Acquisitions drive trebling in revenue

MagneGas 20 August 2018 Update
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MagneGas

Acquisitions drive trebling in revenue

Q218 results

Alternative energy

20 August 2018

Price

US$0.23

Market cap

US$9m

Net cash ($m) at end-June 2018

0.4m

Shares in issue

37.7m

Free float

98.6

Code

MNGA

Primary exchange

NASDAQ

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(26.5)

(60.3)

(97.0)

Rel (local)

(29.1)

(62.9)

(97.4)

52-week high/low

US$10.9

US$0.3

Business description

MagneGas is a technology company that has developed a plasma-based system for the sterilisation and gasification of waste. This process generates a hydrogen-based fuel called MagneGas2 as a by-product that is sold as an alternative metal cutting fuel to acetylene.

Next event

Q318 results

November 2018

Analyst

Anne Margaret Crow

+44 (0)20 3077 5700

MagneGas is a research client of Edison Investment Research Limited

MagneGas’s Q218 results show the transformative effect of the three acquisitions that were made earlier in the year. Sales trebled year-on-year, but as the annualised revenue run-rate achieved in May has not been maintained, we revise our FY18 estimates downwards.

Year end

Revenue (US$m)

EBITDA
(US$m)

PBT*
US$m)

EPS
(US$)

DPS
(US$)

P/E
(x)

12/16

3.6

(9.6)

(10.3)

(31.0**)

0.0

N/A

12/17

3.7

(10.3)

(11.0)

(15.3)

0.0

N/A

12/18e

10.5

(10.4)

(12.5)

(0.5)

0.0

N/A

12/19e

16.8

(5.4)

(8.3)

(0.2)

0.0

N/A

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. **Adjusted for reverse share split.

Record sales in Q218

Total sales increased by 201% year-on-year to $2.9m as a result of the three acquisitions made in Q118 and early Q2. Importantly, revenues from both the Complete Welding and Green Arc acquisitions grew strongly compared with the previous quarter, as management invested in additional sales personnel. Operating costs increased by $0.8m to $4.3m, mainly as a result of the ongoing costs of the acquisitions. Operating losses widened by $0.3m to $3.4m. Net cash reduced from $1.2m at end-Q118 to $0.4m at end-Q218. The use of preferred stock to finance activities is significantly dilutive. During Q218, conversion of Series C preferred stock resulted in the issue of 7.7m new shares of common stock.

Progress executing strategy

The three acquisitions made so far this year take the group halfway to achieving its goal of creating a profitable platform for selling metal-cutting gases and associated products, as management estimates MagneGas will break even on sales of c $20m. The cash generated from gas sales will be used to help commercialise its proprietary technology for plasma sterilisation and gasification of waste. An important milestone on the route to commercialisation was reached in May, with a successful live on-farm demonstration of the technology. Management is also making progress securing EU grants to establish a waste-to-energy facility, to improve the productivity of the gasification equipment and to conduct an extensive trial of the sterilisation technology.

Valuation: Trading at a discount to peers

MagneGas is trading at a substantial discount to the EV/sales mean of our sample of suppliers of industrial gases for both 2018 (0.8x vs 3.5x) and 2019 (0.6x vs 3.3x). We see scope for significant share price appreciation once management has resolved the financing gap. Like our estimates, this analysis excludes any equipment sales, fees from sterilisation of organic waste streams, or expansion in Europe.

Financial performance

Q218 performance benefits from acquisitions

Total revenue grew by 201% year-on-year during Q218 to $2.9m. Stripping out the impact of acquisitions, of which the most recent purchase, Trico, generated $1.4m revenues, like-for-like sales were flat as sales resources were focused on the geographies addressed by the acquisitions, which is where management sees better growth potential and higher profit margin opportunities. Investment in sales teams and marketing campaigns based round MagneGas2 as a lead product have driven strong revenue growth for Complete Welding (San Diego) and Green Arc (East Texas and Louisiana). However, while Trico (Sacramento) won numerous customers in the agricultural sector, this was offset by the loss of a major customer through market consolidation. Gross margin declined from 45% to 32% because of GAAP treatment of acquired inventory, which marks the value up to the current retail price. Stripping out this effect, gross margins were broadly stable at 44%, as improved purchasing power was offset by a less favourable product mix. Operating costs increased by $0.8m to $4.3m, mainly as a result of the ongoing operating costs of the acquisitions, although there were one-off costs of $0.1m related to the Trico transaction. Operating losses widened by $0.3m to $3.4m. Q217 benefited from $1.4m positive movement in the fair value of derivative liability, so net loss widened by $1.3m to $3.5m.

Cash flow and balance sheet

Net cash used in operating activities during Q218 totalled $4.0m as management reduced vendor balances, accrued expenses and other short-term liabilities. Cash used in investing activities was only $0.1m as the cost of the Trico acquisition, which completed in early April, was recognised during Q118. Net cash from financing totalled $2.8m, $2.6m of which was from drawing down Series C preferred stock. Net cash (netted against capital leases, notes payable and promissory notes) reduced from $1.2m at the end of March to $0.4m at the end of June. The use of preferred stock was significantly dilutive. During Q218, Series C convertibles converted into 7.7m new shares of common stock. Between 1 July and 8 August, a further 10.8m new shares of common stock were issued as more of the Series C convertibles were drawn down. As part of the drive to strengthen the balance sheet so it can finance further acquisitions through senior debt, at the end of June management completed a $556k convertible preferred offering with its investment banking partners to clear accrued financing expenses. These preferred shares have already been converted, leading to the issue of 2.4m new shares of common stock during July. Further financing will be required during H218. If necessary, this can be satisfied through further draw-down of Series C preferred stock (estimated c $8m remaining), although we have modelled the funding gap satisfied through issue of debt, as per Edison policy.

Estimates

Revenues: we expect a modest improvement in sales in Florida following the expansion into Pasco County and continued growth from the acquisitions, reflecting the new clients that were secured in Q2. Noting that annualised revenues have fallen since May, some of which is seasonal, we revise our FY18 revenue estimate downwards.

Gross margin: we expect gross margins to rise to above historical levels in Q318, since the inventory acquired with the acquisitions has been worked through, plus there is the benefit of greater purchasing power arising from economies of scale. Noting management’s prediction that the installation of a bulk industrial gas fill plant at its Clearwater facilities in Florida, which it expects will be fully operational by the end of 2018, will improve combined gross margin by 3–5pp, we model a further improvement in FY19.

Operating costs: Q218 operating costs were distorted by $90k on consulting relating to the Trico acquisition, $60k on computer and IT integration activities, and higher than normal travel expenses relating to personnel training and other integration-related activities. Going forward, operating costs will exclude these one-off items and will benefit from staffing changes implemented in Q218 that are expected to save more than $50k/month. However, now that there is more detailed information about the incremental operating costs (including depreciation) associated with Trico, we increase our FY18 and FY19 operating cost estimates.

Exhibit 1: Revisions to estimates

FY17

FY18e

FY19e

Actual

New

Old

% change

New

Old

% change

Revenues ($m)

3.7

10.5

11.6

-10.4%

16.8

16.8

0.0%

EBITDA ($m)

(10.3)

(10.4)

(8.1)

21.5%

(5.4)

(5.4)

0.0%

PBT ($m)

(11.0)

(12.5)

(9.5)

24.0%

(8.3)

(7.3)

12.2%

EPS ($)

(15.3)

(0.5)

(0.7)

-38.7%

(0.2)

(0.5)

-110.5%

Source: Edison Investment Research

Progress against strategic objectives

Adding scale to reach break-even

Management’s stated strategy is for MagneGas to become financially self-supporting by building up sales of cutting gases and associated equipment. Part of this will be through investment in sales teams in the recently acquired businesses, using MagneGas2 cutting fuel as a way of attracting new clients and opening new outlets, such as the one in Pasco County, Florida. Part of the sales growth will be through further acquisitions. Management estimates that the group will break even at around $20m annual revenues.

Expansion into Europe

In July, management announced that it had formed a wholly-owned subsidiary based in London, UK. The newly founded company will be used as a vehicle for applying for EU grants without relying on the joint venture (JV) with Infinite Fuels. Management has already identified two European Commission-sponsored grants. One of these could potentially provide funding to develop the fourth generation of the gasification equipment, the other a multi-year agricultural sterilisation project based in north-east Europe. Longer-term, the UK subsidiary will act as a base for marketing, producing and selling MagneGas2 in the UK and mainland Europe. Developing the fourth generation gasification equipment is important because a much larger area is exposed to the plasma arc in the updated design. This will potentially enable the unit to process pulverised solids such as plastic waste and reduce total production costs by at least 90%, helping MagneGas take significant market share in the global cutting-fuel market.

MagneGas has already demonstrated it can compete successfully for EU funding, having won a $7.2m grant with JV partner Infinite Fuels. The final stages of government administration with regard to this grant are currently being completed, potentially unlocking funding for a biowaste-to-energy project in northern Germany and enabling the JV to start paying consulting fees to MagneGas. Management is also making progress in its discussions with port authorities in Amsterdam, Rotterdam, Antwerp and Hamburg, where it has identified concentrated clusters of users of metal-cutting fuel.

Proving the sterilisation technology

In May 2018, MagneGas achieved its first major milestone on the 18-month pilot with one of the largest dairy farms in Florida. It gave a successful live demonstration of the sterilisation technology at the farm to representatives from the US Department of Agriculture (USDA), the Dairy Farmers of America, the International Dairy Journal and other independent dairy operators, as well as local government representatives. Following this demonstration, the USDA invited MagneGas to present its findings at the Soil and Water Conservation Society’s International Annual Conference on Culture, Climate and Conservation. Management has begun to explore complementary technology opportunities, such as water filtration, that potentially extend the appeal of the waste-water sterilisation proposition.

MagneGas continues to make progress on using waste streams from a major medical company located in Florida to fuel the gasification unit. This would potentially reduce the cost of production further, as currently the medical company pays a fee to dispose of the material.

Valuation

Exhibit 2: Peer multiples

Name

Market cap m ($)

EV/sales last (x)

EV/sales 1FY (x)

EV/sales 2FY (x)

CAGR*

(%) 

Air Liquide

52,368

3.0

2.9

2.8

4%

Air Products & Chemicals

36,717

4.6

4.2

3.9

8%

Koatsu Gas Kogyo Co

396

0.4

-

-

-

Linde

40,876

2.5

2.5

2.4

4%

Maxima Air Separation

67

2.0

1

1

-

Praxair

45,379

4.7

4.4

4.2

6%

Sol

1,080

1.6

-

-

-

Toho Acetylene Co

98

0.3

-

-

-

Mean

2.4

3.5

3.3

-

Magnegas Corp

9

2.5

0.8

0.6

113%

Source: Bloomberg, Edison Investment Research. Note: prices at 17 August 2018. *Year 0–Year 2.

Although we expect MagneGas to start generating revenues from the sale of sterilisation equipment or provision of sterilisation services towards the end of FY18, these sources are treated as upside to estimates. Consequently our estimates are based solely on revenues derived from the sale of industrial gases and associated equipment. We have therefore selected a sample of listed companies supplying industrial gases for our valuation. We note that MagneGas is trading at a small premium to the mean with regard to historical EV/sales multiples (2.5x vs 2.4x), and a substantial discount to the mean EV/sales multiple for both 2018 (0.8x vs 3.5x) and 2019 (0.6x vs 3.3x). While some discount for MagneGas’s small market capitalisation and level of losses is justified, its exceptionally strong projected sales growth should counteract this, at least in part. While there is potential for significant share price appreciation as the full benefit of the Trico acquisition becomes clear, this is being held back by the commentary in the most recent SEC filing, noting substantial doubt about the company’s ability to continue as a going concern.

Exhibit 3: Financial summary

Accounts: GAAP, year-end December, US$000s

 

2015

2016

2017

2018e

2019e

Income statement

 

 

 

 

 

 

 

Total revenues

 

 

2,431

3,552

3,719

10,473

16,800

Cost of sales

 

 

(1,474)

(2,018)

(2,217)

(6,389)

(8,400)

Gross profit

 

 

956

1,534

1,503

4,085

8,400

SG&A (expenses)

 

 

(8,697)

(10,479)

(11,664)

(14,451)

(13,284)

R&D costs

 

 

(342)

(679)

(172)

(3)

(504)

Other income/(expense)

 

 

0

0

0

0

0

Exceptionals and adjustments

Exceptionals

 

(484)

(1,856)

50

0

0

Depreciation and amortisation

 

 

(558)

(651)

(673)

(1,419)

(1,680)

Reported EBIT

 

 

(9,125)

(12,130)

(10,956)

(11,788)

(7,068)

Finance income/(expense)

 

 

(29)

(52)

(15)

(738)

(1,244)

Other income/(expense)

 

 

12

50

(2)

0

0

Exceptionals and adjustments

Exceptionals

 

(730)

(5,338)

(52)

0

0

Reported PBT

 

 

(9,871)

(17,470)

(11,024)

(12,527)

(8,312)

Income tax expense (includes exceptionals)

 

 

0

0

(4,974)

(930)

0

Reported net income

 

 

(9,871)

(17,470)

(15,999)

(13,457)

(8,312)

Basic average number of shares, m

 

 

0.3

0.3

0.7

24

38

Basic EPS

 

 

(37.07)

(52.74)

(22.22)

(0.6)

(0.2)

Adjusted EBITDA

 

 

(8,083)

(9,623)

(10,333)

(10,369)

(5,388)

Adjusted EBIT

 

 

(8,641)

(10,274)

(11,006)

(11,788)

(7,068)

Adjusted PBT

 

 

(8,658)

(10,276)

(11,022)

(12,527)

(8,312)

Adjusted EPS

 

 

(32.51)

(31.02)

(15.31)

(0.51)

(0.22)

Adjusted diluted EPS

 

 

(32.51)

(31.02)

(15.31)

(0.51)

(0.22)

Balance sheet

 

 

 

 

 

 

 

Property, plant and equipment

 

 

6,005

6,403

6,865

7,997

8,373

Goodwill

 

 

2,109

2,109

2,109

3,359

3,359

Intangible assets

 

 

493

437

412

2,366

2,321

Other non-current assets

 

 

779

27

352

352

352

Total non-current assets

 

 

9,386

8,975

9,739

14,075

14,405

Cash and equivalents

 

 

5,320

1,616

587

10,470

861

Inventories

 

 

2,362

1,616

739

2,009

3,222

Trade and other receivables

 

 

373

443

390

1,291

2,301

Other current assets

 

 

320

226

198

198

198

Total current assets

 

 

8,375

3,901

1,913

13,968

6,582

Non-current loans and borrowings

 

 

552

620

584

16,556*

16,529*

Other non-current liabilities

 

 

0

0

0

0

0

Total non-current liabilities

 

 

552

620

584

16,556

16,529

Trade and other payables

 

 

425

416

1,717

1,578

2,532

Current loans and borrowings

 

 

8

9

579

27

27

Other current liabilities

 

 

2,159

8,002

954

772

772

Total current liabilities

 

 

2,592

8,428

3,250

2,377

3,331

Equity attributable to company

 

 

14,616

3,829

7,819

7,576

(736)

Non-controlling interest

 

 

0

0

0

0

0

Cash flow statement

 

 

 

 

 

 

 

Profit before tax

 

 

(9,871)

(17,470)

(11,024)

(12,527)

(8,312)

Net finance expenses

 

 

0

0

0

738

1,244

EBIT

 

 

0

0

0

0

0

Depreciation and amortisation

 

 

558

651

673

1,419

1,680

Share based payments

 

 

509

347

425

330

330

Other adjustments

 

 

2,420

8,515

3,024

1,021

0

Movements in working capital

 

 

852

(682)

2,114

(310)

(1,270)

Interest paid / received

 

 

0

0

0

(738)

(1,244)

Income taxes paid

 

 

0

0

0

0

0

Cash from operations (CFO)

 

 

(5,533)

(8,640)

(4,788)

(10,066)

(7,572)

Capex

 

 

(757)

(1,425)

(129)

(2,710)

(2,010)

Acquisitions & disposals net

 

 

0

0

(325)

(5,045)

0

Other investing activities

 

 

(88)

(55)

(0)

0

0

Cash used in investing activities (CFIA)

 

 

(845)

(1,480)

(454)

(7,755)

(2,010)

Net proceeds from issue of shares

 

 

6,596

6,422

5,008

12,284

0

Movements in debt

 

 

0

0

0

15,448

0

Other financing activities

 

 

40

(5)

(795)

(27)

(27)

Cash from financing activities (CFF)

 

 

6,636

6,416

4,213

27,705

(27)

Currency translation differences and other

 

 

0

0

0

0

0

Increase/(decrease) in cash and equivalents

 

 

258

(3,703)

(1,030)

9,883

(9,610)

Currency translation differences and other

 

 

0

0

0

0

0

Cash and equivalents at end of period

 

 

5,320

1,616

587

10,470

861

Net (debt) cash

 

 

4,760

987

(576)

(6,114)

(15,696)

Movement in net (debt) cash over period

 

 

N/A

(3,773)

(1,563)

(5,537)

(9,582)

Source: Edison Investment Research. Note: *Edison’s policy is to model any funding deficit through debt, although MagneGas is likely to draw down some or all of the remaining Series C preferred stock to address the funding gap. This will be dilutive.

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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