HIL - Hill International

[eclecticvalue]

Here is an overlooked small cap idea that I have found. In summary, it is a company that has multiple catalysts which can unlock value. One of them is a potential sale. The company has cleaned up it's problems that plagued them for the past 3 years and has reduced it's cost structure. So any further revenue growth should bode well for the bottom line. Full write-up is below.

Hill_International.pdf

[mikazo]

I wasn't sure from your analysis whether you were using total revenue or Consulting Fee Revenue. It's an important distinction, so I just wanted to point it out to anyone that is looking at this company.

 

From the 10-K:

 

"Consulting Fee Revenue

We believe an important performance measure is consulting fee revenue (“CFR”). The professionals we deploy to execute contracts are occasionally

subcontractors. We generally bill our clients the actual cost of these subcontractors and recognize this cost as both revenue and direct expense. CFR refers to our revenue excluding amounts paid or due to subcontractors. We believe CFR is an important measure because it represents the revenue on which we earn gross profit, whereas total revenue includes subcontractors on which we generally pass through the cost and earn minimal or no gross profit."

[Homestead31]

also worth noting that insiders have bought a ton, and have publicly called for a sale in the past.  i think what is happening is that they are just cleaning up the business before selling it.  at this point, most of the cleaning up has been completed.

 

As for the consulting fee revenue piece, you are correct to point that out, but i would note that in a sale process a larger strategic could pay a multiple of gross revenue, not just consulting fee revenue, because the delta between gross revenue and CFR is subcontracted out.  However, a larger player would not have to subcontract out - they could keep it in house.  that being said, it is certainly more conservative to focus on CFR, especially as the pool of potential buyers includes PE firms.  Given how cheap this is though, there is still plenty of upside if it is sold on a multiple of CFR.

[KJP]

I've had half an eye on this company for about 3 years, since a January 2017 VIC writeup.  That write up (and another one later in 2017) had the same thesis as you -- this is a relatively straightforward business that should earn 8-10% standalone margins and, more importantly, likely would be sold to a larger player within 6-12 months for ~1x - 1.25x net (or "consulting fee") revenue or ~10x EBITDA because this is an acquisitive industry and the Board is properly incentivized to sell the business.   

 

This made a lot of sense in theory, but hasn't yet worked in practice.  The accounting issues haven't helped and the constant talk of a looming sale likely created business development problems, as revenue-generating professionals decided to leave rather than wait around and become a "cost synergy" for a buyer. 

 

That being said, I agree with you because:

 

1.  Backlog is growing  In the Q4 2018 conference call, there was a general reference to new compensation structures that might boost business development performance, and the comments on the latest VIC post add some color to that.  The results over the last six months suggest something is working, because backlog is once again growing.  To me, backlog growth (if you trust management to report is accurately) is a more important leading indicator in this business than revenue.

 

2.  Incremental margins should be quite high  This company essentially has relatively fixed overhead and then makes roughly 30-40% gross margins on cost-plus consulting contracts.  So, incremental margins should be quite high as the increasing backlog turns into revenue. 

 

3.  A sale still seems likely  The Board (which owns 30+% of the shares) still looks like the type of people who would want to sell this business, rather than run in for 5-10 years.  Moreover, given the high incremental margins in this type of business, horizontal mergers and acquisitions make alot of sense, and, in fact, the industry appears to be quite acquisitive.  You can follow industry M&A via weekly updates here:  https://www.zweiggroup.com/  In addition, it's not only strategics involved here -- PE seems interested in the industry, e.g., the 2017 sale of TRC Companies and the accompanying merger proxy's description of the sales process. 

 

4.  Pieces may be worth more than the sum of the parts  I suspect this business really benefits from local economies of scale and expertise.  I doubt having operations in, for example, Hong Kong or Dubai helps sell services in Orlando. (NV5, for example, emphasizes its local expertise.) Hill appears to have strong franchises in the US and the Middle East and subscale operations elsewhere (Asia, Europe, LatAm).  The segment reporting suggests as much and management acknowledged this in the Q4 2018 call.  Although management suggested it wants to keep and grow these subscale businesses, they present an opportunity to sell the company in pieces to different bidders who can get the most value out of the different geographies.  Splitting the company's net revenue by geography may also be a useful way to do a high-level valuation, e.g., U.S. revenue worth more than Asia, etc.

 

On the flip side, I don't think this company actually has any publicly-traded peers nor am I sure exactly who the strategic buyers would be.  In the various writeups I have seen, people usually use TRC (sold to PE in 2017), Tetra Tech, NV5 Global, Jacobs, and AECOM.  But all of those companies are much more vertically integrated in that they get most of their revenue from design/engineering, architecture, environmental consulting and (in some cases) actual construction in addition to some construction/project management.  Hill, on the other hand, seems to be pursuing a different strategy and is a pure play construction/project manager that deliberately does not get involved in design.  According to Hill, this benefits customers by making Hill unbiased and solely focused on meeting the clients' objectives. 

 

I'm not in the industry and don't know whether Hill's strategy is correct or not. But the bigger question is whether there are buyers for such a large (in terms of revenue) construction/project manager.  NV5, for example, seems much more interested in buying engineering firms to broaden its portfolio of services and geographic reach.  Similarly, PE firms seem to like the AEC industry generally, but is a large project/construction manager the right platform off of which to launch an industry roll-up/bolt-on acquisition strategy?

 

Although these concerns give me some pause, I think the positives (improving business performance, likely standalone cash generation moving forward, Board incentivized for a sale) outweigh them.  This company was on my short list for the 2020 picks thread, and I believe it will do well over the next 12-24 months (but I would have said the same thing three years ago!).

 

 

 

 

[Homestead31]

take a look at Michael Baker.  This company was bought by a private equity shop a few years ago.  Interestingly, some of the insiders at HIL were involved with Michael Baker and fought for a higher price.  The same PE shop previously tried to buy HIL a few years ago, before the restatements. 

 

all the pieces are in place for a sale.

[KJP]

take a look at Michael Baker.  This company was bought by a private equity shop a few years ago.  Interestingly, some of the insiders at HIL were involved with Michael Baker and fought for a higher price.  The same PE shop previously tried to buy HIL a few years ago, before the restatements. 

 

all the pieces are in place for a sale.

 

Thanks for the pointer to Michael Baker ("MB").  MB appears to have been primarily an engineering firm, rather than a PM/CM firm.  That being said, Crescendo's involvement in MB (including its December 2012 letter pushing for an auction) and the fact that DC Capital was sniffing around Hill with a likely lowball initial offer are encouraging signs. 

 

I agree with you that the tea leaves strongly suggest a sale at a price significantly higher than the current share price.

[KJP]

Hill is down 40% in the last few weeks.  Given the current situation, the company's big Middle East business likely doesn't help. 

 

As of 9/30, the company had $17 million in cash and $52 million in debt.  In December, they collected $9 million from a previously written off Libyan receivable.  Based on Q3 and management commentary on the Q3 call in November, I'd expect Q4 to have an operating profit of ~$2.5 - $3 million, but cash flow is murkier due to working capital movements.  So, I'd ballpark cash around $26 million and net debt around $26 million.  The market cap is ~$108 million, so enterprise value is ~$134 million.  That's less than 1x US CFR, ignoring the entire international business. 

[bskptkl]

I couldn't resist buying a starter position after seeing this comment on VIC today:

 

"The stock is down on one seller trying to exit a block. They obviously botched the trade or panicked. Fundamentally, I don't expect much change for HIL even at lower oil prices. I spoke with two people on the board over the last two days and they're not expecting much change either. It's a steal here at $1.90."

[KJP]

Anyone know what's going on with the massive volume the last two days?  I've found no information about it.  Given that share price is increasing, it doesn't appear to be a big seller blowing out of a large position.