Before we get started, the last time I used the word activist in a public Seeking Alpha article title was back on November 4, 2021, when I wrote up MoneyGram (MGI). At the time of publication, shares of MoneyGram where trading at only $5.20 per share. Incidentally, the company agreed to an $11 per share buyout, on February 15, 2022.
Today’s article is about Orion Group Holdings (NYSE:ORN). And, at least at its current valuation, with shares trading at only $2.21, this is one of the most compelling setups I have ever seen. Given that the world is awash with capital, both private equity capital and attractive debt / equity financing – think other publicly traded operating companies, I don’t expect the extent of this opportunity to remain for very long. The market tends to be efficient and value disconnects tend to get arbitraged away by Mr. Market. That said, whether or not it takes a fresh 5% to 10% SC 13/D filer to set this in motion and close this valuation disconnect is an open question.
In case anyone is unfamiliar with the company, here is how the company describes itself in its 10-K.
Orion Group Holdings, Inc., is a leading specialty construction company serving the infrastructure, industrial, and building sectors, providing services both on and off the water in the continental United States, Alaska, Canada and the Caribbean Basin through its marine segment and its concrete segment. Our marine segment provides construction and dredging services relating to marine transportation facility construction, marine pipeline construction, marine environmental structures, dredging of waterways, channels and ports, environmental dredging, design, and specialty services. Our concrete segment provides turnkey concrete construction services including pour and finish, site preparation, layout, forming, rebar, and mesh across the light commercial, structural and other associated business areas. We are headquartered in Houston, Texas with regional offices throughout our operating areas.
-(Source: Orion Group’s 10-K)
Why The Opportunity Exists
Orion Group has two segments: Marine and Concrete. The Marine segment is a decent business and over the past four fiscal years, this business has Adj. EBITDA margins ranging from 8.1% (FY 2021) to as high as 12.3% (FY 2020). The drivers of this business are the quality of its backlog and utilization rates. High/ healthy labor and equipment utilization rates drive profitability. The Concrete segment has been a goat rodeo and Adj. EBITDA margins have ranged from negative 1.5% (FY 2018) to 2.1% (FY 2020).
As I stated above, backlog and the quality of that backlog drive near term results. Please note that Orion’s backlog ending 12/31/19 was healthy. Lo and behold its FY 2020 results were solid, with the company delivering Adj. EBITDA of $55 million.
The reason the stock has gotten dinged is because management has proven to be weak operators, bad at forecasting the business, and simply poor stewards of shareholders’ capital. In late February 2021, after Orion posted a strong FY 2020 results, management guided the Street to Adj. EBITDA of mid to high $40 millions. Yet, as of 12/31/20, Orion’s backlog was really low, and as it turns out, its 2nd half FY 2021 results were terrible.
Enclosed below is look at the key metrics over the past four fiscal years.
Orion has 31 million shares outstanding. As of Tuesday, March 22, 2022, its stock closed at $2.21 per share, which translates into a $69 million market capitalization. After a really poor second half 2021, Orion has $39.1 million of financial debt (on its revolver) and $12.3 million of cash, so $26.8 million of net debt. This translates to an enterprise value of $95.8 million.
However, the company has two pieces of commercial real estate currently under agreement. If both deals close, net proceeds are expected to be $35 million. This consists of its $5 million (Port Lavaca) property and $30 million (East West Jones) property. The Port Lavaca deal is supposed to close by Q2 FY 2022 and East West Jones is targeted to close in Q3 FY 2022.
Management guided FY 2022 Adj. EBITDA to the mid $30 millions. And again, as I noted above, Orion does have a much healthier backlog entering FY 2022, so even though management isn’t super credible, there is a much higher likelihood that they can hit this guidance compared to FY 2021 guidance, as the 12/31/2020 backlog was low whereas its 12/31/2021 backlog is healthy.
On a pro-forma basis, if you can get comfortable the two real estate deals make it across the finish line, we are talking about a pro-forma enterprise value of $61 million ($95.8 million current EV – $35 million of net real estate proceeds).
If you believe management’s FY 2022 Adj. EBITDA guidance that translates to an EV/ Adj. EBITDA FY 2022 of only 1.75X.
Here is commentary from the Q4 FY 2021 conference call on the real estate.
East & West Jones
The Activist Angle
Besides the ridiculously low valuation, notably if you believe the two commercial real estate deals close, in calendar year 2022, this stock is perfect for an activist.
If an activist quietly accumulates a 5% stake and then they could do the following:
1) Find a buyer for the Concrete segment. Even if it is for a low price, say at book value (think about the highest inflation in 40 years and how its market share and equipment could be valuable to another competitor that is a better operator in the concrete space), finding a buyer for the concrete segment would be a catalyst. The Concrete segment generates inconsistently results and isn’t inherently profitable. On a blended basis, because of the drag from the Concrete segment, Orion’s Adj. EBITDA margins looks much lower than its peers and thus screens poorly.
2) Secondly, Orion’s larger publicly traded Marine segment peer, Great Lakes Dredge & Dock Company (GLDD), has a market capitalization of roughly $972 million and net debt of $175 million, or a $1.15 billion enterprise value. In FY 2021, GLDD reported $127.4 million of Adj. EBITDA and a backlog of $552 million, as of December 31, 2021. No question GLDD is a better business, has better Adj. EBITDA margins, and it only has a Marine segment, but it trades at roughly 9X EV/ FY 2021 Adj. EBITDA.
It doesn’t take a rocket scientist to work out that Orion would be the perfect tuck-in acquisition for GLDD and I would argue they could pay $5 per share ($155 million) for ORN and then either sell the Concrete business or slowly run it off, to minimize cash flow burn rates. At that valuation, this would be very accretive to GLDD.
Strong Qualitative Data Points
In addition to the compelling valuation and value that could be unlocked by selling the concrete business (even at a low price), enclosed below are a few excerpts. Exhibits A and B are from Orion’s Q4 FY 2021 conference calls and Exhibit C is from Great Lakes Dredge & Dock Company’s Q4 FY 2021 conference call. They point to the highly favorable outlook for the Marine segment.
Exhibit A – Strong Marine Backlog
“This resulted in a win rate of 11% and a book to bill ratio of 1.11 times for the quarter. As of December 31, 2021, our backlog was $590 million, up from $440 million at the end of last year. Of our year-end backlog, $377 million was in our Marine segment, and $213 million was in our Concrete segment. Approximately, $455 million of the year-end backlog will burn during 2022 with remainder associated with longer term projects burning through 2023 and into 2024.
Additionally, we are the apparent low bidder or have been awarded $138 million of new work subsequent to the end of the fourth quarter. Of this, approximately $24 million is related to the Marine segment, while $114 million is related to the Concrete segment.”
-(Source: Orion Group Q4 FY 2021 Conference Call)
Exhibit B – Favorable Pricing Environment For Marine Work Given The Robust Demand
“I will say that, in our Marine business, nobody should be bidding cheaply in our Marine projects that we’re going after. There’s so much more coming down the pipeline, there was a lot of work already with private sector opening up and then with the addition — additional catalysts of the Infrastructure Act. There’s no reason for people to be filling up on cheap work at this point. So we would expect that to help with bid margins on the Marine business as well or in our Marine business as well.
So, we’re excited about the opportunities we see in front of us and continuing to replace backlog with improved margins. And as you pointed out, we’re already — we’re starting from a base of better absorption of our — in direction at our labor and equipment in the Marine businesses with the backlog that we have. So we’re poised for improvement this year and on into the future.”
-(Source: Orion Group Q4 FY 2021 Conference Call)
Exhibit C – Great Lakes Dredge & Dock Company’s Commentary
GLDD’s Q4 FY 2021 conference call commentary on how robust the outlook is for the marine dredging segment, which confirms Orion’s commentary on future margins in FY 2022.
“We saw continued support for the dredging industry in the U.S. Army Corps of Engineer’s (“Corps”) 2022 budget that was approved by the House of Representatives at a record $8.66 billion, an 11% increase over prior year levels. In this bill the Harbor Maintenance Trust Fund would receive $2.05 billion, which is $370 million over 2021 budget appropriations. The U.S. government including the Corps are presently operating under a continuing resolution with budget approval anticipated before the end of the first quarter of 2022. In September of 2021, a supplemental bill was passed that included approximately $5.7 billion dollars for emergency funding as a result of Hurricane Ida impacts. In addition, the U.S. Congress passed the $1.2 trillion infrastructure bill in November 2021, where the Corps will be granted $11.6 billion in funding to improve the nation’s resilience to the effects of climate change, including flood control and waterway dredging.”
-(Source: GLDD’s Q4 FY 2021 Conference Call)
Putting It All Together
The market appears to have thrown the baby out with the bathwater. If you believe Orion can sell the two commercial real estate properties for upwards of $35 million, as both are under contract, the caveat is that due diligence and finalizing financing appears to be moving slower than originally hoped, Orion essentially has no net debt. Moreover, given the robust backlog entering FY 2022, it is far more likely that Orion can hits its FY 2022 Adj. EBITDA guidance of $35 million whereas its FY 2021 guidance was unlikely as the backlog wasn’t there to support the forecast. Remember, high labor and equipment utilization rates drive Adj. EBITDA margins. And given how robust the demand is for Marine related work, it is also very possible that the initial bid margins are healthy to much healthier in FY 2022, especially compared FY 2021.
An activist could quietly acquire a 5% stake and then push management to sell the Concrete business (even for a relatively low price) and then sell the Marine business to a Great Lakes Dredge or another privately held competitor. The Marine segment should fetch 5X to 6X normalized Adj. EBITDA.
Your margin of safety is the very low valuation, the real estate that resolves balance sheet concerns, and the strong tailwinds in Orion’s Marine segment.
With the stock trading at only $2.21, Orion Group Holdings is a very compelling target, notably for the right activist.