is actually good for free cash flow, since when liabilities like accounts payable increase, it is bad from an accounting perspective, but from a cash perspective that is cash we are keeping on our books that we owe others. Since the company is in distress, they are not investing much and CAPEX is not a concern. Overall, this company is still capable of generating a decent amount of free cash flow and can manage its interest expense.
What Happens Next?
Coast Crane's revolving credit facility matures in March and the company is still working on refinancing it. This may put pressure on the company to execute some sort of deal in the very near future. With an enterprise value under $70 million, it would not take much for a competitor to take over Coast. A LBO may be able to happen as the company still can generate a decent amount of cash flow and already has a capital structure composed mainly of debt - just under $63 million of total debt and a market cap under $4 million. If the lenders want to foreclose the assets, although I personally think this is very unlikely to happen, there is a decent chance that there would be cash left over for shareholders as indicated by the net book value analysis.
Management is still working on scaling back operations for the size of the new smaller company and the board of directors just took a pay cut from $75k a year to $10k and 20,000 stock options with a strike price of 50 cents. Although management has struggled in the past, I think they will be able to navigate these difficult times and their golden parachutes or "change in control bonuses" are only one year's salary. The CEO currently makes $410k a year and the CFO makes $261,375 a year according to their proxy materials. Hopefully this is not enough to discourage any potential acquirers. It would be logical for management to hire a bank to explore these strategic alternatives. They previously had hired RBC to explore strategic alternatives for Essex Crane Rental, but they have not released any press to notify shareholders of the hiring of an advisor to evaluate Coast Crane.
Although it may not make sense for Coast to stay public as small as it is, I think the potential upside is very attractive and the downside is quite limited at these levels. This is a company that has very tangible assets that can always be sold off, the question is at what price. As more information becomes available, particularly their full year 2016 and Q4 results, I will write another article with some comps analysis - those concerned about the book value might be excited to hear that United Rentals (NYSE:URI) trades at about 6.5 times its book value.
Disclaimer: This article is about a stock with an enterprise value below $100 million which carries additional risks. These stocks have less liquidity and are much more volatile. Always do your own due diligence, this article is not investment advice.
Disclosure: I am/we are long ESSX.
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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