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Midwest Energy Emissions Corp: A Coal Complex "Pain Trade" Beneficiary

|About: Midwest Energy Emissions Corp. (MEEC)
Summary

Midwest Energy Emissions Corp is an interesting coal-derivative play that should be able to benefit in a big way from the current “pain trade” taking place in the Coal Complex.

Midwest Energy Emissions Corp, for those unfamiliar, provides a unique, patent-protected “mercury emissions capture technology” to the Coal Complex.

The technology, Sorbent Enhancement Additive Technology (or “SEA” ™), enables plants to achieve and maintain compliance with mercury emissions regulations at a substantially lower cost than current alternative technologies.

This is the investment thesis: that it has a better technology (i.e. more efficacious, is hardware based, is materials base, and is proprietary process and know how enabled).

With historic coal-fired power plant regulations becomes de facto law with a recent supportive ruling by the U.S. Supreme Court the likelihood of realizing this investment thesis has improved.

Midwest Energy Emissions Corp (OTCQB:MEEC) is an interesting coal-derivative play that should be able to benefit in a big, big way from the current "pain trade" taking place in the Coal Complex; that is, the Coal Complex's continued pain should be MEEC's continued gains. MEEC, for those unfamiliar, provides a unique, patent-protected "mercury emissions capture technology" to the Coal Complex - that is specifically to coal-fired power plants - which enables plants to achieve and maintain compliance with mercury emissions regulations. The technology, Sorbent Enhancement Additive Technology (or "SEA" ™), does this at a substantially lower cost than current alternative technologies. Essentially, this is the investment thesis at MEEC: that it has a better technology (i.e. more efficacious, is hardware based, is materials base, and is proprietary process and know how enabled) and that it can offer this technology at a lower cost to actors within the Coal Complex that must comply with the regulations.

With historic coal-fired power plant regulations becomes de facto law with a recent supportive ruling by the U.S. Supreme Court, the Supreme Court on June 17 th, 2016 declined to hear an appeal from 20 states over an EPA regulation known as "MATS", the likelihood of MEEC realizing this investment thesis has done nothing but become higher in visibility. This has started to be reflected in MEEC's equity price. MEEC currently trades on the 52-week highs.

And this is why I think now is an appropriate time to put the MEEC story on microcap investor radar screens - I think MEEC, despite my concerns (and I have a few which I'll breakout), could be on the verge of a major move higher (its equity) OR a total company monetization event. The latter, it should be noted, shouldn't be factored into investment consideration at this point. All told though, MEEC looks ready to lean into an industry that's being bullied into regulation compliance and it happens to have the most cost effective solution for helping meet compliance.

The Technology…

The MEEC story begins and ends with 1) its SEA Technology and 2) MATS (Environmental Protection Agency mandated Mercury and Air Toxics Standards regulations). Without MATS there's little incentive for the coal-fired power plants to move from their current positioning and without the SEA Technology MEEC doesn't have a business model. So, I don't think this part of the dynamic here is that hard to understand. But what is SEA Technology and why is it going to be the largest beneficiary of MATS regulations?

SEA Technology is the result of 20 years and ~$65 million in R&D investment; yes, those figures are huge and yes those figures are accurate. MEEC's connection to SEA Technology (abbreviated from here on out as "SEA") dates back to 2006 when the company partnered with The Center for Air Toxic Metals® (CATM®) at the University of North Dakota Energy & Environmental Research Center (EERC). The EERC, for those unfamiliar, was established in 1992 by the U.S. Environmental Protection Agency to focus national research efforts on trace element emissions. You should be seeing the parallels between the two "enterprises" at this point.

SOURCE: MEEC INVESTOR RELATIONS

In 2009, after several years of testing and developing a range of technologies to address mercury measurement and control, MEEC and EERC agreed on a broad patent portfolio license to fully commercialize a mercury control technology suite (30 global patents); this is what would ultimately become SEA. SEA was launched into commercialization (via contracts with two coal units in the U.S. Pacific Northwest) in 2010 but it was launched to little fanfare and to little (if not extremely low visibility) monetization expectation. Again, without the recent MATS there's no reason for any sane coal-fired power plant operator to have any interest in spending any money whatsoever to better the environment. That said, MEEC has spent the last five years largely plumbing the microcap cellars; presumably forever destined to be a publicly funded science project. But, then came MATS.

MATS…

MATS, which Forbes speculates will have a near-$10 billion compliance cost (U.S. only), requires all U.S.-based coal and oil-fired electric power plants generating 25MW & higher to reduce mercury emissions by ~90%. It also comes with an extremely tight zero compliance-avoidance policy, which includes substantial fines and penalties for compliance failure. To my knowledge of MATS, the only compliance waivers that will be given will be granted to power plants that can prove financial and/or operational hardship. One might believe this to be at least a presentable counter-thesis to the MEEC/SEA bull thesis in that coal-fired power plants have well-advertised financial struggles as-is, but the fact that SEA is substantially lower cost (see actual results below) t han current competing technologies (many already in place) largely ( if not entirely) negates this. The EPA knows this as well. Apparently, MEEC speculators are coming to this conclusion more and more each week (as speculation in the forward looking prospects of the company, via the common stock, are growing in volume and in cost).

In the U.S. alone - which is where MEEC's exclusive focus remains currently - there are between 800-850 coal-fired electric generating units (EGU) that will need to comply with MATS. MEEC currently operates SEA at 19 EGU's with several EGU's having SEA for over 5 years; a data-set and sample size which I believe gives MEEC a potential defensible leadership defining advantage. Definitively MEEC has proven at commercial scale that SEA: is 1) of greater than minimal level efficacy (i.e. it meets or exceeds MATS emission reduction requirements) and 2) that it is a cost/benefit net-positive payout for actors in the Coal Complex (i.e. that SEA, because of low incremental cap-ex versus competing solutions, because of its rapid payback on equipment from lower O&M, and because it allows some EGU's to operate at a higher generating capacity without derate is a cost/benefit analysis winner). All of this matters in trying to determine the forward looking prospects of MEEC - which currently, by any non-adjusted comparable company analysis, is not undervalued in a traditional sense:

Financials…

Again though, I think it should be underlined that largely since inception MEEC has been a publicly funded science project. Let's not forget that MEEC has an accumulated deficit of ~$37.1 million (as of 3/31/2016 reporting - which was down sequentially from ~$38 million as of 12/31/2015 reporting) and let's not forget the ~$65 million invested in SEA since inception (to be clear, not all of this investment was contributed by MEEC). None of this magically took place - absent of any financial engineering. I'll start by addressing how the "science project" funded itself and conclude with the recent results of this funding - both the absurdly positive and the potentially somewhat negative.

To fund SEA development, MEEC had to issue substantial debt (which currently totals ~$12.1 million). It also had to issue considerable incentive AND upside participation to investors which took a risk on an, at the time, unproven technology with low-visibility of ultimate monetization. MEEC's debt, as a result of needing to incent traditional debt holders, is 100% convertible - which does complicate things a bit. BUT, in a way this makes the debt situation at MEEC even simpler in "concept" explanation.

Regardless of this necessary, expanded explanation (which takes place below) the basics of the MEEC cap structure are unchanged from normally expected debt-narratives: SEA development costed money, money MEEC didn't have, so it borrowed. Explaining the "incentive" part of this dynamic is where things get a bit complicated and is where I'll spend most of my time (which is what I think is the fair thing to do in this scenario):

MEEC has a considerable warrant "overhang" and this overhang has potential dilution risk associated (to be clear this dilution risk, in my opinion, is likely to be realized). But, outside of the underlying pricing of the dilution taking place (which is important and I'm not trying to minimalize that), MEEC isn't all that different from, say, a deleveraging Oil & Gas company currently; which plenty seem to be just fine with investing in that sector. Even at dilutive pricing and dilutive sizing, if these warrants are "called in" via exercise, any warrant exercise is still a funding event. For a company looking to expand rapidly, that matters.

Also, remember that ALL of MEEC's traditional debt is convertible as well so any conversion of it should be viewed as highly similar to a traditional debt/equity swap. How productive these quasi-debt/equity swaps are to the MEEC story is going to be dependent on how an investor views MEEC's forward looking prospects - but I view any debt/equity conversion as highly productive. Any immediate-term derisking of the balance sheet and cash flow statement, especially early into the monetization story at MEEC, would be viewed as hugely positive by this author. But, I'm generally in favor of limiting downside rather than maximizing upside so this might not be a universally shared thought; to each his or her own. Still, isn't a debtholder taking (what is currently) illiquid equity, with no claims on assets and with no collateral attached, indicative of a positive outlook and high degree of confidence in the story (on all durations - considering the debtholder just gave up its "getting paid to wait" option)? Again, I think it is but to each his or her own.

When outlining the warrant overhang here, which I wanted to make a point of bringing this into focus because dilution risk is still dilution risk regardless of any book value uptick it might cause, I think it's also important to outline the recent positive swing in financials at MEEC. With MATS causing an uptick to SEA demand MEEC has seen its financials hit an inflection point as of late. MEEC realized an ~350% Y/Y jump in revenue from full year 2014 to full year 2015 AND MEEC is showing a continued rapid rate of growth Y/Y on a TTM basis (as of 3/31/2016 reporting). Further, MEEC expects a Y/Y full year revenue growth rate for 2016 of 138% (equating out to $30 million in full year 2016 revenues at the low end of soft guidance). By my modeling, MEEC should be free cash flow positive on a TTM basis (at June 30, 2016 reporting) and should be hugely free cash flow positive on the full year. MEEC alludes to the full year expectation of being free cash flow positive on the full year (for 2016) on Slide #15 of its May 2016 Investor Presentation (included below):

If MEEC can reach a sustainable state of being free cash flow positive its days of "hard" financing should be behind it. Additionally, MEEC should be able to use its free cash flow to either build greater balance sheet credibility or to accelerate growth; both should be productive for share price appreciate net of dilution. Reaching free cash flow positive is one of the single biggest and single most important milestones a microcap can hit - if MEEC can hit this soon (or if MEEC is already at free cash flow breakeven) the story should have an established bottom. Again, this should be hugely positive for the share price.

On Watch…

MEEC speculators have already started to show interest in the name - shares are trading at 52-week highs. With any real volume, MEEC might be able to reach multi-year highs for pricing that, presumably, should be sustainable. And while I do certainly want folks to take into account the potential dilution risk at MEEC I think it would be misled to not consider the funding benefit and/or balance sheet derisking that would result from warrant exercise or debt conversion to equity. Again, both should ultimately allow MEEC to be on more stable footing and both should ultimately expand the operating optionality of the enterprise. That's not a bad net-result.

Overall MEEC is a story that I find highly interesting and is one that I'll consider investing in, in small size, upon review of the next financials reported. I'm highly interested to take note of the TTM free cash flow figures and read any commentary given via the 10-Q. Stay tuned and good luck.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.