Credit: Shutterstock photoBy Lazarus Investment Partners :
Author's Note: This article discusses a microcap stock. Please be advised of the risks associated with microcap stocks. The text of the interview is an abridged transcription of a conversation between Lazarus Investment Partners LLLP and LiqTech International, Inc. LiqTech had no input into the selection of the title of this article nor into the commentary and analysis that precede the interview. Lazarus is a shareholder of LiqTech and received no compensation for this article. Please see additional disclosures below.
Introduction. One of the hardest materials in the world, after diamonds, is silicon carbide. Denmark-based LiqTech ( LIQT ) uses silicon carbide to create proprietary membranes that clean water and air. Silicon carbide is difficult to manipulate into a membrane, which is why we see value in LiqTech's patents and know-how. The company's products have many advantages over the competition, including a longer life, the lowest total cost of ownership, higher throughput, and thermal resistance.
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The Reset. We wrote about the company a year ago and, to be frank, we were early on our call. LiqTech has incredibly innovative technology but with the benefit of hindsight it's clear that the large energy and industrial companies of the world don't make quick decisions to swap what's familiar with what's new - regardless of the promised benefits. The second challenge LiqTech faced over the past year is that their go-to-market strategy was flawed. They wanted to sell membranes but learned that many companies want a complete filtration system built around that membrane, not just the components.
The good news is that LiqTech has addressed these challenges head on. Sune Mathiesen replaced the outgoing CEO in July and has significant compensation tied to hitting financial targets. Also in July LiqTech announced its acquisition of Provital. This acquisition provides dramatically higher gross margins (72% vs. 10% for the old LiqTech), capabilities in systems construction, and expertise in the pool filtration market.
Under Mathiesen's leadership, LiqTech has shifted its market focus from emphasizing elephant hunting (the pipeline includes everyone from Chevron, to Shell, to E.ON in Germany) to going after smaller integrators and customers that can make quicker decisions and work more easily with LiqTech's membranes.
In addition, rather than pursue every opportunity at hand, they narrowed their target industries to those where they have proven their technology the most: water treatment, industrials, pools, and a type of air filter mandated in some regions called a diesel particulate filter. Finally, LiqTech changed its go-to-market strategy to one of selling complete systems rather than just the membranes. This gives the company a larger selling opportunity since membranes are typically just 10% of a filtration project's cost.
Source: Craig-Hallum, September 2014
Elephants Still Roam. On the lastearnings call(November 13th), LiqTech's CEO explained regarding the large deals the company previously focused on, "It's important for me to underline that we're not neglecting the large opportunities like FMC, Shell and the Saudi Arabian water market that you all heard about but we are creating a more stable business and the large opportunities will now be the icing on the cake instead of being the base of the business."
The most advanced of these large deals is with FMC Technologies ( FTI ), a $13 billion (market cap) energy services leader who signed a multi-year agreement to use LiqTech's membranes in unconventional shale oil/gas applications. On the Novemberearnings callLiqTech expressed confidence that they are on track to receive an order from FMC this year. To maintain exclusivity, FMC has to place minimum orders for 10 million Euro, ($12.5M) next year, which would be game-changing for a company that has $16 million in trailing 12-month revenues.
The interest in LiqTech's membranes from the FMCs and Shells of the world helps validate the technology to us. The company's pipeline also includes world class organizations who are interested in LiqTech's pool filtration solutions. Disney already ordered the new LED-UV product (which, as you'll read in the interview, LiqTech's CEO is very excited about), and LiqTech is bidding on 9 new builds for Ritz Carlton in the Asia-Pac region. They are in tests at SeaWorld and LiqTech's partner bid on over $40 million of opportunities in Saudi Arabia. From Conconcreto in Colombia to 1,000 power plants in Germany there's no shortage of active discussions and opportunities. Just a win here and there would really move the needle for this small company.
Source: LiqTech
Upside Potential. Altogether, LiqTech thinks they will hit $100 million in sales in 2018 which would be almost 8x what they did last year. Craig-Hallum has been using 2.5 - 2.8x EV/sales (that's forward sales, 2015-2016) in setting their price targets. Wm Smith & Co. has highlighted takeouts at sales multiples of 4.3x (R360 Environmental), 3.1x (Norit), and 2.3x (Clean Process Tech), along with strong interest from private equity in the space. LiqTech has referenced GE's acquisition of Zenon Environmental at around $700 million, which was over 3x sales (while Zenon was losing money). Taking the lowest of all these multiples implies $230M in market cap on LiqTech's target sales, which is almost 5x today's market cap.
At $100 million in sales LiqTech estimates that it could do 30% EBITDA margins. Wm Smith's initiation report on LiqTech this year stated that a group of nine firms in the filtration business trade at an average EV/EBITDA multiple of 14x. Without adjusting for the balance sheet, a 14x multiple on $30 million in EBITDA is $420 million in value, almost 9x today's market cap. A below-average multiplier to EBITDA of 10x would still yield a market cap of around 6x that of today. Admittedly, none of these multiples matter if LiqTech doesn't grow, but the point we are illustrating is that if it does grow, the upside is tremendous.
Risks and Challenges. Meanwhile, LiqTech is suffering from a weak stock price on the heels of a choppy Q3, tax loss selling, and negative momentum. The company is guilty of not having yet delivered on its promise and of taking missteps in its prior sales and marketing strategy. It also faces competition, including some much larger companies. Value investors seeking a low multiple to trailing earnings or EBITDA won't find it now in LiqTech. To be a buyer here, you have to believe that growth is possible.
We think the market's focus on year-to-date revenues (up only 32%, and that's including Provital) is overdone. We view the company as just getting going, and don't lose sight of the slow pace of its customer's buying habits. In some sense, it would be easier to excite investors if LiqTech had no revenues. There are so many companies out there awarded market caps in line with or greater than LiqTech's just for the promise of their technology.
Conclusion. With innovative technology that serves a huge and growing market ($40 billion by 2020), a full pipeline, a fresh start with a new CEO and a new strategy, no current financing needs ($7 million cash; Q3 was profitable on a net income basis and had a small operating loss), and tons of optionality, we like our chances - especially at today's valuation of just 3x sales. LiqTech's path to $100 million in sales may have had some twists and turns to date, but we think it's heading in the right direction.
CEO Interview. We extend our thanks to LiqTech's CEO, Sune Mathiesen, for updating us recently on the progress at the company and allowing us to share a transcription of our conversation.
Over the past year, much has happened at LiqTech. What would you characterize as the key learnings for the company over this period?
Sune: Over the past year we learned a lot. The approach we took to the market traditionally was to approach the larger players, especially the oil and gas industry, and try to sell our membrane to them. We discovered that it was quite a hard path. It was hard to sell, first of all, because it's an investment that they are doing primarily for environmental reasons. And, second of all, it was difficult to come with just a membrane to these players and ask them to build a system around that, which is a complex task.
Consequently, we changed our philosophy. We now focus on smaller system integrators; system integrators that can easily build a system around our technology. We are also approaching many more customers, but smaller customers. It's not like we gave up on the larger opportunities. But we try to have them as icing on the cake and have a more stable revenue by approaching these smaller system integrators.
This is one of the reasons we acquired Provital, a system integrator in the pool industry that was already using our ceramic membranes. It allows us to sell systems, not just the membranes. This gives us a much shorter path to the market because we don't have to excite a system integrator who should then excite a customer about the product. We can go directly to the end users now.
Did you learn anything along the way that gave you additional encouragement or validation regarding the technology?
Sune: Yes. Over the past year we sure did a lot of tests. We did a lot of pilots. We have a lot of positive feedback, especially from the oil and gas industry, from the drinking water treatment industry. All of this confirms to us that we have a great product; that we have a solution for tough environments, that we have a solution for drinking water that is outstanding compared to any other technology in the market.
You spoke about the shift in emphasis from larger customers to smaller customers. As the new CEO, what are the other key changes you'll look to be implementing at LiqTech?
Sune: Three words: focus, focus, focus. We are narrowing our focus into industries where we already proved our technology; industries who have accepted our technology.
We divided our business into four sectors. We have water. That could be surface water, ground water, or water for desalination. The second sector is industrial where we focus on removing heavy-metals for power plants and chemical plants, and meeting the needs of oil and gas companies. The third one is the pool market where our acquisition, Provital, has a strong presence. And the fourth is the DPF business, Diesel Particulate Filters, where we've always been active.
We are not spending any significant time testing for other applications where we don't really know if we will be successful. In the past we were too active in too many areas.
We are also changing the company from being a development company into a selling organization. We know we have a great, innovative product. The past was about developing it but now our job is to get people to buy it.
You mentioned the DPF market. What's going on in that market?
Sune: It's always been a lumpy business. One year is the Olympics in London and then you have a lot investments for that. And the next year somewhere else in the world they put into effect some rules that require it. What we see now is that, especially in California, they're starting to enforce the mandate that has been in place for some years, so that creates opportunities. We also see a lot of evolving markets like luxury yachts, like diesel-power generators where we can sell our products. So, we expect growth in our sales in the DPF market, both for 2015 and 2016. Maybe not a boom, but solid growth in the range of 15% to 20%.
How is the company's balance sheet and do we have the capital that we need to grow our business and execute our business plan?
Sune: Yes, we do. I would say we are well-financed. We have no debt. We have more than $3 million in our line of credit. We have $7 million cash in the bank. We have production capacity of around $100 million in revenue and we are running well behind that. So, we have sufficient capacity to grow. We have all the machinery we need, no debt, and money in the bank.
Are we running at a near breakeven pace or better?
Sune: We expect to be cash flow positive in the near future.
Can you tell me a little bit more about the impact of the Provital acquisition?
Sune: We gained a lot from that acquisition. First of all, we gained the ability to produce systems ourselves, to be able to go into the market and offer anything from the membrane to the finished system to the housings and everything in between. If we were to sell only membranes to a project that is typically about 10% of the value of the project. So, now we can gain extra revenue from being able to sell the systems. Between the higher volumes we expect and the old Provital business running at about 65%, 70% gross margin, we are expecting much higher margins for the combined company.
What we are also gaining is a lot of knowledge on how to use the membrane and how to build the systems around it. This we can give to other system integrators to help them implement our membranes much faster into their systems.
And lastly, we gained a new product that I am very excited about, the LED UV light product for the pool market. This is cutting-edge technology. It has lower power consumption, a longer lifetime, more efficiency - it basically outperforms mercury lamps on every single point. This is one of the most exciting things we have going on at LiqTech.
What is the status of the partnership with FMC?
Sune: We have meetings regularly with FMC. FMC expects to be on track for this year and they expect to be on track according to our contract.
And by on track, do you mean to have the first system operational?
Sune: On track means that we need to receive orders worth EUR400,000 this year. And the contract is that, to maintain exclusivity, they need to place orders for EUR10 million next year.
How does the rest of the sales pipeline look?
Sune: It looks very good. We increased our sales efforts a lot. We have a very large pipeline. We have all the old opportunities in there and they have not disappeared. And, on top of that, we added a lot of semi-large and smaller opportunities, so it's now a more diverse pipeline in that sense. Nothing is guaranteed but we're very confident that we have the sales pipeline we need to have a good chance to make incredible progress on our goals.
And are you able to give me either any quantification or examples of what's in the pipeline? Just some way to make it more specific?
Sune: Sure. If you look to the Provital side, we have a target next year of $20 million in revenue. We have a sales pipeline which is more than double of that. If we look to the LiqTech side, our sales pipeline is currently about $40 million to $45 million. And, of course, we are looking to grow these pipelines significantly.
Okay. And some examples of some of the customers that we're talking to and hoping to win over?
Sune: We are talking to a lot of big players. If we look to the Provital side, it's companies like Sea World, companies like Disney and Ritz-Carlton.
If we look to the LiqTech side, it's companies like PDVSA in Venezuela, the state-owned oil and gas company. It's Conconcreto in Colombia. It's FMC. It's Chevron. Just to mention some of the very large opportunities. What we also have in LiqTech are a lot of smaller opportunities, especially in the power plant industry. These are companies like E.ON in Germany and a lot of very smaller power plants, but we have a significant number of those.
When you think about the long term for LiqTech, what do you see? What can this company be in three, four years' time?
Sune: We have the goal to be at $100 million revenue in 2018. That is the official target for LiqTech. Being a $100 million company will mean that we use our production capacity more efficiently. We would then drive down our costs and have higher profits. That is the long-term goal.
Have you shared what kind of margins or profits the company could have at that level of sales?
Sune: At that level of sales, we would expect to be at a 30% EBITDA margin.
And for investors who have a shorter time horizon, what would you highlight as reasons to own the stock in the nearer term?
Sune: Well, first of all, the stock price can always move around in the nearer term. But about the company, we can say that we see ourselves on the path towards $100 million revenue in 2018. It will be one quarter of growth at a time. We put a lot of efforts into our salesforce. I've been with the company now three months and, for sure, we made some significant changes in the organization. We will not explode from one day to the next, but we're targeting steady growth towards our goals, and I'm very optimistic about the future.
Thank you very much.
Sune: Thank you.
Additional disclosures: I will not sell shares of LIQT for 3 days following publication of this article. Please see our full legal disclaimer which applies to this article.
The interview herein may contain historical information and forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 with respect to the business, financial conditions, and operational results of the interviewed company (the "Company"). Such statements reflect the current beliefs, views, assumptions, and expectations of the Company with respect to future events and are subject to uncertainties and risks. Many factors could cause the actual results, performance, or achievements of the Company to be materially different from those expressed or implied by such forward-looking statements. Some of these factors may include changes in the markets in which the Company operates and in the general business environment and economic conditions, the loss or gain of customers, unpredictable sales cycles, competitive pressures, market acceptance of new products, inability to meet efficiency and cost reduction objectives, changes in business strategy, and various other factors, both referenced and not referenced in this article. In addition, various risks and uncertainties, including but not limited to those described in reports filed by the Company with the Securities and Exchange Commission, may affect the Company's operational results. The Company does not assume any obligation to update its forward-looking statements.
Disclosure: The author is long LIQT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
