1 Main Capital - Limbach: A Lucrative Investment That Can Deliver On Both Fronts

The following segment was excerpted from this fund letter.

Limbach Holdings (NASDAQ:LMB)

Limbach Holdings was 1 Main Capital Fund’s largest winner in 2020 and remains one of our most lucrative investments to date. In my Q2’21 letter, I detailed numerous concerns regarding the company’s CEO, that eroded my trust, ultimately leading me to exit the position entirely by Q3’21.

In January of this year, LMB announced that its former CEO would be replaced by then-COO, Michael McCann, at the end of Q1. I believed that Mike was the right leader for this business (along with other executives of the company) and acted quickly to make LMB a large holding for the Fund once again.

As a reminder, LMB is a leading specialty contractor that offers design, engineering, construction, installation, and maintenance services to commercial and industrial clients across the US. The company specializes in HVAC, mechanical, electrical, plumbing, and control systems for institutions with mission-critical infrastructures such as hospitals and data centers.

Since going public in 2016, the company has strategically transitioned from general contractor relationships (GCR) to owner-direct relationships (ODR). In GCR, LMB manages new construction projects or major renovations awarded by GCs. Conversely, ODR involves providing maintenance services or managing smaller renovations assigned by building owners or property managers.

GCR projects are typically measured in years, working capital intensive, and characterized by low margins with high margin volatility. In contrast, ODR projects are shorter in nature, requiring less inventory / receivable build, and offering margins not only more predictable but also 2-3x higher than GCR. The margin discrepancy stems from building owners with mission-critical infrastructure exhibiting greater loyalty and reduced price sensitivity compared to GCs since they view LMB as a trusted strategic partner - especially when it comes to ensuring uninterrupted operations at their facilities.

While ODR accounted for only 20% of revenues and 30% of gross profits in 2017, it now represents approximately 50% of revenues and 65% of gross profits. This shift can be attributed to several factors. Firstly, LMB has become increasingly selective in pricing and accepting new GCR projects, resulting in a 40% decline in GCR revenues and a 20% decrease in gross profits over the past three years. Secondly, LMB has invested in SG&A to drive mid-teens organic revenue growth in ODR revenues during the same period. Lastly, the company made a 2021 acquisition that was largely ODR focused.

The transition resulted in a doubling of EBITDA margins from 3% in 2017 to 6% presently and led to improved free cash flow conversion. Going forward, management anticipates that ODR revenues should grow in the teens, while GCR revenues should shrink in the single digits.

The ongoing business mix shift alone should lead to significant EBITDA margin expansion from current levels. Furthermore, LMB ended 2022 in a net cash position and continues to pursue acquisitions at multiples that promise significant EBITDA and FCF per share growth as they occur.

The Fund’s average cost upon reinitiating its position is approximately $12 per share, equating to roughly 3x and 5x 2023 projected EBITDA and FCF. For comparison, LMB’s peers are valued at 10-12x EBITDA and 15-20x earnings by the public markets.

Exceptional investments often benefit from both EPS growth and multiple expansion. I believe LMB can deliver on both fronts and eagerly wait to see the company’s performance in the coming years.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.