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MNGA: Zacks Initiates Coverage of MagneGas

08/30/2018
By Steven Ralston, CFA

NASDAQ:MNGA

READ THE FULL MNGA RESEARCH REPORT

MagneGas (NASDAQ:MNGA) produces, sells and distributes MagneGas2®, a hydrogen-based fuel synthesized through its proprietary, patented Plasma Arc Flow™ process. Currently, the largest commercial application for MagneGas2™ is as an alternative to acetylene, and management is pursuing an aggressive acquisition strategy of domestic gas and welding suppliers in order to significantly expand geographical reach, boost the top-line and achieve profitability. Simultaneously, MagneGas is pursuing opportunities in Europe, primarily through government-sponsored grants that promote emerging clean technology projects. Revenues are expected to almost triple in 2018.


View Exhibit I

MagneGas sells its fuel product through a distribution network composed of the company’s wholly-owned distribution/retail locations and independent distributors. The company has targeted geographical areas with high concentrations of metal cutting fuel consumption. MagneGas2 is available through third party distributors in Alabama, California, Florida, Georgia, Indiana, Kentucky, Louisiana, Michigan, Nevada, New Jersey, New York, North Carolina, Pennsylvania, South Carolina, Tennessee, Texas, and Vermont.

KEY POINTS

‣ MagneGas is pursuing opportunities to expand and commercialize the company’s core technology which is based on the patented Plasma Arc Flow System.
     • produces, sells and distributes MagneGas2® in the United States
owns and operates 10 industrial gas and welding supply locations situated in Florida, Louisiana, Texas and California.
          ◦ In addition to fulfilling local demand for industrial gas and welding supplies, the company pursues contracts for major metal cutting projects, particularly for the breakup and recycling of retiring vessels, extraction solutions for fire department/first responder market and projects by major marquee customers in the electric utility and waste industries
     • augmenting and strengthening the sales teams is generating organic sales growth
     • embarking on a major European initiative to advancing the company’s gasification and sterilization technologies
Management’s strategy for the U.S. market for 2018 includes:
     • close the acquisitions of several industrial gas/welding supply businesses, which serve the California and Texas markets where there are strong industry dynamics
          ◦ the company closed the acquisitions of NG Enterprises Inc. (d.b.a. Complete Welding), Green Arc Supply LLC and TriCo Welding Supplies between January and April 2018
     • increase the sales force to enhance the company’s sales capacity
          ◦ the expansion of sales personnel at Complete Welding, ESSI and Green Arc Supply has been accomplished
     • utilize MagneGas2® as a competitive advantage to earn new customer relationships
     • financially transform the U.S. business by significantly increasing the revenue base
          ◦ MagneGas reported record revenues for the first and second quarters of 2018
     • future acquisitions in Florida, California and Texas during 2018-2019
     • management estimates that the run rate of annualized revenues is currently $14 million and that the continued implementation of the company’s strategy has a potential to double sales from the current run rate over the next three to five years
‣ MagneGas is also pursuing other applications to further commercialize its patented technology:
     • selling equipment or establishing service models for the sterilization of bio-mass liquid wastes (such as sewage, manure, sludge, industrial waste, agricultural waste etc.) through plasma arc technology and the conversion into irrigation water or fertilizer
     • using the prototype MagneGas 4th generation gasification technology for waste to energy as an alternative to natural gas for powering industrial equipment

MANAGEMENT’S DOMESTIC GROWTH STRATEGY

Since the company’s founding in 2007, management of MagneGas has attempted to develop a viable, profitable commercial enterprise utilizing its patented Plasma Arc Flow process. Initially, management concentrated on selling MagneGas fuel (as an alternative to acetylene) into the metal cutting space by expanding its distribution network through the pursuit of relationships with established independent distributors, retail gas end-users and strategic customers. MagneGas also pursued the sale of MagneGas equipment (Plasma Arc Flow refineries) for a myriad of applications related to processing liquid waste and co-combustion with hydrocarbon-based fuels. The execution of the strategy has required repeated access to the capital markets (both equity and debt) in order fund the company’s financial requirements. MagneGas has twice executed one-for-ten reverse splits of its common shares (on June 26, 2012 and again on May 19, 2017) and most recently a one-for-fifteen reverse split on January 16, 2018.

Beginning in early 2017, management began to pursue a new growth initiative of building a sales base in the industrial gas and welding supplies space which is able to support the company’s R&D projects and operating cost structure. The company’s geographical footprint is being expanded through the acquisition of multiple industrial gas and welding supply businesses. In addition to the acquisitions, the company is augmenting the sales force with experienced personnel who will facilitate access to new clients and thereby help develop incremental demand for MagneGas2. Management’s main focus is to drive sales growth, primarily through acquisitions but also through organic growth, and benefit from the anticipated economies of scale in order to bring the company to profitability.

The acquisition strategy targets the stronger industrial markets in the U.S. where MagneGas2 fuel can be utilized by the company’s sales force to generate incremental complimentary sales. In addition, the sales team at ESSI in Florida was increased with the hire of four experienced sales professionals.

Acquisition Strategy

In October 2014, the company acquired its first in-house distributor, Equipment Sales and Services, Inc. (ESSI). ESSI is a full-line distributor of welding supplies, welding equipment, safety products and industrial gases (acetylene, argon, oxygen, carbon dioxide, helium, nitrogen, propane, nitrous oxide, etc.) to industrial clients, which in 2014 were located in Clearwater/St. Petersburg/Tampa Bay area of Florida from its storefront in Clearwater. The purchase price was $3,000,000

The ESSI acquisition provided control of the sales force and enabled to better generate incremental demand for MagneGas2. Over the next few years, MagneGas opened several new ESSI retail locations in Lakeland, Sarasota and Lutz. The expansion program organically grew the geographical footprint of ESSI and bolstered demand for MagneGas2 and ancillary sales.

In 2017, management embarked on an acquisition-focused growth strategy to acquire independent distributors of MagneGas2 in order to geographically broaden its exposure to the industrial gas and welding supply industry and replicate the organic growth strategy being executed in Florida through ESSI. During the second half of 2017, the company entered into agreements with three industrial gas and welding equipment suppliers, and during the first four months of 2018, the acquisitions of Green Arc Supply, TriCo Welding Supply and Complete Welding and Cutting Supplies were completed, adding two retail locations in Texas, one location in Louisiana, two locations in central California (Sacramento and Woodland) and one location in southern California (San Diego). The company’s sales base has grown significantly from $3.7 million in 2017 to an annual run-rate of approximately $12 million currently.


View Exhibit II

Management intends to continue acquiring industrial gas and equipment supply businesses in order to grow demand for its flagship product (MagneGas2) and create a retail distribution platform of scale that provides MagneGas2, non-proprietary industrial gases, traditional welding supplies and related equipment to the metal cutting space. In addition, management is investing in the company’s sales force to facilitate organic growth by stimulating sales of all products within its suite of industrial gases and welding supplies.


View Exhibit III

Management’s acquisition strategy has transformed and diversified MagneGas’ revenue base into that of a distributor of industrial gases, welding gases, welding tools, welding equipment, hardware and safety products. As a result, MagneGas now also offers a wide array of industrial gases and tools. Excluding MagneGas equipment sales, which tend to be lumpy, we estimate that sales derived from the company’s patented Plasma Arc Flow System (aka MagneGas2™) now account for about 3% of revenues while sales of ancillary equipment and supplies account for the remaining 97%. Management believes that by broadening and deepening client relationships with companies in the demolition, construction and manufacturing industries, MagneGas can grow into complementary end-markets, expand its footprint geographically and increase sales of MagneGas2. The acquisition of several industrial gas and welding supply distributors has significantly expanded the company’s revenue base, from which management anticipates to achieve adequate scale with the aim of improving gross profits and EBITDA.

EUROPEAN INITIATIVE

Legislation in the European Union has incentivized clean tech and renewable fuel initiatives, like the use of the company’s Plasma Arc Flow™ process and MagneGas2, itself. Therefore, MagneGas has initiated a concentrated effort to commercialize its process, both through the sales of MagneGas2 and the sales of equipment for gasification, sterilization and co-combustion applications.

In December 2017, MagneGas announced the formation of MagneGas Europe, LLC, a wholly owned subsidiary and platform for executing a European joint venture. The JV has received two preliminary orders, one for a 300 KW gasification unit and a second for a sterilization unit for agricultural waste in southern Italy.

In February 2018, MagneGas entered into a Letter of Intent (LOI) to form an Ireland-based holding company for the purpose of acquiring Infinite Fuels, GmbH. Once the JV is funded, the joint venture will initiate biodiesel operations at Infinite Fuels facility in northern Germany to act as a pilot a government-backed initiative for converting bio-waste into energy and also become the first MagneGas2 production facility in Europe. The JV has the option to purchase up to six 300 KW gasification units within the next 5 years. The JV will also pay annual consulting fees and royalties to MagneGas, along with the portion of income entitled by its percentage of equity ownership in the joint venture.

On March 1, 2018, MagneGas announced that Infinite Fuels was informed by EASME that its proposal passed the evaluation phase of the grant approval process and has been accepted for a €6.0 million ($7.2 million) grant. The next step is contract negotiation phase, which entails negotiating the legal terms for the project and executing a standard agreement that describes the actions covered, the budget and duration of the project. The grant is paid out over the lifetime of the project and is subject to the submission of a series of financial and technical progress reports at the completion of various stages of the project. Usually the initial funds are 30% of the grant; however, in the EU, MagneGas is a foreign-based company, which is a very unique situation in the EU grant realm. Therefore, MagneGas is negotiating to guarantee a “fairly small” undisclosed amount of money to back the unfunded portion of the grant. Importantly, the grant will provide MagneGas access to non-dilutive capital and will accelerate the path towards commercial operations in Europe.

During the first half of 2018, MagneGas aggressively marketed the company’s process in Germany, France and the UK, specifically targeting major industrial super ports in Europe, including Rotterdam, Amsterdam Antwerp, Southampton, Hamburg, Copenhagen and Calais where there are concentrations of shipping, rail, trucking, oil and gas exploration, production and refining operations, all that require infrastructure maintenance utilizing metal cutting services. Representatives of the company attend Industry Trade Shows and Clean technology Events, such as the Green Maritime Forum in Hamburg, the International Conference on Renewable Energy Gas Technology in Toulouse and Maritime2020 Conference in Copenhagen, where at the latter, MagneGas’ CEO was a key note speaker. Management has met with multiple large port authorities in Europe. MagneGas plans to schedule demonstrations for these large consumers of metal cutting fuels at multiple locations across northeastern Europe during the third quarter of 2018.

BIOMASS STERILIZATION INITIATIVES

MagneGas is on track to sell two sterilization units to a potential client in Italy for the sterilization of landfill leachates (liquid that seeps from landfills). The Plasma Arc Flow™ process has been tested by the prospective customer in tests that verified the chemical oxygen demand (COD) was sufficiently reduced to meet Italy’s stringent regulations on the discharge of wastewater.

In the United States, the company continues to test its Plasma Arc Flow system for sterilizing liquid biomass waste (sewage, sludge, manure, waste oils, agricultural waste etc.), which virtually eliminates all living organisms through a combination of high heat, ultraviolent light, hydrogen peroxide and ozone. The process converts the liquid waste to Class A waste while simultaneously creates a clean burning fuel that is substitutable for natural gas. Furthermore, MagneGas continues to pursue additional commercial applications of its plasma arc technology, including the production of MagneGas fuel as an alternative to natural gas for cooking, heating or powering industrial equipment and biofuel automobiles. Management envisions great commercial potential in the plasma arc Venturi® sterilization system for treating pathogens and nutrients found in animal bio-solid waste.

Indicated Target

Based on comparative analysis that utilizes the valuation metric of Price/Sales, an average industry multiple indicates a share price target of $0.70.

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