Geoff Gannon October 24, 2019

Nekkar: Why We Bought It – And is It Cheap?

Someone emailed me a question about Nekkar:

“I was just curious to understand your thesis on Nekkar. Although they quite correctly have a net cash position of MNOK 0,3bn, they also have close to 0,2 in negative WC (95 in receivables/inventory minus current liabilities of MNOK 274), and I believe most of the cash in Syncrolift (0,2) comes from pre-payments, which over the course of the project will be used for buying raw materials, paying sub-suppliers etc. I am not sure of the percentage but according to the annual filings in 2018 Syncrolift had MNOK 135 in cash and 130 in pre-payments, so I would guess it is a meaningful amount.

EBITDA for Syncrolift was MNOK 30 and 40 in 2017/18. However, if we take out corporate costs of MNOK ~5 which was the average level for the two years, we arrive at a normalized EBITDA of MNOK 35-45. If we slap on a multiple of 6-7x we arrive at a range of MNOK 200-300, so lets use MNOK 250 a midpoint.

With these assumptions I get the following break-up-value of Nekkar ASA:
Net cash Nekkar: MNOK 100
Negative WC Nekkar: -180
Cash (non-restricted) Syncrolift: 25 (?)
EV Syncrolift: 250
= ~200, which is considerably less than today’s market value.”

We don’t value Nekkar on a liquidation basis. Obviously, like an insurer – or anyone with “float” – they would be worth quite a lot less if they ran down their business and closed than if they continued. Syncrolift is quite cyclical. So, this complicates things. If backlog rises over time – the negative working capital position will get more negative (cash will come in the door). If it falls, then cash will end up being used on the project.

So, you’re absolutely right that Nekkar wouldn’t be worth anywhere near what we think it is if it stopped bringing in new orders. The reason for buying the company would be that any new orders would also generate float to the extent that new orders exceed completion on existing orders (backlog rises). They’d always have the same cash on hand (basically) if the backlog stayed essentially flat. Again, this is similar to an insurer. Whenever premiums written today at an insurer drop versus last year, a portion of their balance sheet has to be liquidated and cash flows out the door. They have less customer cash on hand. Nekkar would work the same way. Whenever new orders fall the amount of pre-payments will fall. Whenever new order rise, then pre-payments would rise.

We would never have considered the company unless it was on an ongoing basis. So, the fact that cash isn’t earned isn’t as much of a negative to us looking at this as other people I think. I think other people look at it and say – rightly – that Nekkar can’t (unless they always have this long a backlog) count on having that cash on hand. It’ll flow out of the business in the future.

We look at it and think that any new orders they get will be on similar terms. Therefore, if Nekkar grows revenue much at all over the long-run, they’ll create a lot of value because that growth will be funded with customer money (not retained shareholder money).

I looked at all the long-term business unit data I could get on Syncrolift. I do have concerns about Nekkar. But, they aren’t at the Syncrolift level. Basically, Nekkar may mis-allocate capital at the corporate level. And I’m not at all convinced they will cut corporate costs enough so that a lot of Syncrolift’s earnings at the business unit level will really flow to shareholders. This was a much bigger company. Syncrolift is very small. It can’t support a lot of overhead at HQ and be a good business.

So, really, I would just say that we bought Syncrolift because we think it’s a good business that – if it grows – would create a lot of money for shareholders (because return on incremental invested capital would be very, very high).

You’re right that Syncrolift wouldn’t be worth anything like what we paid in liquidation. The entire value of “float” (cash received in advance of services provided) exists only in an ongoing business. It is a bad thing to have in liquidation – but, a good thing to have if you’re going to grow the business.

Without getting into my exact estimates, if you assume I thought that the company could grow 5% or more a year in terms of new orders, backlog, eventual earnings etc. over time from one cycle to the next (with huge cyclical variations within any few years in that period) then, I’d get a number for the company’s value 10 years from now or something that’d be very high. This happens whenever there is growth with very little shareholder money being used. A company that grows 5-6% a year using almost no shareholder money is going to tend to create more value than a company growing say 8-9% a year while using every dime of shareholder money to do it.

Andrew and I just did a podcast on this subject. I think it’ll go up today. It’s called something like “The Only Way Buy and Hold Ever Works”. So, you might want to search for Focused Compounding Podcast “The Only Way Buy and Hold Ever Works” or follow my partner, Andrew Kuhn, on Twitter (@FocusedCompound) and you’ll see it. Although that’s not a podcast about Nekkar – I think it explains why we’d own something that has cash and owes deliveries. Over time, we think a business model of getting paid in part upfront by customers and then completing their orders over time can be a very good one if we think orders will continue – adjusted for the cycle, we’re nowhere near a low point in Nekkar’s backlog right now, so it’s important to be conservative about volume of business expected in the near future.

Basically, I’d be willing to pay a much higher multiple of EBITDA for a business that uses primarily customer money than a business that uses primarily shareholder money. However, this only makes sense if you look at the business as something to be owned for a while. Not sold soon.

I’ve talked with some people about Nekkar. Generally, they are more excited about the cash on hand, near term prospects, etc. and would put a lower EBITDA multiple on Nekkar than I would. Conversely, I’d value the ongoing business higher and care less about the cash and near term future.

I wouldn’t say Nekkar is a value investment. I don’t think we paid a very low price for it. I do think we got a good business model from it.