Summary
- Company surprisingly closes on the controversial acquisition of Arq Limited after eliminating the requirement to obtain shareholder approval.
- Discussing revised deal terms, legacy ADES shareholders will no longer be provided the option to receive a $0.52 one-time cash dividend in conjunction with the transaction.
- Projected capex requirements for the combined company have been increased materially, thus adding even more risk to the story.
- Given elevated execution risks, investors should avoid the common shares or even consider selling existing positions.
Almost six months ago, I discussed Advanced Emissions Solutions' ( ADES ) controversial decision to merge with Arq Limited or "Arq" after a lengthy review of strategic alternatives - an emerging environmental technology company that converts coal mining waste into a micro-fine carbon powder ("Arq Powder") for use in environmentally sustainable products:
While Arq has constructed a $80 million processing plant in Kentucky with the ability to process over 100,000 tons of mining waste per year and received investments from Peabody Energy ( BTU ), Vitol and Mitsubishi ( MSBHF ), the company has not generated any revenue to date.
In fact, the combined business will require substantial, additional capex over the next couple of years to " enable growth ".
Company Presentation
As a result of the merger, Adjusted EBITDA is expected to be negative in both 2022 and 2023, before turning positive again in 2024.
By 2026, the company expects the combined business to generate almost $200 million in annual revenues at EBITDA margins north of 30%.
But due to material, near-term capex requirements and expectations for the company to lose money in both 2022 and 2023, ADES will have to deploy the majority of its cash hoard over the next couple of years.
As evidenced by the 40% selloff in the company's shares immediately following the announcement, the proposed transaction caught market participants flat-footed. In fact, many investors expected the company to be sold at a premium to prevailing share prices.
But instead of pocketing some decent near-term capital gains, legacy ADES shareholders have now become owners of an emerging technology company with elevated capex requirements and substantial execution risks.
Under the originally proposed terms, the transaction would have required approval by ADES' common shareholders so investors could still hope for the deal being voted down in the anticipated special meeting.
But after the close of Wednesday's regular session, ADES surprisingly announced the completion of the deal at revised terms:
Key changes to the original proposal include:
- ADES retaining control of the combined company thus eliminating the requirement to obtain shareholder approval.
- Legacy ARQ shareholders receiving a combination of common stock and 8% Series A Convertible Preferred Shares which will become convertible into common shares upon shareholder approval.
- PIPE proceeds coming in $5 million lower than expected.
- Legacy ADES shareholders will no longer be provided the option to receive a $0.52 one-time cash dividend in conjunction with the transaction.
In addition, the company has revised some of its original projections for the combined company:
- Capex requirements have been raised significantly from $75 million to $95 million.
- 2024 revenue guidance has been increased from $122 million to $130 million.
- EBITDA expectations for 2024 have been decreased from $17 million to $15 million.
With growth capex requirements much higher than originally projected, shareholder approval of the transaction would have been even more unlikely than already before.
Lastly, the company disclosed the ugly conditions of its new $10 million loan facility:
- The loan has a term of 48 months and bears interest at a rate equal to either (a) Adjusted Term SOFR (subject to a 1.00% floor and a 2.00% cap) plus a margin of 9.00% paid in cash and 5.00% paid in kind or (b) Base Rate (subject to a 2.00% floor and a 3.00% cap) plus a margin of 8.00% paid in cash and 5.00% paid in kind.
- The company will be subject to a $5 million minimum liquidity covenant and required to achieve certain minimum annual revenue and EBITDA levels.
- The lender managed to extract 325,457 immediately exercisable penny warrants.
Bottom Line
At least in my opinion, ADES' move to bypass shareholder approval of the controversial transaction is another slap in the face of the company's badly stricken common equity holders even when considering legacy ADES shareholders retaining a somewhat larger than previously expected stake in the combined company.
Even worse, substantially higher than originally projected capex requirements add even more risk to the story and might very well result in further dilution for common shareholders down the road.
Given elevated execution risks, investors should avoid the common shares or even consider selling existing positions.
For further details see:
Advanced Emissions Solutions Closes On Controversial Acquisition After Skipping Shareholder Vote - Sell