The Pump Stopper
I hate seeing innocent investors lose money on disastrous
investments, so I've made it my mission to unclog America's stock
markets - I am, if you will, the plunger for blockages in the stock
market. Keyw Corp. (
) is a particularly large blockage as the company has destroyed a
huge amount of capital and put itself into an impossible corner
which investors clearly don't understand. KEYW's only options now
appear to be bankruptcy or attempt to immediately dilute
shareholders by 35-40%+.
This Part 1 of my 3 part series, uncovers the following
reality about KEYW:
1. KEYW's looming covenant violations and high probability of
bankruptcy. I walk you through the unforgiving math below.
2. KEYW's backlog accounting presents a headline number that
appears massively overstated.
3. KEYW is NOT a high-margin cyber-security software company:
investors have been misled by promotional
from underwriters who earn huge investment banking fees from
4. KEYW's true business is low-margin government contracting and
based on true peer comparable valuations, KEYW's fair value is
$3.80 -- if the company can avoid bankruptcy.
5. How KEYW got itself into this impossible mess.
1. KEYW Bankruptcy and Covenant Violations:
On a quarterly basis, KEYW has already violated its recently
relaxed debt covenants and is teetering on the edge of a trailing
12-month covenant violation. Without an immediate, massively
dilutive equity raise, KEYW faces imminent bankruptcy risk.
How did KEYW get here? KEYW is a failing rollup of disparate,
apparently unintegrated assets, acquired at very high valuations
that used a lot of debt. The vast majority of KEYW revenue is
contract based, with the US government, and now faces formidable
revenue and cash flow headwinds as the government curtails spending
and contracts roll off.
KEYW's business is now in rapid decline and appears to be
getting worse. In Q4 2013 KEYW total revenue declined -7% yoy.
Then, even though he was nearly halfway through Q1 already, KEYW
CEO Len Moodispaw forecasted a "
" though it should have been obvious by then that the government
business was rolling over. Just weeks later, Len announced
results, with KEYW's government business rapidly deteriorating as
revenue declined -19% year-over-year (yoy).
On the recent Q1 2014 call, KEYW said the business should
stabilize sequentially (quarter over quarter) - let's put aside
management's history of repeated disappointment on winning
contracts and rolling out new products and assume the business
Even if revenue stabilizes qoq, I estimate KEYW revenue would
still decline approximately -20% yoy again in Q2 (see below) and I
expect more of the same in Q3.
The single most important issue for KEYW now is its debt
covenant structure and leverage. This is despite the fact KEYW just
very recently in 3/2014
and relaxed some of the terms on their debt.
Let's look at my estimates and the unforgiving math of what
happens when a roll-up unravels: There is a lot going on in the
chart below but I want to call your attention to the yellow
highlighted row where you can see that EBITDA has been declining
and is estimated to continue that trend. In the last quarter KEYW's
EBITDA declined -64% relative to the same quarter last year.
(click to enlarge)
The simple math is KEYW has too much debt and not enough
cash flow (EBITDA). With EBITDA now imploding, there is a very real
chance KEYW's lenders foreclose on the company soon, leaving the
You can see below, in the yellow highlighted row and red numbers,
that based on the numbers above KEYW will violate the recently
amended terms of their debt next quarter.
(click to enlarge)
You can also see below in the yellow row with red numbers that
KEYW appears to be on the verge of violating the debt terms about
earning enough cash flow to service the debt. My estimates also
show KEYW appears to be unable to even make their debt payments
next year, unless revenue turns around dramatically.
(click to enlarge)
As you can see, KEYW's hands are tied because if they try to
draw down on their revolver or take on more debt, these covenant
metrics and the excessive leverage immediately gets much worse. As
far as I can tell, KEYW's only hope is to immediately sell an
enormous amount of dilutive equity at whatever terms they can get
(I expect a huge discount from the current price, if it is possible
"Related to the balance sheet, we've always had a strong
balance sheet. It's getting better." - KEYW
CEO Len Moodispaw
On 3/13/2014 KEYW had to
amend the terms
of its debt and relax the covenants. This 8k included backward
looking terms to January of 2014.
Was CEO Len Moodispaw in conversations with nervous lenders
while he told the public his balance sheet was strong and getting
2. Math of Potentially Imminent Equity Raise: KEYW's Only
The unfortunate bottom line is that KEYW only has three options
at this point that I can see, and all of them could crush the
1. Continue on their current path, default on their debt, and go
2. Immediately raise at least $100m of equity, according to my
estimate. Either they can pay down debt to a more reasonable ~2X
EBITDA level or attempt to buy more growth. By my calculations,
KEYW needs to purchase (minimum) $5m in EBITDA per quarter or $20m
of annual EBITDA to avoid default. If they buy another government
contracting business, this will cost at least 5-6x EBITDA or
$100-120m and will have to be funded with equity (I don't believe
any lender would lend more debt to a company violating its current
debt covenants and KEYW has virtually no hard assets to borrow
against anyway). That equity is nearly certain to be sold at a
large discount to the current share price, likely with dilutive
warrant coverage. This works out to at least 35%+ dilution to
current shareholders. This $100-120m in estimated equity KEYW
needs aligns "coincidentally" with the $150m shelf offering KEYW
recently filed. This doesn't solve the structural issues KEYW faces
but it would help the company avoid near-term bankruptcy.
Also note, when KEYW's financials looked much better with less
leverage and some growth back in 2012, KEYW seems to have struggled
to raise equity and had to
go to Europe
to generate investor interest. With their business now rapidly
deteriorating I doubt they will be able to convince anyone to give
them $100m in cash with their awful track record of capital
destruction. (See KEYW option 1 above: bankruptcy).
3. If KEYW can't raise equity, their only viable option that I
see is to shut down the failing commercial and cyber business
completely and immediately. KEYW would then be a pure play
government contractor with declining revenue, with a valuation
re-rated to peers at ~0.8x EV/ forward revenue (likely in the $250m
ballpark by my estimate). Putting KEYW's market cap at ~$120m or
~$3-3.50 per share, for -65% downside to the stock. Government
revenue would likely still be declining so it may trade at a
discount, and without organic revenue growth KEYW's balance sheet
could just eventually become strained again anyway.
3. Won't KEYW's Backlog save them? KEYW Backlog Massively
As of January 1st, KEYW states their total backlog is $509
million. This sounds impressive until you read
the fine print
and realize only $132 million is actually funded - the remaining
balance is unfunded, or basically just a placeholder.
For reference, this $132 million funded backlog is a mere 46% of
KEYW's LTM revenue of $285mm. KEYW needs to fill the other 54% of
revenue in an increasingly difficult government spending
environment while its cyber-security products are failing to get
traction and appears to actually be declining (much more detail on
that in report Part 3). Given KEYW government contracts are already
rolling off or re-pricing at lower levels of profitability
(described explicitly on recent earnings calls), plus KEYW's large
aircraft contract facing headwinds next year and some analysts
that contract alone could be approximately half of KEYW's
government EBITDA, KEYW's business has no stabilization in sight
that I can see.
4. KEYW is a Sell Side Promote, KEYW is NOT a-Cyber
Security Technology Business!
Given the ugly reality of KEYW's current financial situation,
why are investors valuing KEYW stock incorrectly?
I believe the primary reason for KEYW's absurd overvaluation is
directly due to the conflict of interest from KEYW's relationships
with Wall Street. As seen below, since KEYW has been addicted to
capital to fuel its failed acquisition strategy, KEYW is an
extremely profitable client of some of Wall Street's lower tier
banks. These banks derived substantial income from KEYW's IPO and
2012 secondary offering.
(click to enlarge)
Note the coverage initiation, upgrade and price target increase
right before the equity offering. You can see similar behavior
above with multiple price target boosts early this year too.
Particularly interesting are the price target increases right after
KEYW CFO Korbath's departure when the stock declined rapidly. I
think KEYW has likely known for a long time (all the way back to
the Chardan initiation in August, 2013) that it would need to raise
This sell side promote cycle began anew on March 24th when the
sell side stepped up to defend the stock in the wake of CFO John
Korbath's awkward departure and the unforgiving math of imminent
covenant breach and debt default.
Before you dismiss short sellers as being financially biased,
think about how much research coverage $10.9 million buys on Wall
Note the average underwriting fee on Wall Street is between 5-7%
of the capital raised. If KEYW fills its entire $150 million shelf,
that would be roughly
another $7.5 to 10.5 million of fees
for these or similar investment banks. No wonder the sell side is
"Holy smokes Batman! This is a huge conflict of interest!"
for picture above)
The Wall Street sell-side bank machine explained
As conflicted underwriters seeking multi-million dollar fees,
the incentive is to issue the most favorable coverage possible to
KEYW, sending the stock price higher and allowing KEYW to issues
new shares at a high price.
The promotion effort for KEYW occurred by comparing KEYW to
companies that are completely unrelated, with the most common
comparison drawn to FireEye's (
) acquisition of Mandiant. Some sell side analysts have erroneously
valued KEYW as high as $3 billion of market cap (10x sales for the
entire KEYW business even though only 3% is cyber revenue).
Just how different is Mandiant?
Mandiant was founded in 2004 and backed by Kleiner Perkins, one
of the world's premier Venture Capital firms. Mandiant organically
grew to over $100 million of revenue before being acquired. Unlike
KEYW, it was not a patchwork of disparate, unrelated assets, one of
which was sold by a consortium of VC firms at a loss (Sensage).
Also unlike KEYW, Mandiant was founded and managed by a team with
deep cyber-security experience - it was not a "me too"
FACT: KEYW's cyber-security revenue accounts for only 3% of the
KEYW's total revenue. Clearly, KEYW is not a cyber-security company
no matter what anyone says. It is a zero probability event that any
strategic acquirer would buy a declining government subcontracting
business (what KEYW actually is) for 10x revenue. Using CapIQ data,
I looked at literally hundreds of Aerospace & Defense
acquisitions going back to 1997 and I couldn't even find one
example of a government contractor getting bought out at 10x
This is so obvious that I can only conclude the sell side
authors writing about KEYW don't even know what KEYW actually does!
If this is how management is pitching KEYW to investors, I'm also
not sure management knows what KEYW does!
I could clear up all of this confusion with one simple question
to KEYW management:
for picture above)
Let's look at the timeline of KEYW's current tailspin:
: KEYW CEO says their balance
sheet is strong
and getting better.
their credit facility. I believe math makes it obvious KEYW
realizes they could need equity at this point.
: KEYW announces the surprising
of John Korbath, CFO - clearly related, I believe, to the debt
covenant amendment and brutally dilutive shelf offering KEYW is
about to file. Note KEYW and the CFO are at the end of Q1 2014
already so they know what earnings are going to look like (i.e.,
a train wreck).
: KEYW's underwriter-analysts promote the stock aggressively
by comparing KEYW to unrelated businesses that trade at premium
a $150mm shelf equity offering.
: KEYW announces and
with revenue imploding -18% YOY, the stock declines rapidly,
KEYW's solvency called into question. I highly recommend you read
the Q1 2014 call as it is one of the worst examples of management
floundering I have ever seen.
Why does KEYW and the sell side seem so confused? Maybe because
KEYW is desperate for equity capital?
The company finished Q1 2014 with a shocking $64,000 of cash on
the books - that is
sixty-four thousand dollars of cash
for a company with net losses of >$11mm LTM, revenue that was
18% in the most recent quarter, and $85mm of debt.
As a public company, KEYW has
free cash flow of roughly $5 million. This is not a typo. Since
2010, the company has generated a mere $5mm of free cash flow. Even
after its recent brutal price decline,
KEYW stock is still valued at 99x lifetime FCF
on an enterprise value basis. That is somewhere between "horrific"
and "unbelievably terrible."
I believe the numbers show, KEYW needs to sell equity NOW if
it is to remain a going concern. This is why they filed a
massively dilutive shelf registration on April 23rd.
4. KEYW Fair Valuation: <1x Sales and a $4
Let's look at some facts to value KEYW appropriately:
Fact 1: KEYW mentions "Direct Peers" in its own SEC filed
proxy statement: both Mandiant and FireEye are absent
This is a direct quote from the 2013
statement (emphasis mine):
Compensation Consultant's benchmarking analysis was based on
two distinct peer groups (Direct and Indirect Peers) which it
jointly with executive management [who presumably should know
what KEYW does, but I am not sure anymore].
should serve as the primary reference point for evaluating the
reasonableness of pay levels while practices should be shaped by
a broader index including Indirect Peers.
Who are these direct peers exactly?
The Direct Peer Group was as follows:
• AeroVironment, Inc.
• ICF International, Inc.
• American Science & Engineering, Inc.
• Mercury Computer Systems, Inc.
• Dynamics Research Corporation
• NCI, Inc.
• GeoEye, Inc.
• Sourcefire, Inc.
• Globecomm Systems, Inc.
FireEye and Mandiant are nowhere on KEYW's own list of their
Fact 2: KEYW's closest peers in its 10-K competitor
section trade at a fraction of KEYW's valuation
In the competitors section of
"We also face competition from a number of large,
such as Science Applications International Corporation (
), CACI International, Inc. (
) and others."
Here you have KEYW directly comparing itself to government
contractors that trade at 0.8x and 0.5x, EV / 2014 sales estimates,
respectively. This is a very fair comparison because 97% of KEYW's
revenue is government contracting and both SAIC and CACI are in
similar if not identical contracting businesses.
Here is KEYW's true comparable public company peer group:
(click to enlarge)
You can see above that peers to KEYW are valued at 0.79x sales
and 14x EBITDA. If you exclude the MRCY outlier, that declines to
~8x EBITDA. Amazingly, KEYW still trades at roughly double the peer
valuation despite near-term risk of bankruptcy with declining
revenue and EBITDA - a rerating to peer valuation on estimated 2014
revenue of $250mm would value KEYW stock at ~$3.00 per share.
More importantly, KEYW trades at 2.5x SAIC's valuation and 1.5x
CACI's valuation, which are the closest peers per KEYW's own SEC
documents. I think $319mm consensus revenue for 2014 is obviously
too high after Q1, with similar declines likely coming in Q2 and Q3
by my estimates, so let's be generous and value it on $285mm of LTM
revenue with a similar multiple to CACI.
Valuing KEYW appropriately, as a government subcontractor
(per KEYW's own filings) with the same valuation as CACI,
produces a fair value of $3.80 for the stock,
assuming KEYW doesn't go bankrupt or massively dilute current
shareholders. This is a shocking ~65% downside from the current
KEYW's valuation premium is very likely to compress in coming
quarters - for starters because sell side estimates are still too
high. Most of the analysts covering the stock have not yet revised
their estimates down after KEYW's Q1 huge miss (is this another
indication a conflict of interest exists?).
5. How Did KEYW Get Itself Into This Impossible Mess?
KEYW is a failed rollup: This is the home of capital
Even though KEYW has only been public since 2010, (per CapIQ) it
ranks as the 20th most aggressive rollup out of 285 (top 9%), and
the #1 out of the Aerospace & Defense index of 5 companies.
KEYW has been a forced buyer - the company went public on the
premise of winning a large prime contract. That failed and the
stock tanked. Management then embarked on an aggressive purchasing
campaign, buying 13 businesses, with the hope of one day "finding"
a sustainable business model- this day has yet to occur, in my
opinion. Why? There is a seller to KEYW for a reason and aggressive
buyers make expensive acquisitions.
KEYW Has Generated -3.1% Return on the $393m of Asset
growth since inception: This is terrible performance
These numbers are staggeringly bad. Even worse, KEYW has
(EBIT declined by $12mm) as a result of the acquisitions the
company has made.
Basically, KEYW could have made more money by purchasing 0.1%
In my opinion, anyone investing in KEYW through an upcoming
secondary offering is signing up for continued capital destruction.
The bigger KEYW gets, the worse it does. Given the over leveraged
balance sheet and history of terrible performance, this next
secondary (if they can even do it) is likely to be KEYW's last, in
A quick look at the valuation multiples the company has
paid makes it clear why the results are so bad
(click to enlarge)
These are overpriced acquisitions, many paid for with debt, and
many of the acquired companies have subsequently performed poorly.
I am particularly shocked at the Sensage acquisition, which was
acquired for 7.1x EV/Revenue and with a tiny revenue base. My
channel check revealed Sensage was "the last girl without a date to
the dance" and had been shopped extensively in the consolidating
cyber-security industry prior to its sale. The VC investors who
sold Sensage were so desperate to find a buyer that they were
at a loss just to get out of the asset.
An extremely detailed report on KEYW's impossible battle to
penetrate the "cyber" market will be coming very soon.
Token Insider buying
Apparently, in a desperate attempt to put a floor on KEYW's
imploding stock price before a potential equity raise, Len
10,000 shares of KEYW in the open market at ~$11.00 a share.
The market is not so easily fooled by such tomfoolery, Len! I
checked KEYW's historic open market acquisitions vs. open market
dispositions, per CapIQ data, in the $10-12 price range. As they
say, "the numbers don't lie" - KEYW insiders, including Moodispaw,
have purchased a total 35,000 shares in this price range and sold
195,400 shares. This is a staggering divide in dollar terms: I
estimate, based on CapIQ data, that KEYW execs have purchased
sold $2,233,622 in a similar price range over time, a startling
Clearly, insiders would rather take profits at this level,
Len, let's see an immediate $1,000,000+ open market buy by you
and the new CFO with your own money and then we'll talk. Until
then, you're not fooling anyone.
I have attempted to contact management several times over the
last 2+ months and have been unable to reach anyone through the
standard investor relations channels. Given the embarrassing
investor Q&A from the last earnings call, I believe KEYW is in
"circle the wagons" mode and avoiding public communication.
Ultimately I see no easy way out for KEYW. I've outlined the
three options KEYW has at this point and all of them point to
enormous downside for the stock. With this in mind, my "bull case"
scenario for KEYW involves 35-40%+ dilution (depending on warrants)
to KEYW shareholders and my downside case involves near-term
bankruptcy and -100% downside. My personal view, based on KEYW's
rampant capital destruction and repeated failure, is that the
market should decline a capital raise until KEYW flushes its failed
strategy down the drain - this would be a positive event for the
capital markets so that future capital can be redirected towards
companies that are creating value. The simple math is unforgiving
here and I wish there were a better outcome.
for Full Disclaimer
 My estimate of required dilution, presented below in more
 Only 3% of KEYW revenue is cyber-security
 At $8, a $100mm equity raise would create $12.5mm new
shares, not including warrants. This would be ~33% more dilution, a
number that is likely too low given the likely need for warrants to
sweeten the deal.
 I consider the lack of growth in this business to be a
failure and my checks reveals KEYW is unlikely to successfully ramp
this business. More details in a future report.
I am short KEYW. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
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