Chart Industries: Massive Overreaction Creates Massive Opportunity
A $4.4B acquisition eroded $5B in value. At some point, the market will realize the math doesn't add up
GTLS stock collapsed after announcing an acquisition earlier this month.
Incredibly, the stock’s enterprise value has dipped by almost $5 billion; the purchase will only cost $4.4 billion.
There are worries here — but there’s opportunity as well. The plunge limits downside risk and shareholders can win big if Chart’s strategy proves correct.
Less than two weeks ago, shareholders in energy equipment manufacturer Chart Industries GTLS 0.00 were sitting pretty. On Tuesday, Nov. 8, GTLS closed just shy of $240. At that point, the stock had returned 50% year-to-date, against a 19% loss in the S&P 500 index, even including dividends.
The rally didn’t necessarily have to end. With Q3 earnings in late October, Chart Industries gave a solid outlook for both Q4 and 2023. At the post-earnings close, GTLS traded at 32x the midpoint of 2023 adjusted dilutedEPS guidance. That multiple looked potentially expensive in the context of the broader market, but not dramatically so in the context of multi-year tailwinds behind the business.
Indeed, the market saw the post-earnings rally as too little, not too much. GTLS had gained a little over 4% the day its earnings were released premarket. It then tacked on another 12.6% over the following seven trading sessions, hitting all-time highs in the process.
After that rally, at the close on 11/8, Chart had a fully-diluted market cap of $10.33 billion, and net debt of $491 million, for an enterprise value of $10.82 billion.
The Howden Group
Before the market opened on Nov. 9, Chart announced that it was acquiring United Kingdom-based Howden for total consideration of $4.4 billion. GTLS plunged 15% at the open, and kept falling. It finished the day down 35.6%. A six-session losing streak followed, in which shares declined another 20.6%.
After a 3% rally on Friday, and pro forma for the acquisition, Chart has an enterprise value of $10.24 billion.
Chart Industries with Howden is worth $580 million less than it was without Howden a week and a half ago. Chart without Howden is worth nearly $5 billion less.
Put another way, if Chart had lit $4.4 billion in cash on fire in a massive bonfire on the front lawn of its headquarters, from a purely fundamental perspective GTLS stock should have closed Friday above $137, 9% higher than its actual close.
To be sure, the story isn’t quite that simple. But it’s close. As a result, the decision tree is relatively simple. Either there’s strong negative implications from the acquisition — or GTLS is a buy here. The latter explanation seems to be the right one.
source: Chart Industries
Introducing Chart Industries
Chart Industries is a diversified manufacturer of industrial equipment primarily (though not exclusively) used in energy and industrial gas end markets. (The ‘GTLS’ ticker is an acronym for “Gas to Liquid Systems”.)
The portfolio includes bulk tanks, vaporizers, fueling tanks, railcars, and many other products:
source: Chart Industries presentation, May 2022
Formerly a company that focused mostly on industrial gases and LNG (liquefied natural gas), Chart has diversified its end marketsin recent years. It’s now targeting what it calls the “Nexus of Clean”, ranging from clean energy (LNG, hydrogen, etc.) to clean water to clean agriculture (including cannabis and CBD, or cannabidiol, production):
source: Chart Industries presentation, May 2022
Chart has four reporting segments:
Cryo Tank Solutions (34% of 2021 revenue): storage of cryogenic liquids, targeting the industrial gas and LNG markets
Heat Transfer Systems (20%): equipment and systems used in gas-to-liquid applications for customers in LNG, petrochemicals, refining, and even HVAC
Specialty Products (33%): equipment for specialty end markets including LNG again, biofuels, cannabis, food and beverage and more
Repair, Service & Leasing (13%).
Chart has been an aggressive acquirer in recent years, spending $1.56 billion on deals just since the beginning of 2016. Until recently, that had been an exceptionally successful strategy. From Jan. 1, 2016 until Oct. 31 of this year, GTLS returned 1,140%, or roughly 44% on an annualized basis.
Was GTLS Stock Too Expensive?
One justification for a $5 billion collapse in a couple of weeks is if the stock was substantially too expensive before the deal was announced. (We will of course double-check the results created from this perspective with analysis of the pro forma fundamental profile.)
So was GTLS overpriced on 11/8? More importantly, was it substantially so? Again, we’re not talking a modest post-acquisition sell-off. Chart’s enterprise value declined by just shy of $5 billion after a $4.4 billion deal.
In retrospect, it’s difficult to see GTLS’ prior valuation as detached from reality. Again, the stock gained not just the day of earnings, but in the ensuing sessions, as investors digested the results from Q3 and the guidance for Q4. That guidance suggests, at the midpoint, 56% year-over-year growth.
To be sure, that figure is inflated. Chart actually reduced its 2022 adjusted earnings per share outlook (even with a lower expected tax rate) because of deal timing. Timing that in turn benefited the 2023 guidance. But this is still a business growing at a rapid clip. At the May Investor Day, Chart forecast a three-year annualized adjusted EPS growth rate above 25% (off a higher expected 2022 base, of $5.35-$6.50).
It’s also a business with significant, multi-year secular tailwinds, including but not limited to LNG demand and the Inflation Reduction Act. The IRA is driving demand in hydrogen (where orders already had skyrocketed in 2021), carbon capture, and water supply and drought mitigation.
At the 11/8 close, GTLS traded at 36x FY23 adjusted EPS guidance (a range of $7.50 to $8.50 non-diluted, or at the midpoint ~$6.60 diluted). That multiple doesn’t seem dramatically out of line. This is a business that has doubled orders this year; is guiding for 50%-plus growth next year, and is serving a good number of markets that are growing at double-digit rates for 10-plus years. For what it’s worth, analysts seemed to think valuation was reasonable. Goldman upgraded to Buy with a $259 price target in September; Jefferies initiated at $250 the following month.
To be fair, there were some doubters. Short interest at 10/31 was 5 million shares, or nearly 14% of the float. Hedges related to convertible debt likely inflated that figure somewhat, but it’s not hard to see why unhedged shorts might take aim at an expensive stock riding a “clean energy” wave. And if we’re going to focus on the analysts supporting the pre-acquisition price, it’s worth pointing out that Wells Fargo and Piper Sandler both slashed targets back toward current levels. (Though to our reading both firms seem to be trying to catch up with the stock rather than making a real fundamental case for the decline).
However, we’re looking for evidence that GTLS was materially and significantly overvalued before the Howden deal. It isn’t there. The $239 peak wasn’t coming from a crazy trading rally or short-term anomaly. A company with a bullish long-term profile issued a strong near-term outlook, and the market priced that company as if its earnings were going to grow at an impressive rate. The simplest thing to do here is to assume that the market was reasonably correct in doing so.
How The Howden Deal Goes Wrong
That in turn leaves the explanation for the decline being that this deal is a disaster. It must be so ill-advised that Chart bears the risk of destroying most, if not all, of the value it is sending to Howden’s private equity owners.
To be sure, there are some concerns here. Valuation is one of them. Chart is paying 13x trailing twelve-month Adjusted EBITDA. That’s a heady multiple in this market. It’s also a notable premium to the price paid by the current owner. KPS Capital Partners acquired Howden from Colfax (now Enovis ENOV 0.00) in 2019 for $1.8 billion.
That said, Howden’s Adjusted EBITDA at the time of the 2019 sale was $200 million; over the twelve months ending August of this year, it was $342 million.
Per a supplemental presentation issued on Nov. 14 (apparently an effort to calm the market), in Howden’s organic revenue growth in 2019 was negative. That wasn’t a blip, either: per Colfax’s 2018 10-K (see p. 51 — Howden is the Air and Gas Handling business) organic revenue and orders growth were negative in both 2017 and 2018 as well.
Over the last twelve months, however, Howden's revenue has grown 27%. There are other acquisitions in there: Howden made six deals last year, and a seventh in March. The only one with a disclosed purchase price closed in December, when EnPro NPO 0.00 sold Howden its compressor products business for $195 million. Assuming the other deals were much smaller ( as appears to be the case) a cited 10.4x EBITDA multiple means that Howden's ~70% EBITDA growth since 2019 has been mostly organic.
Still, that cited 10.4x multiple in the Colfax deal does highlight potential valuation concerns. Howden sold for 9x in 2019, and bought a business for 10.4x; now a P-E firm (which usually has the advantage in negotiations as a seller) is getting 13x. And while Howden grew LTM revenue 27%, Chart itself is only targeting top-line above 10% even including revenue synergies. In other words, there seems a well-founded fear that Chart overpaid.
Interest expense is a concern as well (one raised by both analysts who downgraded the stock). The $1.1 billion in preferred stock will have a 6% yield, along with a conversion price at 97.5% of the GTLS market price at deal close. The $3.375 billion in debt needed to refinance the bridge facility might go off at 8% or more in this market (Chart anticipates it will be 4.25x levered before the preferred), which suggests pre-tax interest expense of some $300 million annually.
If Chart hits the standard M&A pitfalls, it’s easy to see a worst-case scenario play out. Synergies don’t materialize to the level believed; Howden’s growth stalls out; the incremental profit added barely covers (or doesn’t cover!) the interest on new debt and preferred stock. In that scenario, perhaps Chart really is worth almost $600 million less with Howden than without it.
The Case For The Deal
Had I owned GLTS on Nov. 8, saw the deal, and saw the stock open down 15%, I’d have been tempted to cut and run. To assume zero reaction from the market here is foolish.
But, again, we didn’t get zero reaction. GTLS is down 47% in eight sessions. And there is yet a case for the acquisition.
13x EBITDA sounds high, yes. But Howden is a growing business with ~20% EBITDA margins. It plays in many of the same end markets as Chart. That creates revenue synergies and suggests a potential premium to other industrials. It’s the prospects of those end markets, after all, that led to GTLS receiving a premium until two weeks ago.
And 13x is the figure based on standalone earnings. $175 million in anticipated first-year synergies move the EV/EBITDA multiple down to 8.5x, and $75 million in incremental savings in years two and three drop it further to 7.4x.
There’s a strategic logic to the tie-up as well. Chart sees $350 million in revenue synergies thanks to cross-selling, with the November 14 presentation providing an example in the hydrogen liquefaction market:
source: Chart presentation, November 14
Howden also moves Chart into new markets including nuclear, biomass, and mining.
To be sure, every M&A deal looks good on PowerPoint slides. Despite that fact, most fail to provide the anticipated benefits. Chart is levering up in a period of higher interest rates and (at least on a pre-synergy basis) it’s levering up to pay what seems like a hefty premium. And oddly (as analysts have noted), it’s paying up for its revenue growth to actually decelerate (that’s per Chart’s own projections, not the Street’s).
But this deal doesn’t look all that different from any other made in this environment. Synergies are material. Cross-selling holds promise. This deal absolutely can work.
And while the market is panicking now, it’s worth returning to a previous point: Chart spent over $1.5 billion on acquisitions since the beginning of 2016. Its market capitalization over that period (excluding the impact of the current convertible notes) increased by nearly $8 billion.
The plunge over the past two weeks doesn’t assumes little synergy. Chart’s own history suggests that view is too pessimistic.
Valuing GTLS Now
Pre-synergies, GTLS doesn’t look particularly cheap right now. EV/EBITDA is about 15x, based on 2022 performance. Pro forma net leverage before the preferred stock nears 6x.
But including cost synergies (per the Nov. 14 presentation) pro forma Adjusted EBITDA gets to the $1 billion range, suggesting a 4.2x net leverage ratio and a 10x EV/EBITDA multiple. Looking out to 2024, Chart sees Adjusted EBITDA of ~$1.3 billion, with deleveraging getting the net leverage ratio under 3x.
Bear in mind that before the acquisition, GTLS was valued at nearly 30x this year’s EBITDA, and more than 20x the FY23 figure. Should the combined company hit those 2024 targets, there’s a real path to a double or more. At EV/EBITDA of 15x (blended between high-teens for Chart and low-teens for Howden) the enterprise value nears $20 billion with a market cap in the $16 billion range.
To be sure, management targets following acquisitions are nearly always rather high. But in the context of downside risk (which requires Howden blowing up and Chart taking the hit) the upside on offer is enormously attractive. As a result, so is GTLS stock.
As of this writing, Vince Martin has no positions in any securities mentioned. He may initiate a position in GTLS this week.
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Chart guides for non-diluted adjusted EPS; the 32x multiple accounts for potential dilution (see calculation in footnote 2)
An important note on calculations here. Shares outstanding include the basic figure at 10/24 of 36.635 million, per the 10-Q, plus:
280K stock options (assumed exercise price is $60), adding 210K shares via Treasury stock method;
2.7 million warrants with an exercise price of $71.75, adding 1.89 million shares via the Treasury stock method;
4.4 million shares added via full conversion of convertible debt ($258.5M principal with a conversion price of $58.725).
Net debt excludes the convertible notes, which are being treated on an as-converted basis and thus included in fully-diluted market cap.
Same calculation above at new lower price; note that the fully-diluted share count decreases modestly as well (at least via the Treasury stock method). The entire $4.4 billion acquisition price is treated here as debt, though Chart plans to fund roughly one-quarter via preferred stock.
This is exemplified by an unusually broad list of major customers which per the 10-K (p. 3) includes oil majors like ExxonMobil and Shell and industrial gas giants Linde and Air Liquide — but also Samsung, Plug Power, space exploration startup Blue Origin…and Chick-fil-A.
Super good play so far !!
Going strong in as well Monday