2023-07-05 22:03:27 ET
Summary
- Innovate Corp. has announced new projects in the infrastructure and construction segment and plans to launch Glacial AI, a robotic cooling device.
- The company has recently sold assets and repurchased preferred stock, potentially improving its balance sheet.
- Despite risks from high debt, inflation, and failed M&A strategies, VATE stock appears undervalued.
INNOVATE Corp. ( VATE ) recently announced new sizable projects and opportunities in the infrastructure and construction segment, and may soon launch Glacial AI, an autonomous, robotic cooling device. It is also worth noting that management recently sold assets, and repurchased preferred stock, which may enhance the balance sheet in the near future. There are clear risks from the total amount of debt, failed M&A strategies, and inflation. With that, I believe that the stock appears undervalued.
Innovate Corp.
Innovate is a diversified portfolio company that focuses on the operations in the infrastructure and construction, life sciences, and television broadcasting sectors in the United States.
In terms of adjusted EBITDA, the most relevant business segment is the infrastructure segment with a quarterly adjusted EBITDA of $16 million. The other business segments reported either negative EBITDA or less than $4.91 million.
Source: 10-Q Source: Presentation To Investors
In the case of infrastructure and construction, DBM Global Inc. is in charge of providing infrastructure solutions and steel construction services. For the area of ??life sciences, with development of biotechnology products, Innovate operates through the subsidiary Pansend Life Sciences. Lastly, HC2 Broadcasting Holdings is the subsidiary for the strategic air transmission operation within the United States and Puerto Rico.
The infrastructure and construction segment includes five areas of activities that cover the different manufacturing, distribution, and service provision processes with regards to steel construction. In 2022, close to 50% of the revenue came from steel fabrication through the Schuff Steel Company. Banker Steel, another company in the same segment and dedicated to the same manufacturing activities, accounted for 30% of annual revenue. The remaining percentage is completed with activities derived from manufacturing, such as application services or special constructions for the oil and gas industry. This segment concentrates its operations in a few states of the country, and has an international reach with activities in Australia, Canada, India, New Zealand, and Southeast Asia.
The company also runs another segment for the treatment of bone arthritis of the knee and aesthetic products and medical technology for the skin. Management reported 80% of the interests in Genovel Orthopedics, where developments for the treatment of arthritis take place. The company also has a 56% interest in R2 Technologies, a company that develops cosmetic and dermatological products. This subsidiary also generates investments in medical development companies in another sense such as MediBeacon and Triple Ring Technologies.
HC2 Broadcasting, for its part, is the TV broadcasting segment that encompasses 251 stations, and has 1,500 subchannels, reaching 106 markets in the United States and Puerto Rico, including 32 of the most important markets.
I believe that having a look at Innovate makes a lot of sense considering the number of events that may take place soon. One of the subsidiaries expects to make a final submission with the FDA, and there is new programming at HC2 Broadcasting. Besides, I saw several transactions to reshape the balance sheet that include a divestiture and the purchase of preferred shares.
Source: Presentation To Investors
Solid Balance Sheet, But Investors Must Monitor The Total Amount Of Debt
As of March 31, 2023, the company reported cash and cash equivalents worth $16.6 million, accounts receivable of about $253.7 million, contract assets close to $180.2 million, inventory of $21.3 million, and total current assets of about $486.5 million. The ratio of current assets/current liabilities is larger than one, so I do not see liquidity risks.
Long term liabilities include investments worth $7.7 million, deferred tax assets of $1.7 million, and property, plant, and equipment worth $164 million. With goodwill close to $127 million and intangibles of about $186.1 million, total assets stood at $1.044 billion. I do not like the fact that the asset/liability ratio stands at less than 1x. With that, if the income statement continues to report stable net sales, I would not be worried about the current balance sheet situation.
Source: 10-Q
As of March 31, 2023, the company reported accounts payable of about $167 million, accrued liabilities worth $45 million, and current portion of debt obligations of about $32.9 million. Also, with total current liabilities of about $374.5 million and debt obligations close to $664.3 million, total liabilities stood at $1.150 billion.
Source: 10-Q
I believe that the total amount of debt appears quite significant. I would understand investors who do not appreciate Innovate because of its net leverage/EBITDA ratio.
Source: Presentation To Investors
Besides, I believe that the company could receive significant attention from investors if the debt level lowers. Clearly, in the last 20 years, Innovate lowered its debt/EBITDA levels.
Source: YCharts
DCF Model
The operating strategy for each segment changes and is conditioned by the nature and demands of each of the markets in which they participate. In general terms, I expect that Innovate Corp. will successfully grow its businesses in the long term as well as generate sustainable FCFs. I also assumed that we may see expansion of its position in the businesses. In this regard, it is worth mentioning that management intends to acquire new businesses in the coming years.
We are a diversified holding company that owns interests in a number of different businesses. We have in the past, and intend in the future, to acquire businesses or make investments, directly or indirectly through our subsidiaries. Source: 10-k
For the infrastructure and construction segment, I expect further development of long-term projects with great potential for added value, expansion, and diversification of the revenue base, which at this time is a bit concentrated in steelmaking. In addition, I think that diversifying the consumer base in the same way and achieving technological innovations in terms of the production chain and the prediction of the projects for their effectiveness and success could bring significant FCF generation.
Besides, I would be expecting new sizable projects and opportunities in the infrastructure and construction segment mainly because it was announced in the last quarterly report. In addition, if Innovate successfully launches new future projects for higher margin as promised, we may see FCF margin growth.
Source: Presentation To Investors
The objective of the medical sciences segment is the development of certain products. I would be expecting an acceleration in the FCF growth as more and more customers learn about Glacial AI, Glacial Spa, which were recently launched.
Launched in the first half of 2022 in China after receiving China Non-Medical Classification, the Glacial Spa is a cooling experience used to even skin tone, and brighten and lighten skin. The Glacial Spa system will be sold by Huadong’s existing sales force to spas and is intended to be operated by a trained aesthetician. Source: 10-k
Currently undergoing research and development, the Glacial AI is an autonomous, robotic cooling device focused on whole-body skin lightening and brightening. Source: 10-k
Moreover, I would be expecting some stock demand around the second and the third quarter of 2023 as MediBeacon is making a final submission with the FDA. If the company makes sufficient marketing efforts about the conversations with the FDA, I believe that more investors would be interested in Innovate Corp.
Source: Presentation To Investors
In addition, I assumed that Innovate would successfully meet the new demands and trends in content and forms of consumption. One step to meet this objective is to continue adding stations on the cloud infrastructure, achieving savings and operational efficiency. The strategy includes attracting high-quality content providers and offering them the transmission infrastructure nationwide.
The company executed several dispositions in the last quarter, which indicate that cash in hand may increase as soon as the deals close. I believe that more investors would be interested in the company if the divestitures increase. If they expect more cash in hand, I believe that the valuation of the company could increase. In addition, the net debt/EBITDA may decrease, which may also lead to more interest from market participants.
On March 6, 2023, the Company, through New Saxon 2019 Limited (“New Saxon”), an indirect subsidiary of GMH, closed on the sale of its remaining 19% interest in HMN to subsidiaries and an affiliate of Hengtong Optic-Electric Co Ltd. The sale was consummated pursuant to the terms of a supplemental agreement entered into by the parties in June 2022. New Saxon received gross proceeds of $54.2 million, and interest income of $0.5 million, of which $4.4 million was withheld for a foreign tax payment. Source: 10-Q
I tried to be as conservative as possible with Innovate. From 2023 to 2033, I included negative net sales growth and a small net income margin. Net sales would lower from close to $2 billion in 2023 to less than $1 billion in 2033. I included 2033 net income of close to $39 million.
Source: My DCF Model
My financial model includes 2033 net sales close to $779 million, net income worth $38 million, share-based compensation expenses close to $2 million, 2033 depreciation and amortization of about $92 million, and amortization of deferred financing costs of -$75 million.
Also, with asset impairment expenses worth -$6 million, deferred income taxes close to -$9 million, changes in accounts receivable close to $355 million, and changes in inventories of $8 million, I included changes in accounts payable of -$377 million and accrued liabilities of $-246 million. Finally, I obtained CFO worth $65 million, and with 2033 capex of $16 million, 2033 FCF would be $82 million.
Note that I assumed a WACC of 8.5%, which is close to the interest paid for the 2026 Senior Secured Notes and the 2026 Convertible Notes. Other investors may use other costs of capital, however I would not expect them to be far from my figures.
On February 1, 2021, our Non-Operating Corporate segment repaid the 2021 Senior Secured Notes and issued $330.0 million aggregate principal amount of 8.50% senior secured notes due February 1, 2026 (the "2026 Senior Secured Notes"). The 2026 Senior Secured Notes mature on February 1, 2026, and accrue interest at a rate of 8.50% per year, which interest is paid semi-annually on February 1 and August 1 of each year. Source: 10-k
As of December 31, 2022, we had $51.8 million 2026 Convertible Notes outstanding. The 2026 Convertible Notes were issued under a separate indenture dated February 1, 2021, between the Company and U.S. Bank, as trustee (the "Convertible Indenture"). The 2026 Convertible Notes mature on August 1, 2026 unless earlier converted, redeemed or purchased. The 2026 Convertible Notes accrue interest at a rate of 7.5% per year, which interest is paid semi-annually on February 1 and August 1 of each year. Source: 10-k
If we assume 2033 terminal EV/FCF of 19x and a WACC of 8.5%, the implied enterprise value would be $961 million. If we add cash and cash equivalents worth $16 million, and subtract the current portion of debt obligations of about $32 million and debt obligations worth $664 million, the equity valuation would be $280 million. Finally, the implied price would be $3.58 per share.
Besides, considering that the 3 years median EV/EBITDA multiple stands at close to 15.6x, I believe that my EV/FCF does not look far from reality.
Source: YCharts
Competitors
In general terms, Innovate competes with a series of public and private companies that in many cases have historical recognition, contact, and access to superior resources. In particular, each segment of operations competes in different markets, and the scope or positioning of the company in this regard is variable.
The steel and infrastructure segment faces great competition, and the company's projection is that this will grow in the coming years. The market is fragmented in the United States and also internationally, so there are no large monopolies capturing large positions in it. The competition is driven mainly by the effectiveness in the completion of the projects, the times of distribution and fulfillment, and the price.
The market in the medical area is also highly competitive, and is subject to great changes in relation to technological innovations and transformations in this regard. In addition, due to regulatory conditions and regional laws, some products may participate internationally without being approved in the United States. In the specific niche of pain treatment and technological innovations for aesthetic treatments, the company has a better position at the national level than in international markets.
Risks
The company carries a history of recent losses in recent years and has considerable financial debt as well as large operating costs that require large amounts of capital to continue. A large part of the company's future success depends on its acquisition strategy, where it encounters great competition from other investing companies, and also coexists with the risk of not having the capacity to integrate its business model into the company's current infrastructure. To these factors I would add the risks of exposure to international operations, the inflationary situation in the United States, and the crisis variables in the global economy.
In each subsidiary, there are risks inherent to the businesses in which they are involved. To name a few in each case, the infrastructure subsidiary is conditioned by the renewal of contracts and the successful projections. Also, the dependence on suppliers, the risks in labor safety, and the variations in transport conditions affect the activities of this segment.
The medical sciences subsidiary has not yet found a way to generate income on its operating costs. It faces high competition, and depends on a large series of regulations to be able to introduce its products in the market. Another factor to consider is the company's lack of experience and the possibility that its products will not be adopted by professionals in the field. In this case, the great bet of this segment is on the patent strategy and brand research on its aesthetic production line, which could generate a qualitative and quantitative leap in the success of its operations.
Conclusion
Innovate Corp. recently announced new sizable projects and opportunities in the infrastructure and construction segment. Besides, shareholders would most likely benefit from new traction in the revenue line thanks to new products Glacial Spa and Glacial AI, an autonomous, robotic cooling device. Additionally, the company recently sold assets, and repurchased preferred stock. In my view, further transactions to reshape the balance sheet may interest investors. I do see risks from the total amount of debt, inflation, failed introduction of products, or failed M&A strategies, however the stock could trade at higher price marks.
For further details see:
Innovate: Infrastructure Growth And Glacial AI Could Imply Undervaluation