Thoughts on PESI from LCA Y/E Letter

Perma Fix (PESI) is one of the newer holdings in the Long Cast Advisers portfolio. I wrote about it in our year-end letter (link) and wanted to just focus on it here for interested followers. 

PESI operates in the nuclear waste remediation business through two segments.

The Treatment segment (62% of TTM revenue) is an asset heavy operator of low level and mixed low level radioactive waste facilities in Tennessee and Washington and a liquid waste facility in Florida. (Can go here and search by site ID for RCRA information or the links below for the company’s self reported information.)

Tennessee. Diversified Scientific Services (DSSI). Site ID: TND982109142

Washington. Perma Fix Northwest (PFNW). Site ID: WAR000010355

Florida. Perma Fix of Florida (PFF). Site ID: FLD980711071

Treatment is a capacity utilization business where volume growth offers operating leverage and non-linear margin expansion once fixed costs are scaled. 

Historical financials understate the true earnings power of this segment for two reasons: 1) TTM results are negatively impacted by closure costs for a facility ("M&EC") that is now closed. Excluding those costs, which are one time in nature, proforma margins are in the ~30% range. 2) PESI has never operated a strong Services component but now that one is growing, it can feed additional volume to treatment facilities, where incremental margins are +70%. In short, I think the earnings trajectory in Treatment may shift positively.

Concurrent with the closure of M&EC the company exchanged pf'd shares for common at $4.80, which served to simplify the capital structure. Furthermore, with the closure, the company received $5M from its insurer that had been held in collateral associated with insuring the facility, a benefit to the balance sheet and w/c. 

The Services segment (38% of TTM revenue) is a variable cost model. It’s essentially boots on the ground in Tyvek suits with picks and shovels plus engineering expertise, et al. This segment is benefiting from a turn-around under relatively new CEO Mark Duff, appointed in 2017, having replaced the founder who had run the company for decades. The growth in services has the multiplier effect of increasing waste volume to Treatment.

An interesting part of the Services turnaround in my mind is that the Mr Duff actually once ran and grew this exact business. A look at old filings and self reported biographies indicates that in the mid-2000’s until 2010 he was President of a company called “Safety and Ecology” where he grew revenues from $50M to $80M. He was running it when it was sold in 2008 to what appears a fairly schlocky public rollup called Homeland Security. He was gone however by 2011 when SEC was sold to PESI, which failed to sustain its growth (ie drove it into the ground).

After SEC, Duff was a project manager at the Paducah Gas Diffusion site, first for LATA-Kentucky and then for the Shaw Group / CBI JV that took over the site when that contract changed hands. Now he’s back at the original SEC and two years into a turnaround that is taking shape.

I'm writing a fairly abbreviated summary here. A lot of information is disclosed in the financials. One of the aspects that worried me during my d/d related to the growth in fixed price work on the Services side. Any company that goes into a new business under f/p terms is asking for trouble. However, as I understand it, this is not hard dollar / low bid / fixed price rather it's fixed unit price so there is limited risk of taking a loss on a services contract. 

And IMHO the pros > cons. The company has a lot of attributes I find attractive and various tailwinds to support growth. It is easy to understand and has a long operating history accessible for analysis. Its primary customers (DOE, DOD cleanup sites, et al) are spending money and re-letting contracts after a long lull, including potentially large contracts on which PESI is rumored to be a named sub-contractor.

Finally, large legacy contractors like Fluor and AECOM are selling / have sold their managed services businesses to private equity, who in turn I think are mostly attracted to the outsourced IT programs. This could create potential disruptions for themselves and opportunities for smaller companies like PESI, especially given its newly installed but experienced management team.

At current prices - after Friday's sell off - the company is valued at ~$90M EV. It trades at 1.5x TTM revenues, 6x TTM gross profit and 18x pro-forma EBITDA (after adding back one-time closure costs). This looks expensive, especially given AECOM sold their managed services division for 12x EBITDA. Some of the multiple is driven by rumours of the large contract I mentioned above. 

If we apply 12x EBITDA to just the Services segment, this implies the Treatment business trades for 1.5x sales and that’s hard to fathom. PESI’s Treatment business is one of three named contractors on DOE contracts to handle low level waste. The others are Energy Source and Waste Control. Those two tried to merge in 2015 a deal valued at 8x sales that deal was blocked on anti-trust grounds. I’m pretty sure 8x is not the right sales multiple for PESI’s treatment but in an environment like we have today, with increased volumes concurrent with high barriers to entry, it is likely worth more than the multiple inferred by comparative valuations on the Services business.

Regarding the sell off, I think the contract everyone is waiting for was supposed to be awarded by the end of January. It wasn't. Why not? There's a protest on a separate contract at the Hanford site, which is pushing out the schedule for other contracts. Overall, if they win the contract, it’s revolutionary but even if they don’t, the increased spending in general will lift all boats in the space. (But it would be better if they won). 

Historical figures are only good as a baseline and investors will make money on future results. What can this company look like in an environment where a large customer is spending again, there's some competitor dislocation and a relatively new management team that for the first time has Services experience? 

I think for the long term shareholder, it offers a wide success pathway and ample opportunity for returns even though current multiples don’t screen for value. But you should do your own homework. I'd be happy to hear what you find and I am always open to critique. 

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