Bought Boom

Today I purchased 7428 shares in Boom Logistics (ASX:BOL) at a price of $0.175 each. For those of you who have never heard of this business, it provides crane and lifting solutions to customers in the resources, energy, utilities and infrastructure segments. I had briefly taken a look at this company a few years back and passed, but it was brought to my attention again by a good friend of mine, Alex, who posted about Boom on his excellent blog The 8th Wonder.

After conducting my own research, I reached similar conclusions to Alex about the business, eventually deciding to stop sucking my thumb and to just pay a little extra for some shares. Since I don't think I can put forth the case for investment any better than he already has (and because I'm admittedly a little lazy right now), I recommend you go read his thoughts here and here. Alternatively, he's given me permission to simply copy and paste those posts right here for your convenience. Enjoy!

23 Cents on the Dollar

Boom Logistics (ASX:BOL), Australia’s largest crane and lifting solutions provider, caught my eye recently with its price trading at nearly one fifth of tangible book value. After further inspection and a phone call with management, I took a position at $0.12.



Times have certainly been tough of late for anything marred with the mining service brush, and it has been no different for Boom. While this is not a high quality business by any stretch of the imagination, it seems that the market is currently pricing Boom as if death is imminent. When the herd is avoiding a sector like the plague, this has the potential to create opportunities for the contrarians among us.



Boom’s derives the majority of its revenue through maintenance contracts with Australia's major mining companies (as well as energy, infrastructure and civil construction work) which bodes well as Australia shifts from a mining ‘capex’ cycle to one of operation and maintenance. An improvement in residential construction that is underway, along with the increasing trend of crane intensive high density buildings, is also a positive as it may help to soak up crane supply and boost utilisation across sectors. 



While Boom’s profit history has been disappointing due to asset write-downs and restructuring charges, its consistency of operating cash flow is attractive. Over the last 5 years, Boom has averaged $50m of operating cash flow per annum, almost as much as its current market cap. Management have guided they expect capex to be less than depreciation ($20m expected), which coupled with the $11m of asset sales, bodes well for free cash flow (FCF) in the vicinity of $30-40m for FY14. This places Boom on a FCF multiple of less than 2 times!



What is certain is that a stock is unlikely to remain at 2 x FCF or 0.2 of book for long, either free cash flow or book value will reduce or the price will rise. As I expect FCF to be resilient, this gives management optionality in terms of capital management.



Management are aggressively repaying debt (with $12m repaid in the first quarter and a full year target debt balance of $90m) and have stated the intention to buy back stock on market to capitalise on the discount. Boom’ s net debt to equity is currently 33% and is likely to reduce below 30%, which is less than half that of peers such as Ausdrill and Emeco who trade on similar discounts.



The currency sensitivity is also interesting. Boom invested $140m over the last 3 years when the AUD was close to or above parity with the USD. As cranes are sourced from international suppliers, Boom was able to take advantage of the strong currency and replenish its fleet at relatively good prices. However, with the AUD at $0.90 and with expectations that it will continue to fall, cranes are not getting any cheaper in Australia. This bodes well for Boom’s crane values and reduces the probability of future write-downs. However, given the size of the discount at which the price trades at, shareholders have a significant buffer even if write downs do materialise.



There are a number of catalysts which have the potential to provide a rerating: an on market buyback, continued debt reduction announcements, a return to bottom line profitability and a takeover offer from private equity or a trade buyer. Given that sentiment is so bad towards the sector, even a slight normalisation has the ability to provide a rerating.



As Boom trades at such a large discount to NTA, an acquisition creates interesting accounting implications for a potential acquirer. For analysis sake, let’s assume McAleese (ASX:MCS) (who has a large presence in the QLD lifting market and who also has been a substantial shareholder of Boom in the past) is successful at acquiring Boom at $0.20 per share. This represents a ~50% takeover premium for current shareholders. However, as Boom has NTA of $0.51, MCS is likely to record a profit on acquisition of $0.31 per BOL share, as they have acquired $240m of equity for only $94m. No doubt a large profit created by sound capital management would give MCS’s management a tick of approval from their new shareholders. Given its discount, operating cashflow history, relatively lowly geared balance sheet and open register, it seems plausible for Boom to attract some takeover attention.



To me, the epitome of an investment (protection of principal whilst also providing a sound probability of an adequate return) is often found in stocks that have very low expectations incorporated into the share price. If bad news eventuates, the downside is less severe as many were already expecting bad news. However, if good news eventuates, the price is way too low and must quickly rally, thus providing the return. It is these asymmetric opportunities that I love to fill my portfolio with.



Boom is certainly not a buy and hold forever stock idea, nor should one be expecting the price to revert to book value in the near term. My view is that buying at a P/B of 0.20 and waiting for one of the aforementioned catalysts provides a reasonable probability of selling at 0.40 of book (the medium term average) in the next 3 years. If it takes all three, that gives 26% annually. Any sooner is a bonus!

Half Yearly Result Update 

Boom Logistics reported its half year results last week which were on par with my expectations . However, with $319m of equity that is currently generating poor returns, management have some decisions to make.



First, let's revisit the thesis. My attraction was based around the ability to buy lots of tangible assets cheaply, and as the group’s cranes were under employed, disposals and reduced capex were two likely drivers of significant free cash flow. Steve Johnson from Intelligent Investor said it best, 'these businesses have been cash sinks as they grow, they should spew out cash as they shrink'. While it is still early days, it seems management are beginning to gain some traction and the wheels are turning in the right direction. 



Operating cash flow for the half came in at $11m, which was a little below par. It seems clients have been stretching out payments as Booms receivables only decreased 5% while sales fell 23%. Asset sales of $8m were achieved which contributed to $13m of free cash flow, with the majority directed to reduce the debt balance to $102m on a net basis. Importantly, there was no asset impairments and NTA increased to $0.52 per share. To refinance its banking facilities, management were required to conduct a thorough assessment of its assets and to come through without an impairment certainly adds confidence. I will be eagerly watching the full year result for an improvement in operating cash flow and further debt reduction.



I caught up with CEO Brendan Mitchell last week and we discussed an interesting opportunity for further assets sales. There is currently $65m of assets which lay under utilised with the majority idle due to the BMA contract loss. While it seems the preference is to get them re-employed into another contract, management will consider selling the entire fleet if this doesn't occur in the reasonably near term. While conditions remain tough and there is plenty of surplus equipment for sale in the market, prices for cranes haven't plummeted as far as Booms share price would lead you to believe. Indeed, $1.6m of assets were sold for a profit in January. Here lies the opportunity. $65m is nearly 90% of Booms current market cap, however for the sake of conservatism, if we assume a 50% haircut, management could still repay a further $10m of debt and buy back $22m (30%) of stock. This would most certainly reduce balance sheet risk and create immense value for ongoing shareholders.



It seems odd, but I think missing out on further contract wins could work out to be better for shareholders. And if Boom does win work, its not a negative either, creating somewhat of a win-win situation.

Farewell Forge

This week has been a bad one for just about everyone involved with Forge Group, which has officially gone into voluntary administration. 'Sad' and 'mad' are probably a couple more words that employees, shareholders, creditors and counterparties would use to describe how they feel about this extraordinary turn of events. Even though I don't belong to any of those groups, it's depressing to be reminded of how ruinous things can get when companies fail. 

In my last post on Forge, when it was in the middle of its 24 day long trading halt, I speculated on what might happen, and already started to draw some lessons to be learned. Eventually, management spilled the beans, and it wasn't pretty: they would incur a $127 million profit downgrade on the two troubled power contracts, with a net cash outlay of $45 million required to complete them. It seems to me like management didn't have any good reasons for the downgrade - they just completely stuffed up in managing these contracts. Instead of raising money at around the rumoured $0.50 or $0.625 per share level, ANZ came to the rescue by waiving debt covenants, increasing Forge's working capital facility from $11 million to $60 million, and deferring principal repayments. The string attached to the deal was that ANZ would receive 11.2 million warrants (equivalent to 13% of the shares on issue), exercisable at a comical $0.01 each. Essentially, shareholder dilution was far less than expected, but the increase in debt raised the risk profile of an already weakened business. 

Shares started trading again on 28th November, opening at $0.38, dropping to a low of $0.285, rising back up to a high of $0.865, and then settling down to close at $0.685. That's what the price range for a normal stock looks like over a year or two, never mind a single day! From the $4.18 prior to the trading halt, $1000 invested in Forge would have plummeted to just $68 at the low, and $164 at the end of the day, which is one of the sharpest declines I've personally witnessed. Here's what the one year chart looks like.

At that point in time, I think a sensible argument could have been put forth for a very high risk, high reward punt on Forge. If it were to survive and in a few years recover even to a fraction of where it was before, an investor might make 3x or 4x their money, while the most they could lose would be 1x their money if Forge went bankrupt. Were you to apply a 50% probability to each scenario, the mathematical expectancy would compel you to invest. Despite the seductive logic of the numbers and the attractiveness of contrarian bets to value investors such as myself, I decided against an investment (again I thank my lucky stars with Forge), as the situation was just too risky for my liking. 

Securing $40 million in asset management works in North America, reaffirming the $830 million Roy Hill contract was still on track to go ahead, and BlackRock Group (the world's largest asset manager) buying up shares, all served to push the share price to a high of $1.96 on 30th December. There was some serious volatility on this day, opening at $1.10, rising to an intraday high of $1.96 and closing at $1.585. The newfound optimism was cut short with a trading halt on 10th January, followed by the announcement of a further $23 to $28 million writedown on the troubled West Angelas Power Station project. 

Ten days after coming back onto the market, Forge went back into another trading halt. Again, the news wasn't pleasant: instead of the $45 to $50 million pro-forma EBITDA guidance for FY14 given after the first trading halt, it would now be a loss of $20 to $25 million. In other words, the underlying business was expected to lose money. This downgrade was attributed to two more contracts becoming unprofitable, tougher market conditions, and the necessity of managing the business for short-term cash flow. In a sign of the dire situation, management arranged for a shareholder meeting on 4th March to renew their capacity to issue up to 15% of the shares outstanding without prior shareholder approval. Various third parties were disclosed to have taken an interest in acquiring Forge, but in the end all of them walked away. 

Thirteen days later, and Forge is in another trading halt, but this time it isn't coming out. The financiers withdrew support for the company on 11th February, with the inevitable result of administrators being appointed. Forge must have been bleeding so much cash that ANZ had to put an end to the business. Indeed, according to the Australian Financial Review, debts had built up to a staggering $500 million, with creditors such as ANZ and insurance bondholders expected to lose money. With their estimated $200 million exposure and now worthless warrants, ANZ are no doubt kicking themselves for replacing NAB as Forge's main lender in mid-2013. Of the 1753 staff in Australia, more than 1400 employees were retrenched, and it will be difficult for them to find jobs in a weak mining services sector. On the plus side, the sale of Forge's assets, and the Federal Government's scheme will ensure they receive their basic entitlements, while some of them may be able to find work with new contractors. The international businesses in South Africa, Asia and the US will operate as usual until a buyer can be found, so the 814 overseas employees might have a bit more luck. Shareholders are very unlikely to be receiving anything, perhaps a sincere apology from management is all they can hope for. 

Even after going through all these developments, I'm still dazed at how this came to be. If you take a cursory look at Forge's last annual report for FY13, you see a very decent set of financials for a mining services business: return on average equity of 33%, a current ratio of 1.4, $90.7 million in cash, another $10.5 million in term deposits and debt of just $25.7 million (ie. net cash of $75.5 million compared to equity of $213.4 million). One lesson to be learned is that a perfunctory glance at a few numbers or ratios will not cut it - as I outlined last time, there were some warning signs in the financials, and if investors understood how Forge made its money, they would see a much larger degree of leverage. Nevertheless, if someone told me Forge would have $500 million in debt within seven months and had gone into administration I probably would've laughed. 

This business had a very fast rise, with net profit rising from $2.7 million in 2007 to $62.9 million in 2013, but an even faster decline. It reminds me of the pendulum that Howard Marks speaks about in his book, The Most Important Thing, where he tells investors to keep in mind that almost everything moves in cycles and that eventually the pendulum will swing the opposite direction. For a time, the mining services sector was doing quite swimmingly, helping businesses like Forge to produce excellent results, and luring investors into thinking that the mining boom was the new norm. Most people forgot about the cyclicality altogether, but now we have an unpleasant reminder of its distorting effects and that investment adage: what the wise man does in the beginning, the fool does in the end. 

Maybe another lesson to be learned is the role that luck plays in investing. While you could sit here all day and try to scrutinise every piece of evidence with perfect hindsight, I think the biggest factor here was just bad luck. It all started with the problems at the two power contracts, which without inside information, would have been impossible to foresee. This kind of blow up could have happened at many other mining services companies, but Forge shareholders had the misfortune of being in the wrong place at the wrong time. 

My best wishes go out to all those affected by Forge Group's collapse.