Major Positive Update on PPSI

I think the risk/reward remains attractive at current share price levels.

Pioneer Power Solutions (PPSI) — Initial post here, last update here

In this post, I am sharing my quick thoughts on Pioneer Power Solutions (PPSI) following major recent update from the company. I believe the update is mostly positive. While I intend to reassess the situation after the company provides further details with its Q3 earnings (expected in the "next couple of weeks"), for now, I continue to think that the risk/reward is attractive.

Before diving into the update, let me provide a quick refresher for those not familiar with the idea. PPSI is a manufacturer of electrical power management products with two key product lines: the mature, cash-generative e-Bloc (switchgear systems) and the still-unprofitable but fast-growing e-Boost (portable fast-charging units for EVs). The PPSI investment thesis is pretty straightforward: the company presents a cheap way to bet on the anticipated growth of EV infrastructure. PPSI has been trading at sub-20x 2024E P/E, an undemanding multiple given company’s rapid c. 50% topline growth in 2022 and 2023.

The big news came yesterday as PPSI announced it has divested the e-Bloc business to PE firm Mill Point Capital for $50m compared to PPSI’s current market cap of $73m ($65m EV). The consideration is comprised largely of cash, $48m, along with $2m in equity of the e-Bloc business. The transaction values the e-Bloc business at c. 11x 2023E EBITDA (before corporate overheads), which appears to be a fair valuation. With one of the two business segments divested, the sale will transform PPSI into a pure-play mobile fast-charging unit manufacturer.

So, what do we make of this divestiture, and what are the implications for the investment thesis? I think there are two key aspects that need to be discussed, namely 1) PPSI’s allocation of the divestiture proceeds and 2) the valuation of the RemainCo.

Let’s start with capital allocation. During the conference call, PPSI’s management stated that it expects to return capital to equity holders via stock buyback or a special dividend while also mentioning that the company will be looking for a value-accretive acquisition. Management provided limited further details, and the company expects to provide a more detailed plan on capital allocation together with Q3 results/call. So, it is difficult to make any strong conclusions until management sheds more light on capital allocation going forward.

Having said that, I would expect a sizable special dividend and/or stock buyback to be announced. Why? Well, PPSI, led by its long-time CEO, has a track record of initiating substantial special dividends after asset divestitures. Here, I would point you to PPSI’s divestiture of its Transformer Business back in Aug'19 for $68m, with $61m of the consideration in cash (interestingly, the sale was performed to the same PE firm, Mill Point Capital). At the time of the sale closing, PPSI’s management similarly hinted that it was “evaluating various options for the proceeds, including returning capital to shareholders and strategic M&A.” Then, just one month after the divestiture closing, PPSI announced a $1.37/share or $12m special dividend. The dividend was later enjoined by a court related to PPSI’s then-ongoing legal case against another electrical equipment manufacturer, but nonetheless, this highlights management’s willingness to return capital to equity holders.

Now, you could point out here that the previous special dividend was a small portion of the total Transformer Business divestiture proceeds, so the chances of the company pursuing a large acquisition with the remaining proceeds from the recent e-Bloc segment sale might be substantial. And I would agree, as the potential acquisition would have strong rationale given how subscale the e-Boost business currently is. During the conference call, management hinted that a potential acquisition might be large, with the target boasting >$25m in annual revenues, which would allow the company to benefit from corporate overhead synergies and enable e-Boost to reach profitability faster (see the exchange from the conference call below).

Question: I want to get a little sense of what you see in terms of your M&A strategy and maybe it's too early to sort of detail it, but what are some of the opportunities you see? And how do you think M&A can improve the E-BOOST sort of segment?

Answer: Yes. I mean, financially, it allows us to get bigger faster and really carry the burden, spread the burden of the overhead among more -- a larger scale. With that said, it would have to be something we've done a lot of work to take E-BOOST from a real money-losing business to something that's close to breaking even to hopefully making significant net profit within the next 12 months. So with that in mind, it would have to be sizable at least $25 million of revenue a year. It would have to not be bleeding. And of course, it would have to be related and enhance what we've already built up here. So it may be a very narrow group of candidates, but that's what we'd be looking for.

I must admit that a potential acquisition is not something I would generally like to rely on in an investment setup. However, I think that the chances of any value-destructive transaction are limited. From the quote above, management has hinted that it would be selective with respect to M&A, highlighting only “a very narrow” potential target pool. I would note here that since the large divestiture of the Transformer Business, PPSI has not pursued any acquisitions, instead opting to pursue growth with new products launched in-house (i.e., e-Boost). So, I think it is more likely that we will see reinvestments into the e-Boost business rather than large, value-destructive acquisitions if no suitable M&A opportunities arise. Another aspect worth keeping in mind is that PPSI’s CEO holds a sizable 20% stake. At current market prices, the CEO’s stake is valued at c. $15m compared to his annual salary of $1.2m in 2023, so I think incentives are well-aligned.

So, these are my thoughts on potential capital allocation. While this is mostly speculation on my part before the company reveals concrete plans, I think it is reasonable to conclude that management is unlikely to waste the divestiture cash proceeds.

Let’s now turn to the valuation of the RemainCo. Again, I’d note that this is my preliminary assessment as management expects to provide more specific financials and guidance for the e-Boost business along with Q3 results. But, based on currently available information, the e-Boost business seems cheap. Pro forma for the divestiture proceeds, the RemainCo is currently valued at $15m. This compares to e-Boost’s revenues of $9m in 2022, $11m in 2023, and $7m in H1’24. While this might not seem like huge growth, the key aspect here is e-Boost's expected revenue inflection in H2’24 and 2025 given the recent growth in customer orders. During the conference call, management stated that the e-Boost business is expected to generate $20m in 2024 (implying $13m in H2’24 alone and 50%+ annual growth).

And I would expect the topline to grow significantly in 2025 given the massive order backlog growth (see the table below). My understanding is that the backlog for the Critical Power Solutions segment (i.e., e-Boost) does not include several new orders announced in late Q2, including $7m and $5m. So, it would not be unreasonable to expect PPSI to generate $30m+ in revenues in 2025 based on existing orders alone.

Aside from the existing backlog, there is a strong likelihood of further significant orders for PPSI’s products. Despite the slowdown in EV adoption in the U.S., EVs remain a fast-growing market (see here), so it’s safe to say that demand for mobile charging stations will continue to grow. There is also growth potential with the launch of new products. I would note here that PPSI intends to launch HOMe-Boost, an EV fast-charging unit for homeowners, in early 2025. Considering the ample growth runway, the implied RemainCo’s valuation of 0.8x EV/2024E revenues seems undemanding.

So, that’s my take on the recent segment divestiture. To quickly summarize, I think we might see a substantial special dividend and/or stock buyback, while the chances of a value-destructive acquisition are low. Pro forma for the divestiture proceeds, the RemainCo is inexpensive, trading at sub-1x 2024E revenues for what is a high-growth business with plenty of growth runway and nearing profitability.

While PPSI shares have jumped 5% since the announcement and are now up over 60% from the write-up levels, I continue to believe that the risk/reward remains attractive given the aspects outlined above.

I will be waiting for Q3 results for more information from management on capital allocation and the RemainCo’s expected operational performance. For now, I continue to like the setup and have maintained my position.