Zekelman Industries IPO: Risky, But Not Expensive

Assuming 2019 forward EBITDA of $570 million, Zekelman Industries, Inc. (ZEK) will be selling shares at 7.6x Forward EBITDA, which does not seem expensive. With that, investors need to get to know several risks on this name. The most significant risk is the debt outstanding. It may not seem a problem right now, but it could be an issue in three to five years when a large portion of the debt is due. Additionally, the fact that the company is controlled by directors will not be liked by investors.

Source: Prospectus

Zekelman hired very relevant investment banks to organize the IPO. It is very beneficial:

Source: Prospectus

Business, Brands And Applications

Founded by the Zekelman family in 1984 and headquartered in Chicago, Illinois, Zekelman Industries, Inc. is the largest manufacturer by volume of Hollow Structural Sections and electrical conduit products in North America as well as the most significant producer of standard pipe products in the U.S.

Source: Prospectus

The manufacturing capabilities of Zekelman are large. The company runs 13 manufacturing facilities and has produced as much as 2.1 million tons of product in the last 12 months period. Zekelman Industries also owns a long list of brands. Some have been acquired and others were designed in-house. The most significant is Atlas, which is responsible for 49% of net sales. It is used in construction architectural applications, structural components for vehicles as well as some other applications.

Source: zekelman.com

In addition, Wheatland Tube, Western Tube and Picoma represent 27% of net sales and are useful for encasement of electrical wires in construction applications among other uses. The images below provide more detailed information on the products and brands offered by Zekelman:

Source: Prospectus

Source: Prospectus

With Zekelman being a large manufacturer in North America, it is interesting that the company makes 86% of its net sales in the United States. What about Europe, Asia, South America and the rest of the world? Zekelman notes that operating in other countries is complicated since the transport of their products is expensive:

“Because many of our customers’ product applications require domestically manufactured pipe and tube components, and since imported products and our product portfolio in particular, must be shipped long distances via ocean freight at a high cost and at risk of product damage, we believe domestically produced standard pipe and energy tubular products will remain competitive with imported products.” Source: Prospectus

With that, could the company not run facilities outside the United States? The image below shows the list of facilities run by Zekelman. It is worth noticing that all of them are in North America:

Source: Prospectus

Additionally, out of the company’s total headcount, 2,300 employees, all of them work in the United States and Canada:

Source: Prospectus

Taking into account the expertise accumulated by Zekelman, an international expansion should not be that complicated. It remains a potential source of growth that should push revenues and the stock price up. With this in mind, following the next steps of Zekelman seems interesting.

Demand, Acquisitions And Future Growth

The largest buyers of steel pipe and tube products are non-residential construction, infrastructure and large industrial conglomerates. With this in mind, the demand for Zekelman’s products should move in relation with the building of new non-residential construction. According to U.S. Census and the FMI, the total non-residential put in place in the United States has grown at a moderate level since 2013, and it is expected to grow at a 3.8% CAGR level in the next four years. It is shown in the image below:

Source: Prospectus

However, Zekelman’s revenue growth and company growth could be larger than 3.8% CAGR. Keep in mind that the company does not only grow organically, but also through acquisitions of other smaller competitors. The image below provides a list of the transactions executed from 2006. Notice that the most relevant brands, such as Atlas, Western Tube and Picoma, were acquired from other competitors:

Source: Prospectus

Goodwill Comprises of 40% of The Total Assets

The balance sheet is the part that investors may dislike. Since the company has acquired several companies recently, the amount of goodwill is significant. As of September 30, 2017, Zekelman shows $2.284 billion in total assets and goodwill of $0.914 billion. Additionally, customer relationship equals 181 million. These are assets acquired, which could be impaired in the future reducing the total value of assets and the total assets per share. The share price could decline sharply if this happens, thus investors need to understand very well the risk. The image below shows the assets in 2017 and 2016. Note that total assets increased by 16% as a result of the acquisitions of Western Tube and American Tube in 2017:

Source: Prospectus

Financial Risk Seems Large

The total amount of liabilities equals $1.808 billion in 2017 with $1.289 billion in long-term debt. This means that the assets/liabilities ratio was 1.26x and the ratio of long-term debt/assets was equal to 0.56x, which seemed too large. The financial risk of Zekelman is very worrying. Investors need to understand well that if the new transactions are not successful, the risk is large on this name.

Source: Prospectus

A large portion of the debt will be paid in three to five years, thus investors should watch out from the year 2021 to 2023. The table below is what most investors need to study closely: Source: Prospectus

Sales Growth: 34.81% y/y

The company reported net sales of $2.095 billion for the year ended September 30, 2017, 34.81% more than that of 2016. Deducting the acquisitions of Western Tube and American Tube, which reported $220 million and $70 million respectively, the revenues increased by 16.15% in 2017, which seems large. In addition, it seems remarkable that the company reported net income of $141 million in 2017, 138% more than that in 2016. Investors will appreciate these financial figures:

Source: Prospectus

The cash flow from operations is also very beneficial with 159 million in 2017 and $174 million in 2016. Using 186.66 million shares outstanding after the offering, the cash flow per share will be approximately equal to $0.85. If the shares are sold at $19, they will trade at 22x the company’s CFO, which does not seem very high.

Source: Prospectus

Use of Proceeds: To Repay The Debt

As expected, the company will use the proceeds from the IPO to repay a portion of its debt. Most investors will not appreciate it. But, it seems the right thing to do right now. Zekelman does not look appealing with such massive debt outstanding. The debt/assets ratio will diminish, and the financial risk will be a bit lower.

Source: Prospectus

Capitalization and Valuation

Zekelman expects to have debt of $849 million and cash of $44 million after the IPO goes live. With 186.66 million shares outstanding at $19, the market capitalization will be equal to $3.54 billion. With these figures in mind, the expected enterprise value will be equal to $4.34 billion. The image below provides the expected capitalization:

Source: Prospectus

EBITDA for the year ended June 30, 2018 was equal to $492 million. The EBITDA for the year ended September 30, 2017 was $369 billion, 26% more than that of 2016. With these figures in mind, 2019 forward EBITDA of $570 million seems reasonable. The image below provides further details on this matter:

Source: Prospectus

Using 2019 forward EBITDA of $570 million, the EV/Forward EBITDA equals 7.6x, which seems appropriate as compared to other peers.

  • Nucor Corporation (NUE) trades at 7.88x EBITDA with 25,000 employees, net debt of approximately $2.8 billion, and enterprise value of $23 billion.

  • PAO TMK ADR (OTCPK:TMKXY) trades at 6.59x EBITDA with debt of $3 billion, and enterprise value of $4.27 billion.

Regarding other competitors, there are many in the U.S., which are private and small. Thus, the company seems to have potential candidates to acquire. The image below provides further information on the competitors of Zekelman:

Source: Prospectus

Controlled Company

The assessment of the shareholders shows that the company is fully controlled by directors inside the firm. In addition, the CEO will own 46.3% of the company after the IPO. The table below provides more details:

Source: Prospectus

With this information in mind, most investors will not appreciate that the company is controlled. The Board of Directors seems independent, but there are still some risks. The Board and the CEO could take decisions to benefit the controlling shareholders, which could damage the interest of minority shareholders:

Source: Prospectus

The lines below provide information about transactions that do not seem to benefit shareholders at all. There are related parties controlled by directors of the firm which sold buildings to the company and have commercial relations with Zekelman Industries. It is not ideal:

Source: Prospectus

Conclusion

With shares being sold at 7.6x forward EBITDA, the company does not seem expensive as compared to other peers. However, investors will need to get to know that there exists large amount of risks on this name. Firstly, the financial risk with debt of $849 million is quite worrying. Secondly, the balance sheet shows large amount of goodwill, which could be impaired. Finally, this is a controlled company. The Board of Directors could take decisions to benefit the controlling shareholders.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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