On 3/13 we added short Mammoth Energy Services Inc. (TUSK) to our Best Ideas list. On 3/15 we hosted a call to discuss the thesis.
Link to TUSK Conference Call Video and Audio Replays
Our TUSK thesis is centered on its $945MM contract for electrical T&D work in Puerto Rico. Mammoth’s subsidiary, Cobra Energy, is earning a ~40-45% operating profit margin for its work in Puerto Rico, while other more established companies in the T&D space are earning between 0%-10%. With PREPA in bankruptcy protection, FEMA (funded with U.S. taxpayer dollars) is paying TUSK hundreds of millions of dollars in exorbitant profits.
At best, we believe TUSK will never see a contract like its current one in Puerto Rico again. The disaster recovery in Puerto Rico was plagued by a litany of factors that resulted in the award of two unprecedented and controversial, no-bid contracts by PREPA to Whitefish Energy and Cobra Energy. At worst, Cobra’s contract remains under scrutiny and could lead to cancellation or amendment.
We view the electrical T&D industry as highly competitive and fragmented; industry leaders, such as Quanta Services (PWR) and EMCOR Group (EME), typically earn a 5 – 10% operating profit margin. The amount of revenue and profit that TUSK is earning in Puerto Rico will never be repeated. This sets TUSK up to disappoint lofty revenue and margin expectations in 2H18 and 2019.
We value TUSK at ~$20/share, 33% downside from the current price of $30.
Additional detail on the intensifying government investigations and new PREPA documents…
Office of Inspector General (OIG) Will Investigate Cobra Contract……On 3/15/18 the acting Inspector General for the Department of Homeland Security, John Kelly, testified before the House Committee on Natural Resources. In his prepared testimony, Mr. Kelly wrote, “In Puerto Rico, we have work underway and planned, including…review of disaster-related contracting including the contracts with Whitefish Energy, Cobra Acquisitions, Bronze Star LLC (blue tarps) and Tribute Contracting LLC (meals), among others…” (John Kelly Testimony, Hedgeye emphasis). The other three contracts mentioned by name in the statement have all been canceled. During the Q&A portion of the hearing, Kelly stated that PREPA is an organization with “known risks” and that a lack of oversight would be a “recipe for disaster.”
FEMA Money Didn’t Flow to PREPA……PREPA is dependent on FEMA funds to pay Cobra Energy. Based on PREPA’s most recent cash flow update, FEMA provided a total of $1MM to PREPA for the weeks ended 3/2 and 3/9, compared to an average of $25MM per week through January and February. In a footnote, PREPA stated: “FEMA has informed PREPA that the $745M has been approved and $100M is expected to be transferred to the [General Account] during the week of 3/16/18” (PREPA Grid Status Update – 3/14/18, Hedgeye emphasis). It appears that FEMA, for now, has blessed the increased contract award and will continue to reimburse PREPA for Cobra Energy’s work on the island. Through the quarter-to-date, Cobra Energy has billed PREPA for an incremental ~$135MM of work. As of 3/10/18 Cobra Energy has billed PREPA a total of $335MM and been paid $200MM.
USACE Contractors Continue to Exit the Island……According to the most recent update by the USACE, Fluor and PowerSecure had 1,077 T&D employees on the ground in Puerto Rico, a ~20% decrease from 3/14/18. The rest of that workforce is slated to leave the island by early April despite significant pressure by Senate Democrats to extend the current contracts. Cobra Energy will assume some of the work left behind by the exiting USACE crews; Cobra’s line assignments recently increased from 9 to 11. According to the outgoing Interim Executive Director of PREPA, the company is in the process of procuring contracts with three contractors to help complete the grid restoration work. If that is indeed the case, it will a) set a new standard on contract value and profitability for Puerto Rico work as PREPA will likely use a competitive bid process for new contracts, and b) increase the competition for Cobra Energy and lower potential rates if funds are found to pay for grid upgrades, which we view as unlikely.
PREPA Gets A CEO……Walter Higgins III was named the first CEO of PREPA on 3/20/18. Unlike past leaders at PREPA, Higgins is from the continental United States with years of experience working in the utility space and has no political connections in Puerto Rico. He was most recently the CEO of Bermuda Electric Light Company. If there is new business to be won for grid upgrades, Cobra Energy will likely have a more difficult time convincing the new leadership that 45% operating profit margins are acceptable terms.
Please let us know if you have any questions or comments.
Kevin Kaiser
Managing Director
Alec Richards
Director
