A high-quality, rapidly growing recurring revenue services business, with an unnoticed growth catalyst and a clear path to becoming the go-to player for an unmet need
Hey Jake, what do big coal players in the US use for water treatment? For example AMR? I tried to look at can't find anyone specific so I'm guessing they use an in house team?
Very compelling. How do you get to 24 EBITDA of 9 though? Not sure I followed the maths- sounds like 5.5m incremental revenue - call it 2.5-3m (50% flow through) ebitda extra on top of FY23?
So FY23 should probably come in just shy of $5m EBITDA. Add the new Selen-IX plant (conservatively call it $1.8 contribution + one new average operating project ~.8m). Then, given where copper is trading, I think we are pretty clearly looking at additional ~$1m from there. Finally, given Technical Services has been growing at 40%, I think it's more than fair to assume some additional growth from that segment. I'd also note that, given the Tech Services backlog, and management upping their projection from two new operating projects per year to what is now 2-4, I'd be surprise if we are only tacking on 2 new operating projects in FY 24. So, that's roughly the math. It may be that this run-rate happens sooner or later than expected -- there's a lot of visibility here over time, but its tough to be precise on a quarterly or even an annual basis given lumpiness of projects transitioning to the operating phase.
I see what you're saying. Good catch. I suppose that should probably say ~8m given the assumptions I laid out (though those assumptions are almost surely too punitive). On sizing - obviously this isn't the most liquid name out there, so that needs to be kept in mind, although daily volume has already started ticking up a fair bit over the last couple weeks. I think this is a highly asymmetric bet given the valuation isn't particularly demanding even on the current run-rate earnings (which are largely from contracts that won't be rolling off for years) and we can be quite certain earnings are going to continue growing for at least a few years to come. Therefore, I have personally sized this up quite a bit. But as always, not advice.
* 3 out of 4 of their patents will expire in 2027,2028 and 2029, respectively. None of them covers the selenium removal though but it can still be a significant hit on revenue if they protect something critical.
* Also, they are sole bidders on 60% on projects, but has this gone up or gone down over time? Because there are indeed other existing competitors that offer selenium treatment, e.g. Chemtreat which provides a non-biological solution that can consistently reduce selenium levels to < 5ppb:
If indeed the piece of bidding cake has been declining, then this may be the cause. This particular company is private but has patented their technology as recent as 2018 (4 years after BQE's patent). Since the curent NPDES limit is < 5ppb, a miner who doesn't know better may want to choose the competitor over BQE if they are significantly cheaper. However NPDES is only for US as I understand it. So worst case is that BQE meets hard competition in US
*Another risk is coupled to the commentary above, which is the fact that we do not really understand this technology and BQE might have just developed "by chance" the first practicle non-biological version but not necessarily the best. Given the fact that the competitor has a recent solution may indicate that other companies are to come with their own solutions building on top of the other companies patented solutions.
EPA identified biological methods in 2015 the best available technology economically.
Another citation from the article:
" Biological treatment for the reliable removal of selenium is a proven technology in many industries, with over two dozen systems installed and a dozen more under construction. Since first introduced, the systems have advanced to produce safe, environmentally compliant, reliable and cost-effective performance.
Thanks for the comments Osten. I guess I'd start by suggesting that we zoom out and ask whether anything really turns on this: there's an enormous unaddressed market out there with little competition at the moment and a rapidly growing book of long-duration recurring revenue contracts; if the company maintained its present growth rate for another 1-2 years and then just completely stopped growing, we'd have a 20+ year stream of steady cash flows we'd be buying at a double digit cash flow yield. That said, let me address these concerns more directly -
On the three patents: I don't think these patents are materially important. The key lies 1) in the know-how; 2) the well-established relationships (e.g. they've been working with Glencore for some 20 years); and 3) the huge white-space (there are enough projects to go around for plenty of players);
Sole source bidding: they are the sole source bidder on most of their contracts because they make bids only selectively. The market is so large and unaddressed and they are so small that they have said they have the luxury of being selective and only looking for projects which they are the best equipped to address (see the Smallcap Discoveries interview I linked to)
Selenium Tech: I'm not sure what you mean by "we don't understanding the technology". I'm sure BQE and people operating in the space understand how it works. Again, my push back is -- the single Selen-IX plant they just brought online is going to single handedly double company-wide EBITDA once it fully ramps - BQE doesn't need to capture the entire space. I flagged above that there may be further competitors with new tech eventually, but the patent protection on Selen-IX seems pretty robust to me, and in any event by the time those technologies come online BQE's profits should be multiples higher than they are today;
- EPA may have made that identification because in 2015 there were no non-biological methods on the market as I understand it. Biological treatment does work effectively in some circumstances, but as I noted above, it provides real challenges for seasonal or non-continuous operations, as the system cannot be easily shut on/off, and it creates unwanted waste in some cases (I would watch the Stantec presentation I linked to).
What I mean by when I say we don't understand the technology is that we, the individual investors, do not really understand the technology how it really works, so we cannot say how well it stands in comparison to other companies, etc. So if a vastly better solution is developed then suddenly they may only be sole bidders of perhaps 20%.
But here I am thinking long term so I am not saying it will affect them short/medium term, so it is still a great thesis in that aspect and the TAM seem to be infinite more or less
A question I want to find out though is how this sole bidding number of 60% have fluctuated over the years.
It will be interesting to see how this plays out, thanks for sharing
You definitely raise good questions and you're right to think long-term; perhaps a better way to put my point above is that your concerns, imo, raise more questions of uncertainty rather than of risk - that is, if the competitive dynamics for BQE end up being weaker than we think, that might impact our long term upside, but I don't see it as posing any downside risk at this valuation.
I'd add a couple more points to your concerns:
- Selen-IX is obviously quite new, and a lot of the literature and discussion we've both looked at hasn't really had to time to digest its pros and cons over the competition with respect to how things work in the field - i.e. what the scientists say vs. what makes sense practically speaking for mining company might be at odds (and given what we've seen of the adoption of the technology, it seems that Selen-IX has quite a bit of appeal for the miners);
Some further reading if interested: 1) This Alberta gov research on the treatment of selenium at coal mines. The chart on page 36 ranks treatment options, with Ion exchange coming in just below RO and nanofiltration (Selen-IX is not entirely Ion exchange (its also electrochemical) so this chart may not be really capturing BQE)
The science angle here is definitely something I am working on getting more fluent with and I'll try to write a follow up piece flushing this out eventually.
It's possible, but I think one should be cautious reading too much into it. There's a ton of unnuanced, histrionic commentary on Loper's implications from liberal media that should be taken with a grain of salt. The decision will surely have an impact on the promulgation of new rules under ambiguous statutory provisions and injects a lot of uncertainty going forward, but we aren't going to see the status quo upended over night. And remember, Chevron deference applied in both directions - i.e. it accorded deference to the administrative state while the executive was controlled by Republicans. In short, it's worth monitoring but this isn't going to quickly change any of the relevant landscape for our purposes.
Wow one of the best write ups I’m seen in a long time! One question: do you know how many consulting projects result in operational mines? At 8M I’m assuming 22 projects going right now with operational revenues on a significant delay.
Also anyone know anything about the major shareholders and how that came to be?
Thanks Michael. I'm not sure it's possible to answer because there are so many variables outside of BQE's control that go into whether a consulting project will transition to the operations stage. However, if you read the MD&A's, the company provides a list of each project with Technical Services work ongoing, so if you review those over time you can get a decent sense of conversion. I'd also note that Technical Services involve several stages of work, which BQE bills different amounts for. So although the stated average project revenue tracks over time, early stage ones generally bill less revenue. .
The major shareholders have been holding these shares for the better of a decade, so they're sitting on a very low cost basis. Don't think there's anything particularly interesting about their involvement, but happy to answer any specifics.
Hey Jake - how scalable is the model? The ceo mentioned 5 employees per project is that in perpetuity? It sounds like at some point they hit optimized margins pretty quickly and then future growth is predicated on revenue growth only. My concern is with consulting businesses you lose operating leverage pretty quickly due to linear human capital costs
It's a good question, and you're right to note that labor is the really scale impediment here. Having said that, it doesn't concern me at all given where we are in this story. Given the current force, the company can bring on enough new operating projects to multiply current earnings a couple times over before this becomes an issue. By then, there will be ample time and capital to invest in further labor. Yes, there are limits to operating leverage as a result, but a steady state 50% EBITDA margin is good enough for me.
How do you get to 50% margins? I looked at their expenses which they break out in the report the growth has been tracking revenue growth. Not sure how much more margin expansion you’re going to get beyond here (20-25%)?
Overall revenue composition is quickly shifting towards operational services, which does between 45-55% project level margins depending on the project. Meanwhile, SG&A, as indicated by management, should continue to decline as a percentage of sales. Perhaps 50% is ambitious, but ebitda margins should definitely trend towards high 30s, low 40s in pretty short order. Indeed, already in Q3 23, Ebitda margins came in at 34%. This number was lower annualized due to Q1 and Q4 being seasonally depressed, but Q3 is a good indication of the operating leverage here as revenues increase.
Ok makes sense I wish management would break out exact margin profiles in the report can you point me to where you saw the 45-50% for operational services? On a side note - did you talk to management about their trade receivables? Based on my calculation they seemed to have leveled off around 90 DSO but is there a pricing power concern here, just wondering why they extend this credit period if they have little competition in these contracts?
It's been communicated by management but it can also be seen from the financials. FY 2023 Revenue was 18m, Operating expenses before depreciation was 9m, good for ~50% margins. Revenue was also titled towards Technical Services last year, which is slightly lower margin, so this should improve a little over time. This can also be gleaned from the investor deck.
Management is very responsive and open to answering any questions.
So I’m going to give you a bear case - trade receivables have been growing a lot I mean a lot. Ultimately Buffett says what matters is the cash that the business can return to you. If you sum up last 5 years operating cash flows (assuming this is a good proxy since the business is capital light), and normalizing out the one time cash infusion in 2022 (haven’t dug into what caused this sudden jump), the current price gives you a 3-4% cash flow yield which makes this quite expensive at current prices. To even get a 10% yield the price needs to drop by half. The market had the price right a few months ago. I may be wrong here but the receivables are going to really drag cash flows unless they find a way to scale that. Interesting business but I’ll probably keep it on the watchlist and see how they execute to generate a high quality cash stream.
The way to think about it is that growth is, in large part, a function of mining capex (as more mines come online, the more need there is for BQE), but that the company's in place earnings are largely non-cyclical (because once operations are running, they are recurring as regulations require it). Moreover, there are opportunities to grow the business beyond the mining cycle (e.g. through remediation projects e.g. the coal ash pond contract they entered into). Given the present size of the earnings stream and how impactful a single operating project is, I am not much worried about cyclicality.
Great analysis. If the pearl is discovered, I am very confident about the future! My price target is 175 CAN$ in the next 3 years.
Hey Jake, what do big coal players in the US use for water treatment? For example AMR? I tried to look at can't find anyone specific so I'm guessing they use an in house team?
Michael it's less about coal producers like AMR and more about utilities running coal powered plants. The burning of thermal leads to ash deposits which contain contaminants including selenium. Those deposits were historically stored in "ponds" which, when unlined, pose of threat of steeping into bodies of water/water supply. There are tons of these ponds across the US that are unlined and untreated and the EPA has put pressure on the utilities to clean these up. Because a lot of these ponds are the responsibility of a small number of utilities, its a large opportunity for BQE if they can establish a relationship or two with large utilities. https://earthjustice.org/feature/coal-ash-contaminated-sites-map#:~:text=Damage%20to%20Aquatic%20Life%20from%20Coal%20Ash%20Disposal&text=The%20release%20of%20bioaccumulative%20toxins,to%20people%20consuming%20contaminated%20fish.
Very compelling. How do you get to 24 EBITDA of 9 though? Not sure I followed the maths- sounds like 5.5m incremental revenue - call it 2.5-3m (50% flow through) ebitda extra on top of FY23?
Hi Tim --
So FY23 should probably come in just shy of $5m EBITDA. Add the new Selen-IX plant (conservatively call it $1.8 contribution + one new average operating project ~.8m). Then, given where copper is trading, I think we are pretty clearly looking at additional ~$1m from there. Finally, given Technical Services has been growing at 40%, I think it's more than fair to assume some additional growth from that segment. I'd also note that, given the Tech Services backlog, and management upping their projection from two new operating projects per year to what is now 2-4, I'd be surprise if we are only tacking on 2 new operating projects in FY 24. So, that's roughly the math. It may be that this run-rate happens sooner or later than expected -- there's a lot of visibility here over time, but its tough to be precise on a quarterly or even an annual basis given lumpiness of projects transitioning to the operating phase.
thanks Jake, makes sense. I thought you had assumed no growth in Tech Services + China JVs - so if you keep $5m EBITDA + $2.6m from projects = 7.6m.
Regardless, lots of upside here and excited to see how it unfolds over the next two years. How do you think about sizing this position?
I see what you're saying. Good catch. I suppose that should probably say ~8m given the assumptions I laid out (though those assumptions are almost surely too punitive). On sizing - obviously this isn't the most liquid name out there, so that needs to be kept in mind, although daily volume has already started ticking up a fair bit over the last couple weeks. I think this is a highly asymmetric bet given the valuation isn't particularly demanding even on the current run-rate earnings (which are largely from contracts that won't be rolling off for years) and we can be quite certain earnings are going to continue growing for at least a few years to come. Therefore, I have personally sized this up quite a bit. But as always, not advice.
Thanks for the thesis. Some notes:
* 3 out of 4 of their patents will expire in 2027,2028 and 2029, respectively. None of them covers the selenium removal though but it can still be a significant hit on revenue if they protect something critical.
* Also, they are sole bidders on 60% on projects, but has this gone up or gone down over time? Because there are indeed other existing competitors that offer selenium treatment, e.g. Chemtreat which provides a non-biological solution that can consistently reduce selenium levels to < 5ppb:
https://www.chemtreat.com/solutions/selenium-removal-technology/
If indeed the piece of bidding cake has been declining, then this may be the cause. This particular company is private but has patented their technology as recent as 2018 (4 years after BQE's patent). Since the curent NPDES limit is < 5ppb, a miner who doesn't know better may want to choose the competitor over BQE if they are significantly cheaper. However NPDES is only for US as I understand it. So worst case is that BQE meets hard competition in US
*Another risk is coupled to the commentary above, which is the fact that we do not really understand this technology and BQE might have just developed "by chance" the first practicle non-biological version but not necessarily the best. Given the fact that the competitor has a recent solution may indicate that other companies are to come with their own solutions building on top of the other companies patented solutions.
* Finally there is something I am not fully grasping. According to many sources the biological method is the inferior method. But according to this article: https://www.watertechonline.com/industry/article/14299043/stantec-inc-dont-debug-the-selenium-treatment-system
EPA identified biological methods in 2015 the best available technology economically.
Another citation from the article:
" Biological treatment for the reliable removal of selenium is a proven technology in many industries, with over two dozen systems installed and a dozen more under construction. Since first introduced, the systems have advanced to produce safe, environmentally compliant, reliable and cost-effective performance.
"
Cheers
Thanks for the comments Osten. I guess I'd start by suggesting that we zoom out and ask whether anything really turns on this: there's an enormous unaddressed market out there with little competition at the moment and a rapidly growing book of long-duration recurring revenue contracts; if the company maintained its present growth rate for another 1-2 years and then just completely stopped growing, we'd have a 20+ year stream of steady cash flows we'd be buying at a double digit cash flow yield. That said, let me address these concerns more directly -
On the three patents: I don't think these patents are materially important. The key lies 1) in the know-how; 2) the well-established relationships (e.g. they've been working with Glencore for some 20 years); and 3) the huge white-space (there are enough projects to go around for plenty of players);
Sole source bidding: they are the sole source bidder on most of their contracts because they make bids only selectively. The market is so large and unaddressed and they are so small that they have said they have the luxury of being selective and only looking for projects which they are the best equipped to address (see the Smallcap Discoveries interview I linked to)
Selenium Tech: I'm not sure what you mean by "we don't understanding the technology". I'm sure BQE and people operating in the space understand how it works. Again, my push back is -- the single Selen-IX plant they just brought online is going to single handedly double company-wide EBITDA once it fully ramps - BQE doesn't need to capture the entire space. I flagged above that there may be further competitors with new tech eventually, but the patent protection on Selen-IX seems pretty robust to me, and in any event by the time those technologies come online BQE's profits should be multiples higher than they are today;
- EPA may have made that identification because in 2015 there were no non-biological methods on the market as I understand it. Biological treatment does work effectively in some circumstances, but as I noted above, it provides real challenges for seasonal or non-continuous operations, as the system cannot be easily shut on/off, and it creates unwanted waste in some cases (I would watch the Stantec presentation I linked to).
Great, that clears it up.
What I mean by when I say we don't understand the technology is that we, the individual investors, do not really understand the technology how it really works, so we cannot say how well it stands in comparison to other companies, etc. So if a vastly better solution is developed then suddenly they may only be sole bidders of perhaps 20%.
But here I am thinking long term so I am not saying it will affect them short/medium term, so it is still a great thesis in that aspect and the TAM seem to be infinite more or less
A question I want to find out though is how this sole bidding number of 60% have fluctuated over the years.
It will be interesting to see how this plays out, thanks for sharing
You definitely raise good questions and you're right to think long-term; perhaps a better way to put my point above is that your concerns, imo, raise more questions of uncertainty rather than of risk - that is, if the competitive dynamics for BQE end up being weaker than we think, that might impact our long term upside, but I don't see it as posing any downside risk at this valuation.
I'd add a couple more points to your concerns:
- Selen-IX is obviously quite new, and a lot of the literature and discussion we've both looked at hasn't really had to time to digest its pros and cons over the competition with respect to how things work in the field - i.e. what the scientists say vs. what makes sense practically speaking for mining company might be at odds (and given what we've seen of the adoption of the technology, it seems that Selen-IX has quite a bit of appeal for the miners);
Some further reading if interested: 1) This Alberta gov research on the treatment of selenium at coal mines. The chart on page 36 ranks treatment options, with Ion exchange coming in just below RO and nanofiltration (Selen-IX is not entirely Ion exchange (its also electrochemical) so this chart may not be really capturing BQE)
https://open.alberta.ca/dataset/456eee9c-86d5-46e6-bc2e-e605c6599eba/resource/b96ac61e-78db-4b2c-b0.
2) A Canada gov. paper likewise discussing the various options, specifically referring to BQE; https://www.canada.ca/content/dam/eccc/documents/pdf/managing-pollution/sources-industry/cmer-remc/CMER-Discussion-Document.pdf
The science angle here is definitely something I am working on getting more fluent with and I'll try to write a follow up piece flushing this out eventually.
"If anyone sees other clear risks here, please do let me know, as I am really struggling to come up with reasons to be bearish on this thesis."
=> Chevron ruling?
It's possible, but I think one should be cautious reading too much into it. There's a ton of unnuanced, histrionic commentary on Loper's implications from liberal media that should be taken with a grain of salt. The decision will surely have an impact on the promulgation of new rules under ambiguous statutory provisions and injects a lot of uncertainty going forward, but we aren't going to see the status quo upended over night. And remember, Chevron deference applied in both directions - i.e. it accorded deference to the administrative state while the executive was controlled by Republicans. In short, it's worth monitoring but this isn't going to quickly change any of the relevant landscape for our purposes.
Wow one of the best write ups I’m seen in a long time! One question: do you know how many consulting projects result in operational mines? At 8M I’m assuming 22 projects going right now with operational revenues on a significant delay.
Also anyone know anything about the major shareholders and how that came to be?
Thanks Michael. I'm not sure it's possible to answer because there are so many variables outside of BQE's control that go into whether a consulting project will transition to the operations stage. However, if you read the MD&A's, the company provides a list of each project with Technical Services work ongoing, so if you review those over time you can get a decent sense of conversion. I'd also note that Technical Services involve several stages of work, which BQE bills different amounts for. So although the stated average project revenue tracks over time, early stage ones generally bill less revenue. .
The major shareholders have been holding these shares for the better of a decade, so they're sitting on a very low cost basis. Don't think there's anything particularly interesting about their involvement, but happy to answer any specifics.
Thanks again for the thesis. Tiny note for completeness - the timestamp you said you were missing in Section 4 is at 1:00 30.
Best write up i have read in years. Growth maybe limited by manpower though, their biggest concern at least told in the interview with Paul Andreola.
Hey Jake - how scalable is the model? The ceo mentioned 5 employees per project is that in perpetuity? It sounds like at some point they hit optimized margins pretty quickly and then future growth is predicated on revenue growth only. My concern is with consulting businesses you lose operating leverage pretty quickly due to linear human capital costs
It's a good question, and you're right to note that labor is the really scale impediment here. Having said that, it doesn't concern me at all given where we are in this story. Given the current force, the company can bring on enough new operating projects to multiply current earnings a couple times over before this becomes an issue. By then, there will be ample time and capital to invest in further labor. Yes, there are limits to operating leverage as a result, but a steady state 50% EBITDA margin is good enough for me.
How do you get to 50% margins? I looked at their expenses which they break out in the report the growth has been tracking revenue growth. Not sure how much more margin expansion you’re going to get beyond here (20-25%)?
Overall revenue composition is quickly shifting towards operational services, which does between 45-55% project level margins depending on the project. Meanwhile, SG&A, as indicated by management, should continue to decline as a percentage of sales. Perhaps 50% is ambitious, but ebitda margins should definitely trend towards high 30s, low 40s in pretty short order. Indeed, already in Q3 23, Ebitda margins came in at 34%. This number was lower annualized due to Q1 and Q4 being seasonally depressed, but Q3 is a good indication of the operating leverage here as revenues increase.
Ok makes sense I wish management would break out exact margin profiles in the report can you point me to where you saw the 45-50% for operational services? On a side note - did you talk to management about their trade receivables? Based on my calculation they seemed to have leveled off around 90 DSO but is there a pricing power concern here, just wondering why they extend this credit period if they have little competition in these contracts?
It's been communicated by management but it can also be seen from the financials. FY 2023 Revenue was 18m, Operating expenses before depreciation was 9m, good for ~50% margins. Revenue was also titled towards Technical Services last year, which is slightly lower margin, so this should improve a little over time. This can also be gleaned from the investor deck.
Management is very responsive and open to answering any questions.
So I’m going to give you a bear case - trade receivables have been growing a lot I mean a lot. Ultimately Buffett says what matters is the cash that the business can return to you. If you sum up last 5 years operating cash flows (assuming this is a good proxy since the business is capital light), and normalizing out the one time cash infusion in 2022 (haven’t dug into what caused this sudden jump), the current price gives you a 3-4% cash flow yield which makes this quite expensive at current prices. To even get a 10% yield the price needs to drop by half. The market had the price right a few months ago. I may be wrong here but the receivables are going to really drag cash flows unless they find a way to scale that. Interesting business but I’ll probably keep it on the watchlist and see how they execute to generate a high quality cash stream.
How do you think about cyclicality for a business like this?
The way to think about it is that growth is, in large part, a function of mining capex (as more mines come online, the more need there is for BQE), but that the company's in place earnings are largely non-cyclical (because once operations are running, they are recurring as regulations require it). Moreover, there are opportunities to grow the business beyond the mining cycle (e.g. through remediation projects e.g. the coal ash pond contract they entered into). Given the present size of the earnings stream and how impactful a single operating project is, I am not much worried about cyclicality.