Extending retail platform in Greater Texas

MagneGas Applied Technology Solutions 28 November 2018 Update
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MagneGas Applied Technology Solutions

Extending retail platform in Greater Texas

Q318 results

Alternative energy

 

28 November 2018

Price

US$0.28

Market cap

US$39m

Net cash ($m) at end September 2018

0.9

Shares in issue

137.7m

Free float

99.8

Code

MNGA

Primary exchange

NASDAQ

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

3.9

24.0

(95.2)

Rel (local)

8.2

34.6

(95.3)

52-week high/low

US$6.8

US$0.1

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 events

FY18 results

Tbc

Analyst

Anne Margaret Crow

+44 (0)20 3077 5700

MagneGas Applied Technology Solutions is a research client of Edison Investment Research Limited

MagneGas’s Q318 results show the beneficial impact of the three acquisitions made earlier this year, with revenues trebling to $2.6m. Management continues to pursue this ‘buy-and-build’ strategy, recently completing three small acquisitions that strengthen its retail network in the key Greater Texas region. As management held back on sales recruitment in anticipation of these transactions, organic growth was muted over the summer so we leave our estimates broadly unchanged.

Year end

Revenue (US$m)

EBITDA* (US$m)

PBT* (US$m)

EPS* (US$)

DPS (US$)

EV/Sales (x)

12/16

3.6

(9.6)

(10.3)

(31.0)**

0.0

10.6

12/17

3.7

(10.3)

(11.0)

(15.3)

0.0

10.3

12/18e

10.3

(11.4)

(13.6)

(0.2)

0.0

3.7

12/19e

16.8

(5.6)

(7.7)

(0.1)

0.0

2.3

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

H118 acquisitions drive strong revenue growth

Total Q318 revenues trebled year-on-year to $2.6m as a result of the three acquisitions made in H118. Revenues were slightly lower than the preceding quarter, reflecting seasonal effects. Operating costs increased by $1.9m year-on-year to $4.5m as a result of the ongoing operating costs of these acquisitions. Operating losses widened by $1.3m year-on-year to $3.5m (Q218: $3.4m). Net cash rose from $0.4m at the end of June to $0.9m at end September 2018, as the company realised $3.4m by drawing down Series C preferred stock, which resulted in the issue of 27.4m new shares of common stock. Since the period end, MagneGas has converted further Series C stock into 31.9m new ordinary shares, issued 20.3m new shares under an agreement in August to raise up to $3.75m (gross), and issued 21.8m new shares in October in a private placing raising $4.6m (net).

Continued expansion of retail platform

The three small acquisitions made in recent weeks have an aggregate of $2.75m annualised sales. As they will be integrated with existing operations they will not add materially to cost. The total consideration was $3.5m, payable in cash. Collectively, they take the group closer to achieving its goal of creating a profitable platform for selling metal-cutting gases and associated products. The cash generated from gas sales will be used to help commercialise its proprietary technology for plasma sterilisation, waste-to-energy and precious metal recovery.

Valuation: Funding gap needs to be resolved

MagneGas is trading at a small premium to the EV/sales mean of our sample of suppliers of industrial gases for 2018 (3.7x vs 3.4x) and a small discount for 2019 (2.3 x vs 3.1x). We see scope for share price appreciation as the growth from the recent acquisitions comes through and once management has resolved the financing gap. Like our estimates, this valuation analysis excludes any equipment sales, fees from sterilisation of organic waste streams, or expansion in Europe.

Progress against strategic objectives
Adding scale in US to become financially self-sufficient

Management’s stated strategy is for MagneGas to become financially self-supporting by building up sales of metal cutting gases and associated equipment. Part of this is investment in sales teams in recently acquired businesses, using MagneGas2 cutting fuel as a way of attracting new clients. The group continues to make acquisitions, most recently of three unrelated smaller businesses in the Texas and Louisiana region for a total consideration of $3.5m, payable in cash. Collectively these add c $2.75m annualised sales, bringing the total to c $1.1m/month. Together with Green Arc Supply, which was acquired in February 2018 and has two locations in Texas and one in Louisiana, this creates a business with an estimated $4m annual sales in the Greater Texas area. This gives access to one of the largest markets for industrial gases in the US, which management aims to grow to $10-15m over the next two to three years, and to $25m in the medium term.

Unlocking potential of European markets

In October, MagneGas announced that it had finally closed the $7.0m grant with partner Infinite Fuels. This unlocks funding for Infinite Fuels’ bio-waste to energy project in northern Germany and enables the partner to start paying consulting fees of around $25/month to MagneGas. Securing this grant is encouraging, as MagneGas is working on two other European Commission-sponsored grants independently of Infinite Fuels. The first, a €2.5m grant under the Horizon 2020 programme, was submitted earlier this month and could potentially provide funding to develop the fourth generation of the gasification equipment. The second, which is likely to be submitted in early 2019, is for a multi-year agricultural sterilisation project based at a very large dairy farm in the Netherlands. 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 metal cutting fuel market. The company intends to fund these projects from its own resources if the grant applications are not successful.

Proving the technology

In October, MagneGas achieved its second major milestone on the 18-month pilot with one of the largest dairy farms in Florida. It gave another successful live demonstration of the sterilisation technology at the farm, this time processing solid rather than liquid waste. This second phase has also extended the type of pathogens and living organisms that are killed by the process, including for example the organisms that cause algal blooms, and demonstrated the efficacy of the process for breaking down pharmaceutical wastes and the nutrients on which algal blooms feed. During the Q318 results call management noted that the project with a major medical manufacturing company in Florida to convert contaminated ethanol into fuel was progressing well and referred to preliminary work using the process in the recovery of precious metals.

Management

Earlier this month Scott Mahoney moved from chief financial officer to chief executive officer, while Ermanno Santilli stepped down from the chief executive role to become chief technology officer, focusing on commercialising the sterilisation and waste-to-energy technologies. Mr Santilli remains on the MagneGas board. At the same time, the company purchased all of the Series A preferred shares held by the Santilli family, which had given them complete voting control. The consideration payable was $1m cash and 5.0m new ordinary shares. The Series A shares have since been cancelled, returning voting control to its common stock shareholders.

Financials
Q318 revenues benefit from acquisitions

Total revenue trebled year-on-year during Q318 to $2.6m. Sales in the Florida operation declined by 6% year-on-year (ie by $50k), while quarterly sales on a pro forma basis, assuming that the three acquisitions made in H118 were part of the group declined by 2% year-on-year ($44k). The year-on-year growth is therefore entirely due to the acquisitions, especially Trico, which generated $1.3m revenues during Q318. Like-for-like sales in the acquired businesses were flat, while sales in Florida declined slightly as management attention was focused elsewhere. Q318 sales were $0.3m lower than the preceding quarter. A comparison with the pro forma number for Q317 indicates that this reduction is a seasonal effect. The summer months are typically quieter as neither agricultural customers nor major customers engaged in electricity generation schedule repair projects during the period. Moreover, management chose not to invest in additional sales people in the Texas area since it was confident of building up sales capacity in the region via acquisition. It is encouraging to note that after three consecutive months when sales totalled $0.9m, in October sales rose to $1.05m. As the two acquisitions completed at the end of the month, the month-on-month rise is primarily attributable to organic effects.

Gross margin was similar to the prior year period (38% in Q318 vs 37% in Q317). However, the Q318 value was distorted by GAAP treatment of acquired inventory, which marks the value up to the current retail price. Stripping out this effect, Q318 gross margin was 46%, showing the benefit of improved purchasing power as the group achieves economies of scale and selective price rises to reflect changing tariffs. Operating costs increased by $1.9m year-on-year to $4.5m (Q218: $4.3m) as a result of the ongoing operating costs of the acquisitions made earlier in the year. At least $0.2m of this increase was related to one-off costs of making and integrating acquisitions. Operating losses widened by $1.3m year-on-year to $3.5m (Q218: $3.4m). Q317 was affected by $0.8m amortisation of debt discount (Q318: $0.1m) and $1.0m deemed dividend (Q318: $0.4m), so net loss attributable to shareholders was broadly unchanged year-on-year at $4.0m.

Cash flow and balance sheet

Net cash used in operating activities during Q318 totalled $2.4m. The working capital movement was neutral, with a reduction in inventory broadly balancing a reduction in accounts payable. Cash used in investing activities was $0.8m compared with only $0.1m in H118, primarily for additional gas cylinders in northern California and Florida and the gas fill plant in Florida. Net cash from financing totalled $3.8m, $3.4m of which was from drawing down Series C preferred stock. Net cash (netted against capital leases, notes payable and promissory notes) rose from $0.4m at the end of June to $0.9m at end September 2018. Management estimates that the current cash-burn rate is less than $500k/month and will drop to below $400k/month once the recent acquisitions have been fully integrated.

The use of preferred stock was significantly dilutive. During Q318, Series C shares converted into 27.4m new shares of common stock. Between 1 October and 9 November, 3,120 of the 4,795 Series C preferred warrants remaining at the end of September were converted into 31.9m new ordinary shares, so most of the potential dilution from this source has already taken place. At the end of August, the company agreed to sell up to 25.0m shares of common stock at $0.15/share and an equal number of warrants at an exercise price of $0.30/share, raising up to $3.75m (gross). Between 1 October and 9 November, MagneGas issued 20.3m new share and 20.3m warrants under this agreement, so most of the potential dilution from this source has already occurred as well. As part of the drive to strengthen the balance sheet so it can finance further acquisitions through senior debt, in October management raised $4.6m (net) through a private placing of 21.8m new shares at $0.23/share and warrants with an exercise price of $0.3654 per warrant to purchase up to 21.8m new shares. Further financing will be required during FY19. If necessary, some of this can be satisfied by drawing down the remaining Series C preferred stock (estimated c $2-3m remaining). We model the funding gap as satisfied through issue of debt, as per Edison policy.

Changes to estimates

Revenues: While the recent acquisitions in Texas and Louisiana are expected to add annualised incremental revenues of $2.75m, this is offset by slower than expected organic growth because management did not build up the sales teams at the existing operations in Texas and Louisiana in anticipation of being able to grow the number of sales personnel through acquisition. We therefore leave our revenue estimates broadly unchanged, modelling a 7% increase in FY19 average monthly sales compared with the October 2018 run rate of $0.5m.

Gross margin: We assume that Q418 gross margin will be affected by GAAP treatment of acquired inventory and model it at 40%. We assume that the acquired inventory will have been worked through by the end of March 2019 such that better pricing and deployment of equipment for decanting bulk gas into cylinders in Florida will enable the group to realise a 50% gross margin from that point onwards.

Operating costs: Since the three small businesses will be integrated with the group’s existing operations in Texas and Louis, and the additional sales personnel working for the three new acquisitions represent similar incremental costs to the sales people that were not recruited for the existing operations, we model Q418 costs at Q318 levels. We model FY19 costs at Q318 levels, stripping out $150k/quarter for one-off acquisition related costs, together with a $2.5m positive adjustment to reflect the impact of rationalisation cost-savings that were expected earlier in FY18 and are likely to be realised now that Scott Mahoney has become CEO. This gives an average monthly cash outflow during FY19 of $0.5m, in line with management’s estimate of the current run-rate.

Interest: We had previously treated the Series C convertibles as interest-bearing debt. Since most of these have now converted to shares, the level of interest modelled as payable in FY19 is significantly less than in our previous set of estimates.

Exhibit 1: Revisions to estimates

FY17

FY18

FY19

Actual

New

Old

% change

New

Old

% change

Revenues ($m)

3.7

10.3

10.5

-1.2%

16.8

16.8

0.0%

EBITDA ($m)

(10.3)

(11.4)

(10.4)

8.7%

(5.6)

(5.4)

4.2%

PBT ($m)

(11.0)

(13.6)

(12.5)

7.7%

(7.7)

(8.3)

-7.4%

EPS ($)

(15.3)

(0.2)

(0.5)

-141.7%

(0.1)

(0.2)

-292.2%

Source: Company data, Edison Investment Research

Valuation

Although there is potential for MagneGas to start generating revenues from the sale of sterilisation equipment or provision of sterilisation services during FY19, these sources are treated as upside to our 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 substantial premium to the mean with regard to historical EV/sales multiples (10.8x vs 2.0x), which is the period before the rapid growth from acquisitions, at a small premium to the mean EV/sales multiple for 2018 (3.7x vs 3.4x), which does not show the full year benefit for the acquisitions, and at a small discount to the mean multiple for 2019 (2.3x vs 3.1x), which is when the full benefit of the acquisitions becomes apparent. 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 recent acquisitions becomes clear, this is being held back by the dilutive effect of the Series C shares and the commentary in the most recent SEC filing, which states substantial doubt about the company’s ability to continue as a going concern given the need to raise additional finance.

Exhibit 2: Peer multiples

Company name

Market cap ($m)

Historic EV/Sales (x)

Year 1 EV/Sales (x)

Year 2 EV/Sales (x)

CAGR *(%)

Air Liquide

45,678

3.0

2.9

2.8

3.7

Air Products and Chemicals

35,062

4.4

3.8

3.5

11.8

Koatsu Gas Kogyo Co

48,853

0.4

-

-

-

Praxair

47,306

9.0

-

-

-

Maxima Air Separation Center

270

2.2

-

-

-

Sol

964

1.7

-

-

-

Toho Acetylene Co

10,331

0.3

-

-

-

Mean

2.0

3.4

3.1

MagneGas

39

10.8

3.9

2.4

112.5

Source: I/B/E/S estimates Edison Investment Research. Note: Prices at 12 November 2018. *Year 0 to Year 2.

Exhibit 3: Financial summary

Accounts: GAAP, Yr end: December, USD: Thousands

51774765

 

2016A

2017A

2018E

2019E

Income statement

 

 

 

 

 

 

Total revenues

 

 

3,552

3,719

10,346

16,800

Cost of sales

 

 

(2,018)

(2,217)

(6,635)

(8,631)

Gross profit

 

 

1,534

1,503

3,712

8,169

SG&A (expenses)

 

 

(10,479)

(11,664)

(15,053)

(13,432)

R&D costs

 

 

(679)

(172)

(12)

(360)

Other income/(expense)

 

 

0

0

0

0

Exceptionals and adjustments

Exceptionals

 

(1,856)

50

0

0

Depreciation and amortisation

 

 

(651)

(673)

(1,317)

(1,680)

Reported EBIT

 

 

(12,130)

(10,956)

(12,670)

(7,303)

Finance income/(expense)

 

 

(52)

(15)

(895)

(439)

Other income/(expense)

 

 

50

(2)

0

0

Exceptionals and adjustments

Exceptionals

 

(5,338)

(52)

0

0

Reported PBT

 

 

(17,470)

(11,024)

(13,565)

(7,742)

Income tax expense (includes exceptionals)

 

 

0

(4,974)

0

0

Reported net income

 

 

(17,470)

(15,999)

(13,565)

(7,742)

Basic average number of shares, m

 

 

0.3

0.7

64

138

Basic EPS

 

 

(52.74)

(22.22)

(0.2)

(0.1)

 

 

 

 

 

 

 

Adjusted EBITDA

 

 

(9,623)

(10,333)

(11,353)

(5,623)

Adjusted EBIT

 

 

(10,274)

(11,006)

(12,670)

(7,303)

Adjusted PBT

 

 

(10,276)

(11,022)

(13,565)

(7,742)

Adjusted EPS

 

 

(31.02)

(15.31)

(0.21)

(0.06)

Adjusted diluted EPS

 

 

(31.02)

(15.31)

(0.21)

(0.06)

 

 

 

 

 

 

 

Balance sheet

 

 

 

 

 

 

Property, plant and equipment

 

 

6,403

6,865

9,961

10,337

Goodwill

 

 

2,109

2,109

3,359

3,359

Intangible assets

 

 

437

412

2,366

2,321

Other non-current assets

 

 

27

352

352

352

Total non-current assets

 

 

8,975

9,739

16,038

16,368

Cash and equivalents

 

 

1,616

587

2,003

5,039

Inventories

 

 

1,616

739

1,984

2,301

Trade and other receivables

 

 

443

390

1,984

1,841

Other current assets

 

 

226

198

198

198

Total current assets

 

 

3,901

1,913

6,169

9,380

Non-current loans and borrowings

 

 

620

584

556

11,529

Other non-current liabilities

 

 

0

0

0

0

Total non-current liabilities

 

 

620

584

556

11,529

Trade and other payables

 

 

416

1,717

2,551

2,531

Current loans and borrowings

 

 

9

579

27

27

Other current liabilities

 

 

8,002

954

772

772

Total current liabilities

 

 

8,428

3,250

3,350

3,331

Equity attributable to company

 

 

3,829

7,819

16,764

9,022

Non-controlling interest

 

 

0

0

0

0

 

 

 

 

 

 

 

Cashflow statement

 

 

 

 

 

 

Profit before tax

 

 

(17,470)

(11,024)

(13,565)

(7,742)

Net finance expenses

 

 

0

0

895

439

Depreciation and amortisation

 

 

651

673

1,317

1,680

Share based payments

 

 

347

425

330

330

Other adjustments

 

 

8,515

3,024

1,955

0

Movements in working capital

 

 

(682)

2,114

(5)

(194)

Interest paid / received

 

 

0

0

(895)

(439)

Income taxes paid

 

 

0

0

0

0

Cash from operations (CFO)

 

 

(8,640)

(4,788)

(9,969)

(5,926)

Capex

 

 

(1,425)

(129)

(1,510)

(2,010)

Acquisitions & disposals net

 

 

0

(325)

(8,107)

0

Other investing activities

 

 

(55)

(0)

0

0

Cash used in investing activities (CFIA)

 

 

(1,480)

(454)

(9,617)

(2,010)

Net proceeds from issue of shares

 

 

6,422

5,008

21,581

0

Movements in debt

 

 

0

0

(552)

11,000

Other financing activities

 

 

(5)

(795)

(27)

(27)

Cash from financing activities (CFF)

 

 

6,416

4,213

21,002

10,973

Increase/(decrease) in cash and equivalents

 

 

(3,703)

(1,030)

1,416

3,037

Cash and equivalents at end of period

 

 

1,616

587

2,003

5,039

Net (debt) cash

 

 

987

(576)

1,419

(6,517)

Movement in net (debt) cash over period

 

 

(3,773)

(1,563)

1,995

(7,936)

Source: Edison Investment Research

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NSW 2000, Australia

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

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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