Thoughts on Advanced Emissions Solutions – ADES

Advanced Emissions Solutions, Inc. trades at a price that does not reflect the optionality of its pollution control assets. These assets include various “refined coal” power plants, emissions-reducing chemicals, and intellectual property. While only the refined coal facilities currently produce meaningful cash flow, the company’s other assets could have significant value.

“Refined Coal” – Tinuum Group, LLC

Let me first say that “refined coal” or “clean coal” are nothing more than marketing terms. Burning coal to generate power is a filthy process and no current technology can remedy that. But there are ways to reduce the impact of coal pollution and limit the release of mercury and nitrogen oxide into the atmosphere. “Refined Coal” plants have been fitted with equipment that treats coal and the resulting combustion gasses, resulting in less pollution and environmental impact. The US government wishes to encourage these technologies and has provided special tax incentives to operators who employ them.

Advanced Emissions Solutions, through its investment in Tinuum Group, LLC, owns many coal-fired power plants equipped with these technologies. About half of these have been leased to various operators, including utilities and non-utility financial investors interested in generating tax benefits. Simply from the plants now in service, Tinuum will earn hundreds of millions in lease revenues between now and the end of 2021. After that, the tax provision that created the incentives for using refined coal technology sunsets and presumably, Tinuum will receive no further cash flows.

Tinuum signed another plant lease at the end of March, bringing the number of plants in service to 14. Another 7 refined coal facilities are equipped and ready for an investor, and Tinuum can install its technology at another 7 if demand materializes. Acquiring new operators for the remaining plants has been a challenging process for Tinuum, given some uncertainty over IRS treatment of various types of investors in refined coal and general uncertainty over the future of coal-generated power. But the company feels the worst of the uncertainty is behind, and is optimistic about placing idle plants into service.

Advanced Emissions Solutions owns 42.5% of Tinuum, and expects its share of distributions to total $275-300 million between now and the end of 2021. Depending on Tinuum’s success in leasing out additional plants, the total distributions to Advanced Emissions Solutions could be much higher. By the company’s estimation, each additional plant leased to an operator could add $5-7 million in annual distributions.

Emissions-Reducing Chemicals

Advanced Emissions Solutions once did a large business selling emissions control equipment. But this turned out to be an unattractive business model and the company has exited, choosing instead to focus on its proprietary chemicals. In 2015 and 2016, coal-fired power plants by and large installed mercury-scrubbing equipment to meet environmental mandates. These systems now require chemical consumables that keep them running effectively and make them last longer by reducing corrosion. Advanced Emissions Solutions estimates the total annual market for these consumables is $400-600 million, and the market for the specific product types that Advanced Emissions Solutions offers is around $100 million. Thus far, the company has managed to capture only a small portion of this market. But the company believes its offerings are competitive, and the industry seems to be agreeing. Chemicals revenue grew over 400% quarter-over-quarter to $2.3 million. If the company’s products continue to take market share, the chemicals business could be a very valuable one for Advanced Emissions Solutions.

Intellectual Property

Advanced Emissions Solutions holds 36 US patents, plus additional international and/or pending patents. Some of these patents are related to technology used at the Tinuum facilities, for which the company receives royalties. Others relate to the chemical business. The company is seeking ways to monetize these and other patents, whether through licensing or outright sales. It is very difficult to quantify any potential outcome and I will not venture a guess as to if, when, or how much gain the company could ultimately achieve. Nonetheless,  the company’s intellectual property is both a competitive advantage and a potential source of cash.

Company Background and Strategy

One reason the market has been slow to recognize the value of Advanced Emissions Solutions is the company’s tumultuous past. Under the previous management team, the company suffered from very poor capital allocation: a high research & development spend with little to show for it and under-utilization of Tinuum’s assets. Operating costs ballooned, and the company even got into trouble with its financial filings, becoming delinquent and being delisted. New management came in in 2015 and quickly set about reducing costs, restating the financials and focusing on efficiency. The result is greatly reduced costs and a new focus on getting the most out of the company’s best assets. The company also settled some lingering litigation and returned to the NASDAQ.

Advanced Emissions Solutions’ operating costs have been slashed in half, from over $40 million in 2015 to a $20 million annual run rate for the most recent quarter. In previous presentations, management guided for ultimate annual corporate costs of $12-14 million. That seems optimistic to me, but I think $15-16 million is very much achievable.

Capital allocation policy has been revamped. The company just completed a tender offer for 6.2% of its shares, paying $9.40 for a total of $12.9 million. Advanced Emissions Solutions also initiated a dividend and now pays a generous 25 cents per quarter. This dividend is very well supported by Tinuum’s regular distributions. Going forward, the company will focus on returning capital to shareholders, investing in the growing chemical segment, and potentially on acquisition opportunities if they can find compelling deals.

Just recently, the company implemented a tax asset protection plan. Advanced Emissions Solutions has over $100 million in net operating loss carryforwards, which will shield the company from taxation for some time.

Valuation

Evaluating Advanced Emissions Solutions’ worth in full is a challenging process. However, I believe the value of Tinuum in its current state alone, less corporate costs, equals the company’s enterprise value. Any potential value from additional facility leases by Tinuum, growth in the chemical business, or monetization of the company’s intellectual property would only increase value.

My very conservative short-hand valuation incorporates $275 million in distributions received from Tinuum between now and 2021, less $16 million in annual corporate costs over the same period. Discounted at 10%, the present value of the Tinuum distributions less corporate costs equals $158 million. To this figure I would add the $10 million in cash the company holds following their tender offer and dividend payment. Finally, I would credit the company for its NOLs at 10 cents on the dollar. (Normally, I am very skeptical of the value of NOLs. However, given that Advanced Emissions Solutions is already producing substantial profits, I think it is very likely the NOLs are fully utilized.) That adds another $10 million, for a very rough valuation of $178 million.

As I write, the company’s enterprise value is $181 million. So all of the company’s positive optionality is valued by the market at $3 million. Again, the company possess multiple levers for achieving a much higher value, the easiest of which seems to be the potential for additional facility leases by Tinuum. It should be clear that I believe Advanced Emissions Solutions is worth substantially more. However, I think that highlighting the company’s very limited downside is most appropriate in this scenario where the timing and amount of additional value from unproven assets is uncertain.

Alluvial Capital Management, LLC holds shares of Advanced Emissions Solutions for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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14 Responses to Thoughts on Advanced Emissions Solutions – ADES

  1. Austin says:

    Thanks for the post and great blog.

    I’ve been looking at this and agree that it’s cheap. What do you think about management compensation? Judging by the most recent proxy it looks quite high for a company with a market cap south of $200M. I worry that the management team, having every desire to keep their highly paid positions, will make one or more value destroying acquisitions. They’ve already telegraphed that they are on the hunt…..

    This said, Sampson has made all the right moves up to this point and should be commended for that.

    • otcadventures says:

      Definitely a concern. Like you said, Sampson has made good moves so far. But nearly every management team is liable to begin empire-building. As highly compensated executives, the temptation is even more present. I do wish management were paid less and owned more stock. I’ll be watching the company’s capital allocation policy carefully.

  2. Phil S. says:

    If the company is going to receive a lot of distributions, against a relatively small corporate overhead, then won’t that generate profits, and taxation, eating up the NOLs?

    Another way – are you essentially double counting the NOLs, or ignoring taxes, with your valuation?

    (275M distributions, less 5 years costs at 16M/per)=195M gross profits.

    I’m not sure what their tax rate would be, absent NOLs, but let’s say 35%. That leaves ~127M in the absence of NOLs. But if the first $100M in gross profits are shielded by the NOLs, then we have roughly 100M in gross profits, shielded, plus 95M that takes perhaps a 35% tax haircut, so a total of about 162M. But I haven’t discounted the 162M at all. Exact discounted value would depend on both discount rate and timing – you got 158M discounted, but I don’t think you accounted for taxes at all. With a 10% discount rate, and assuming the 162M is somewhat spread over the next 5 years (perhaps a bit front loaded, as the first profits are tax-shielded by the NOLs, and the later profits are not), a discounted value might be in the neighborhood of ~130M. Add in 10M in cash, but nothing in NOLs (remember, we used those up shielding the gross profits), and we’re ballpark 140M, versus your 181M.

    Or did I miss something and/or did you already account for taxes somehow?

    • Phil S. says:

      Note: I was basically trying to use your numbers, except for the tax issue. I haven’t looked into this company myself, so I can’t vouch for whether your #s are sensible in general.

      And for what it’s worth, I’d probably choose a somewhat lower discount rate, but on the other hand, I’d look very closely at whether management could be expected to use cash flow from the distributions productively – either returning it to shareholders or investing it productively…

      • otcadventures says:

        You make some great points. To your question about possible double-counting, I am assuming that the cash flows from Tinuum will be much higher than the actual taxable income. This is likely because Tinuum is essentially in run-off as the 2012 tax law cliff approaches. Depreciation and/or write-downs should shield Tinuum’s distributions from taxation. That said, it is possible that taxable earnings will consume the NOLs. In my view, that’s a good problem to have, even if it results in higher tax expense down the road. Fully utilizing the NOLs would probably mean that either Tinuum’s earnings come in higher than expected or the chemicals business takes off.

  3. valuedontlie says:

    Have you thought about a potential scenario where these RC’s burn less or significantly less coal than anticipated? This would seem to impact the cash flow they receive pretty heavily. I guess if renewable sources accelerated relative to coal sources through 2021, that would be a potential downside case.

  4. ActOfWill says:

    Hi thanks for posting this is a great idea. I get a bit confused in the last paragraph where you jump from NAV $178m to EV $181m – are you therefore not double counting the cash of ca $10m?

    • otcadventures says:

      Yes, I totally did. I realized that shortly after posting it, but decided to let it go. Either way, $3 million or $13 million is a pretty small price for the optionality the company possesses.

      • ActOfWill says:

        Looking into this a bit deeper. The contracts are cancellable and I would rather discount this with a 15% rate because of that risk.Also one could argue that corporate costs could continue if the contracts are actually cancelled.
        So sum of that brings me to the conclusion that you are paying roughly $1.75-2.25/sh for the stub business – depending on your view of stock-based compensation. Not a clear no-brainer to me based on these assumptions.

  5. JG says:

    Personally I am mostly concerned about Goldman’s ability to renegotiate their contracts each year. As long as they only utilize a portion of their facilities, it seems they are in the weaker negotiation position although its obviously a win-win to keep these structures alive till 2021. It is all above how the pie is divided…

    Anyway, given the upside optionallity from the chemicals business, and risk profile of their RC business, I think this is attractively priced.

  6. Andrew says:

    I was quite concerned about the contracts being renegotiated reading the annual report as well. But the recently signed RC deal suggests to me that the current circumstances are still similar and no imminent risk of significant change in terms are on the table.

    Any idea of why this is being shorted so heavily?

  7. Maybe4less says:

    Isn’t there a chance that the existing contracts are canceled early? There is a reason that 7 of the equipped plants are not being used…

  8. Austin says:

    I just glanced at their Q2 results. On slide 16 of the quarterly IR presentation, both the upper and lower bounds of their “Expected Future ADES Cash Flows” are $50M lower than those in the Q1 presentation. They didn’t have anywhere close to $50M in cash flow from the refined coal segment in 1H 2017…..so if I’m looking at this correctly there is a mysterious gap?

  9. West says:

    Any thoughts on Q2 2017 call/earnings? They got their G&A down. And the press release and earnings call seemed to be very bullish for Tinuum right now in adding monetizations through 2017 and early 2018. I calculate each additional monetization could be worth $1/share (depends on discount rate and size). Monetizing only half a facility seems pretty bullish as well (owning tax credits for their own account only makes sense if they have cash flows to use them). Any new thoughts?

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