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SHFK - Schuff International


mbrock77
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I wanted to start a thread here on Schuff International. OTC Adventures and Oddball Stocks have already done excellent jobs summarizing the case for investment (in chronological order):

 

http://otcadventures.com/?p=39

 

http://www.oddballstocks.com/2012/10/schuff-potential-10-bagger-or-bankrupt.html

 

http://otcadventures.com/?p=627

 

Schuff released their 2013 annual report on Friday (http://www.schuff.com/index.php/download_file/view/391/198/) and the numbers look, to my untrained eye, to be very strong. Although revenues dropped a bit, margins improved across the board and net income more than tripled to $12m ($3/share); long term debt, which was a concern, is now $9m, down from $29m in 2011; book value increased to $25/share; and the backlog more than doubled to $426m, which I believe is an all time high.

 

With a market cap and EV around 100m (share price $23) the stock seems to be undervalued. I would be interested to here what others here think.

 

One particular issue that may be a concern is a lawsuit filed against Schuff by BP for some faulty fireproofing at one on their refineries. It seems the liabilities here could be substantial. Anyone with any legal knowledge have an opinion?

 

Here is the description of the lawsuit from the 10K:

 

In December 2012, two lawsuits were filed against our subsidiaries that involve fabrication work pertaining to a refinery in Whiting, Indiana (“BP Refinery”), owned by a subsidiary of British Petroleum (“BP”). In December 2012, BP brought suit in the United States District Court for the Northern District of Indiana (the “Indiana suit”) against Carboline Company (“Carboline”), Trinity Steel Fabricators, Inc. (“Trinity”), the Company’s subsidiary, SSC, Tecon Services, Inc. (“Tecon”) and Alfred Miller Contracting Company (“AMC”), asserting contract and warranty claims as to SSC, arising out of allegations that fireproofing applied to steel that SSC and Trinity supplied to a modernization project at the BP Refinery was defectively fireproofed. The steel fabricators, Trinity and a Schuff subsidiary, subcontracted the application of the Pyrocrete® 241 to AMC and/or Tecon. These applicators purchased the Pyrocrete® 241 from the manufacturer, Carboline. BP alleges that the Pyrocrete® 241 is defective and causing damage to BP’s property and that the defects are caused by the preparation or application of the Pyrocrete® 241, or by defects in the product itself. BP alleges that it has and will continue to incur substantial damages. BP has not quantified its damages; however, they are believed to be at least in the tens of millions of dollars. Remediation of the fireproofing has commenced but is not expected to be completed for some time, and total alleged damages will remain uncertain until that work is completed.

 

And an article about Schuff suing an insurer to provide legal coverage:

 

http://www.law360.com/articles/514475/steel-co-sues-liberty-mutual-for-defense-in-bp-defect-row

 

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My fund has owned Schuff for year or so.  Schuff's 2013 results exceeded my expectations.  They have aggressively paid down debt from the share repurchase, which we expected.  Margins came in better than I thought.

 

The lawsuit doesn't worry me at this point, but all I know is what the AR stated and need to research it further.  My initial thoughts, and I am not a lawyer, is that BP has a tough case.  I doubt Schuff chose the product, it was likely the design firm, with BP's approval.  Thus if the product doesn't work it would not be Schuff's fault.  Even if Schuff chose it, and it was the nature of the product, BP still has a tough argument because they likely approved the choice.  If it wasn't the nature of the product, and it comes down to application, which Schuff likely insured, particularly since it was contracting the work out.  In addition whoever the general contractor was, they would have signed off on the installation.  There is a reason large projects have inspectors - to avoid having mistake imperil all the work after that step.

 

With their only reporting being annual reports, we may have to rely on news reports.     

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I own it also and think it is still pretty cheap. Around 5.5x my rough estimate of "normalized earnings" (basically 12 year averages earnings adjusted for unusual items, changes in capital structure, and a couple other things).

 

Don't really have much to add about the lawsuit, had assumed they would have some insurance coverage so that article is a little concerning.

 

Similar as Tim, the results exceeded my expectations. The jump in backlog was encouraging too.

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I own it also and think it is still pretty cheap. Around 5.5x my rough estimate of "normalized earnings" (basically 12 year averages earnings adjusted for unusual items, changes in capital structure, and a couple other things).

 

Don't really have much to add about the lawsuit, had assumed they would have some insurance coverage so that article is a little concerning.

 

Similar as Tim, the results exceeded my expectations. The jump in backlog was encouraging too.

 

I just read the article.  The article stated that the insurer's argument on why it refused to defend Schuff is because the sub-contractor claimed it did nothing wrong.  If true, then I am not very worried.  I read the insurers comment as implicitly saying that if the sub acknowledged doing something wrong (even inadvertently) then the insurer would represent Schuff (and thus likely be liable).  Sounds to me like property damage is covered, but the insurer is staying out in case it is found to be the product itself that was faulty.    I'm sure others would read it differently.     

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I looked at this when it was on oddballstocks and passed, I think because I was worried about them taking on more debt while they weren't earning much money.  In retrospect they were smart and I was dumb and they conducted one of the greatest buybacks I've seen.  I guess the lesson is that when you have a solid business with large inside ownership buying back half the shares at a significant discount to book value and average earnings, you should probably think twice before passing.  Also, it pays to listen to Nate Tobik.

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I was searching the forum for "project manager" and funny enough, Nate showed up. So would be curious if he has thoughts on this lawsuit.

 

I'm sort of in Tim's camp now, i.e., that it's probably not too much of a concern. As he mentioned, they subcontracted this out, so the risks get pushed to where the expertise is (not Schuff in this case). Though I'm not sure if the subcontractors have deep enough pockets and what the implications are if they don't. But I can't imagine Schuff wouldn't have all kinds of CYA language in their SOWs.

 

majtone, painful as it may be to pay 2x the price, my impression is that if you can get shares around recent prices you haven't "missed it". It still looks cheap to me, and I for one am not selling my shares, though I would consider it in the $40 range (obviously pending some other development / improved understanding of this suit). May be tough without an ask price, but there are still folks selling, and I imagine it will bob around quite a bit with only annual reporting.

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Looks like they sold for about $31.33 a share. 

 

May 13, 2014, 7:02 a.m. EDT

HC2 Enters Into an Agreement to Acquire a Majority Interest in Schuff International, Inc.

 

HERNDON, VA, May 13, 2014 (Marketwired via COMTEX) -- HC2 Holdings, Inc. ("HC2") HCHC +0.80% announced today the signing of a definitive agreement with SAS Venture, LLC, a Delaware limited liability company ("SAS") to acquire SAS's 2.5 million shares of common stock of Schuff International, Inc. ("Schuff"), representing approximately a 60% interest in Schuff. SAS is the largest shareholder of Schuff.

 

Robert Pons, HC2's Executive Chairman, stated, "We are excited to enter into an agreement to acquire a majority interest in Schuff, the largest steel fabrication and erection company in the United States. We also look forward to working with Schuff's management team and employees and continuing its tradition of building complex steel projects around the world."

 

The aggregate consideration is approximately $79 million. Completion of the transaction is subject to customary closing conditions, including the expiration or termination of any applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.

 

About HC2

 

HC2 operates as a holding company of operating subsidiaries primarily in the United States and the United Kingdom. HC2's indirectly wholly owned subsidiary PTGi International Carrier Services, Inc. ("PTGi ICS") is one of the leading international wholesale service providers to fixed and mobile network operators worldwide. PTGi ICS owns and operates its own global network of next-generation IP soft switches and media gateways. Founded in 1994, HC2 is headquartered in Herndon, Virginia. For more information, visit: www.HC2.com .

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Looks like they sold for about $31.33 a share. 

 

May 13, 2014, 7:02 a.m. EDT

HC2 Enters Into an Agreement to Acquire a Majority Interest in Schuff International, Inc.

 

HERNDON, VA, May 13, 2014 (Marketwired via COMTEX) -- HC2 Holdings, Inc. ("HC2") HCHC +0.80% announced today the signing of a definitive agreement with SAS Venture, LLC, a Delaware limited liability company ("SAS") to acquire SAS's 2.5 million shares of common stock of Schuff International, Inc. ("Schuff"), representing approximately a 60% interest in Schuff. SAS is the largest shareholder of Schuff.

 

Robert Pons, HC2's Executive Chairman, stated, "We are excited to enter into an agreement to acquire a majority interest in Schuff, the largest steel fabrication and erection company in the United States. We also look forward to working with Schuff's management team and employees and continuing its tradition of building complex steel projects around the world."

 

The aggregate consideration is approximately $79 million. Completion of the transaction is subject to customary closing conditions, including the expiration or termination of any applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.

 

About HC2

 

HC2 operates as a holding company of operating subsidiaries primarily in the United States and the United Kingdom. HC2's indirectly wholly owned subsidiary PTGi International Carrier Services, Inc. ("PTGi ICS") is one of the leading international wholesale service providers to fixed and mobile network operators worldwide. PTGi ICS owns and operates its own global network of next-generation IP soft switches and media gateways. Founded in 1994, HC2 is headquartered in Herndon, Virginia. For more information, visit: www.HC2.com .

 

Just to clarify, management sold their 60% stake to HC2, not the entire company.  Shareholders now get to tag along with HC2 while the current management continues to run the company.

 

This is great news.  Not surprisingly the stock hasn't moved much either!

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Why do you think this is great news? Don't see a lot of possible positives...

 

Really?  Management, the same ones who tried to execute a 'take-under' and tussled with major shareholders are no longer in control.  Now you have a private equity company whose goal is going to be extract value from the company.  Either they resell Schuff later on, or they start to pump out dividends.

 

One of the main issues with Schuff is that management has been out for themselves and not shareholder friendly.  HCHC is a fully SEC reporting company, and since they will own 60% of Schuff we'll now have quarterly consolidated financials available.

 

Now we have a company with the ability to do $13 per share in earnings in the next year or two with a controlling shareholder who's going to want to maximize value.  How are minority shareholders losing here?

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Management is willing to sell a controlling stake at $31.33, so what does that say about the value of the non-controlling stake? Because it's a controlling stake they basically sold whatever it is they could have gained from abusing minority shareholders. Do you think HCHC will care about minority shareholders, or will they try to extract as much value as legally possible? Why do you think they only bought the 60% stake instead of launching an offer for the whole company?

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yeah why are they selling this at like 2-3x peak earnings? That is not very positive. I really liked this one at 9$, but at 28$ it seems margin of safety is mostly gone now.

 

While 2007 and 2008 were peak earnings is that really relevant?  How likely is another bubble, particularly in large condominium projects and hotels that use a lot of fabricated steel.  I wouldn't project a $700 million revenue year with 20% margins any time in the future.  $500 to $550 million with margins in the mid to possibly high teens seem more like the peak to me. 

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I don't know about that. Based on the current back log they are probably going to hit those figures this year.

yeah but for a sufficient margin of safety that would need to be sustainable for a few years at the very least. I prefer stocks that have cycles that are more replacement driven (and where it is pretty clear this needs to happen). Rather then counting on another economic boom.

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I don't know about that. Based on the current back log they are probably going to hit those figures this year.

 

Hitting the revenue figure is certainly possible but having margins go from 14% to 23% is not easy.  We are clearly not in the same market as 2007.  I seriously doubt that they can raise their margins that high that quickly.  The market has to be extremely tight to be able to bid with that much built in margin, and I don't see that right now.  I own the stock and would love to be wrong. 

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Management is willing to sell a controlling stake at $31.33, so what does that say about the value of the non-controlling stake? Because it's a controlling stake they basically sold whatever it is they could have gained from abusing minority shareholders. Do you think HCHC will care about minority shareholders, or will they try to extract as much value as legally possible? Why do you think they only bought the 60% stake instead of launching an offer for the whole company?

 

I think I understand your concerns but how would they extract value in way that benefits them over other shareholders?  They appear to need to borrow money to make the deal, which is probably why they only purchased 60% (that and you don't need a fairness opinion or shareholder approval).  Regardless,  they need distributed cash.  That must happen for all shareholders.  This isn't a case of a single owner/CEO extracting money through excessive compensation.  Sure they could over charge for services but that would open them up to a lawsuit.

 

The more I think about the more I think it is a positive over the Schuff's owning the majority, which I think is oddball's point.  Is it as good as a full buyout?  No, which I think is your point.  Who knows maybe someone comes along and makes an offer for all the company.

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I don't know about that. Based on the current back log they are probably going to hit those figures this year.

 

Hitting the revenue figure is certainly possible but having margins go from 14% to 23% is not easy.  We are clearly not in the same market as 2007.  I seriously doubt that they can raise their margins that high that quickly.  The market has to be extremely tight to be able to bid with that much built in margin, and I don't see that right now.  I own the stock and would love to be wrong.

Was talking about the mid to possibly high teens margins. Totally agree with you that 23% is very optimistic.

The more I think about the more I think it is a positive over the Schuff's owning the majority, which I think is oddball's point.  Is it as good as a full buyout?  No, which I think is your point.  Who knows maybe someone comes along and makes an offer for all the company.

Thinking about it a bit more, I do think that the change in ownership isn't a bad move. But what is IMO a big negative - and way more important than concerns about the treatment of minority shareholders - is the fact that management was willing to sell at this price. I know, there can be all kinds of reasons for selling, but still. How much upside is left if the party that knows the most about the business is willing to sell a controlling block for a negligible premium?

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management was willing to sell at this price

 

exactly, why would three generations of shuff give up control for just over book value after they went through great lengths to regain control just a few years back and when things seemed to have been turned around and everything seemed to indicate a very bright near term future?

 

sounds like either they believe that the company is fully valued or they need to sell for some reason, for example some kind of family situation

 

regards

rijk

 

 

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I personally don't think that it is likely that they needed to sell. Given that Schuff was almost debt free I'm sure they could have figured out something to raise a significant amount of cash while maintaining control (for example repeat the 2011 playbook, raise debt and buyout family member that requires liquidity or just raise debt and do a tender offer, a dividend or something along those lines).

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