The CoVest Select Team on launching CoVest and their $OEC thesis (podcast #126)

The team from CoVest discusses why they launched CoVest and then dives deep into their thesis for OEC. You can learn more about CoVest here.

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Transcript begins below

Andrew Walker: Hello, and welcome to The Yet Another Value Podcast. I'm your host, Andrew Walker. If you liked this podcast, it would mean a lot if you could rate, subscribe, and review it wherever you're getting it. With me today, I'm happy to have two people, Jake Miller and Kyle Mowery from CoVest Select. Gentlemen, how's it going?

Jake Miller: Going good. Thanks, Andrew.

Andrew: Great. Well, hey, let me start this podcast the way I do every podcast. First, a disclaimer to remind everyone that nothing on this podcast is investing advice. I think we're going tohave a little bit more disclaimers later so I'll pause it there. But then a second with a pitch for you two, my guests. I've known the CoVest team, and the GrizzlyRock team for a long time kind of from a distance. I know you guys do outstanding and really deep research on your portfolio names. The thing that connected us recently is YouTube, recently was CoVest Select, which is kind of the catalyst for getting you on. I think it's a product that I was telling you guys before, I'm really excited about, I think our audience is going to be really excited about hearing and knowing there's opportunity out there.

So maybe we can do today, just you guys could do a quick 32nd overview of CoVest, then we can kind of dive into the stock and company we're going to talk about today. And then at the end for our listeners who are interested, we'll wrap back around with kind of a more wholesome discussion of CoVest. Jake, I guess turned it over to you to start CoVest.

Jake: Yeah, that sounds good. And if you don't mind, the compliance team over here wanted us to read another disclosure disclaimer. So always. So this discussion expresses our research opinions, you should assume that as the publication date of this podcast, one or more clients of GrizzlyRock Capital and CoVest Select has a long position in the subject stock and stands to benefit if its share price increases. Following the publication of this podcast, we intend to continue transacting in the securities of the company covered herein. And we may be long, short, or neutral at any time hereafter, regardless of our initial recommendation. Our opinions are based upon the interpretation of certain facts and observations, all of which are based upon publicly available information.

Andrew: Great, so disclaimer out the way, Kyle, did you want to just do the 32nd high-level overview of CoVest?

Kyle Mowery: Yeah, and thank you, again, Andrew, for having us on. We're really proud as the GrizzlyRock team here to launch this new small-cap co-investing platform. We've been doing small caps for almost 11 years as GrizzlyRock. What we're doing now is we're taking the best ideas, curating them, and taking them out to institutional investors as a kind of a small cap co-investment platform, if you will, collaborative, constructive, looking for businesses with inflecting, fundamentals, etc. So we built this platform for ourselves but we realized that a number of our friends are smart managers that do really good work and from time to time, there are ideas that just deserve a lot more capital than certain managers have.

So we've built a full business around it, including institutional business development and investor relations, operations, compliance, sec registration, and all that. So covest-select.com is how you can kind of learn a little bit more about this emerging platform that's up and running back by the GrizzlyRock team. Thank you for your kind words and small caps and hopefully, we can shine the light on some of the stuff that we're seeing here today.

Andrew: Perfect. That's great. Again, for anyone who's listening, there'll be a link in the show notes to the CoVest website if you're interested and we'll do a little bit more wholesome talk at the end of it. But let's turn to an actual name that is the type of name and research that you'd want for a CoVest portfolio. The name we're going to talk about is Orion, the ticker is OEC. I guess I'll just start, I don't know if Jake or Kyle want to start, but we'll just say, what is OEC? What do they make? What are they?

Jake: Sure, yeah, I'll give you the quick rundown here and we can kind of take it from there. So OEC is the best thought of as two segments. The first is the rubber black segment. So that makes commodity carbon black. This is a ubiquitous product that everyone interacts with every day and they probably don't know it. Pretty much anything that's black that you have in your house has some carbon black in it. My phone case has carbon black in it. About 60% of this market is replacement tires. 15% is going to be new car tires, and the rest is various rubber goods, industrial and mechanical rubber goods.

So they are the third largest player in the commodity carbon black space by 10% market share. This segment accounts for about 45% of total company EBITDA. Carbon black is sold on annual contracts with commodity pastures so while they do use a lot of fossil fuels, oil, the pricing of those commodities is not a risk for this business, in the earnings of this business. It is a commodity product, as I've said, but capacity right now is tight. Pricing is upcycled and for a number of reasons, we don't expect any material capacity increases for quite some time. So again, while it might not be the greatest business ever, it is a multi-chemical business. The supply-demand outlook looks really strong for the next several years.

Andrew: That's quite a bit. It might not be the greatest business ever, but the supply-demand out looks really favorable. Hey, and price for everything. I think we're going totalk, this is very cheap. But yeah, and that was the regular carbon black segment, I believe, did you want to talk about the specialty as well?

Jake: Yeah, so especially carbon black segment actually is a pretty good business. And we think that doesn't get the credit it deserves in the market. So this is a true specialty chemical business. These are small volumes, custom products, and pricing power over time, that it's demonstrated. And this is about 55% of the company's EBITDA and about 55% of this segment's EBITDA comes from real proprietary technologies, things that they're the only ones that can do, and they sell that at about 40 over 40% margins. So these are things like lampblack, thermo-black, and seed oil black. And it's actually a secular growing business with some really nice tailwinds behind it.

Andrew: Can I just pause you there? When you say lampblack, can you just say what lampblack is, so people can get a real thought of what a specialty thing that they are very few people can create?

Jake: So they have a number of processes beyond to make these specialty carbon blacks that are just not used anywhere else. There are a couple of them out there. acetal in black is one that uses acetylene gas to make a number of products for EV batteries. And I think what we'll talk more about today, but it's just a proprietary technology process to make especially for blacks.

Andrew: Perfect. Look, I think that's a great overview. We're going todive into lots of stuff here today. I had two of you coming on so I would like to joke that I did twice the due diligence for this episode. I think my wife was a little annoyed because that eight o'clock Saturday, and I was like, I gotta look up OEC. But let me turn it over to you. We're going totalk about a lot of stuff. But just high level. There are lots of opportunities in the market. What do you think the market is missing, that you guys are seeing that makes OEC a compelling investment that will generate a kind of risk-adjusted alpha going forward?

Kyle: Yeah, absolutely. So it's a small cap, industrial global business. And it's perceived as a chemical business that's about to enter this downturn, right? Especially in Germany, its crown jewel is in Cologne, Germany. And all we're going to see all winter is headlines about how terrible the EU gas supply natural gas supply is. And that is a feedstock into their gas, black, super high proprietary formulation, super profitable gas black business that goes into solvents and coatings and things. So why is it interesting, that this company is exiting an investment cycle of $300 million of CapEx going into the United States, it's an industry-wide cycle that was under the EPA under Obama came in and mandated a reduction of NOx and SOx?

So that is concluding in six to nine months. You're entering a cycle in which the numbers are going far higher per management at their analyst day. And free cash flow is going to go from being tepid to being in the high 20s. Mid to high 20%. free cash flow yields. Free growth CapEx for the next couple of years and analysts stay in June of 2022. Management came out and said they're basically going to earn two-thirds of their market cap in the next three years. So you have a situation now that's currently priced at a low multiple 5.2 times street numbers for this year, street numbers for next year should be higher, even in a recession, those numbers would be higher. They're getting a higher return on this invested capital that's going into that has been invested in the United States. And they're growing their specialty footprint in China, Italy, and now they're going to grow these EV battery materials in Texas you got numbers going up free cash flow going up, and the world looks at it like a cyclical industrial.

Andrew: Yep, that's great. Just to add to that look, so Kyle mentioned things are going up. I think the company they've been reiterating as I can just the last three appearances they made. We were at Credit Suisse last week, they say we're at an inflection point investor day, they say we're benefiting from megatrends annual meeting, and they say demand is way outstripping global supply. You alluded to it. Kyle alluded to it. So Jake, I just wanted to talk, like what makes this supply-demand balance and kind of that inflection point so positive happening here?

Jake: So I assume you're talking about the rubber black business, which again, relies on annual contracts with commodity pass-throughs. But I think what happened there is that just for a long time, they didn't earn their cost of capital on this business, right? So you never saw any new capacity expansion, because, you know, no one's going tomake that investment and you can't order good return there. That only got worse with the EPA situation that started in 2019. So the EPA came in and said, you need to add scrubbers, so to get rid of your SOx, and NOx, that took a lot of CapEx for these guys, that's going to be substantially finished by the end of this year. So it's just not someplace where people own or they could return over time. I wasn't new capacity expansion.

Then fast forward to this year, you have the Russia-Ukraine situation. So between Russia and Ukraine, those exports, supplied about 35% of the EU carbon black market and maybe about 7 or 8% of the global carbon black market. So that's done and you can't ship carbon black, it's not like you can just say, oh, we'll just get it from China, right? For a number of reasons. It's heavy, it's dirty, if you put it into a container or the hull of a ship, you can't really use that container for anything else besides carbon black just because of the way it treats these shipping materials. So I think that underinvestment coupled with the Russia-Ukraine situation really made the market especially tight.

Andrew: Kyle, did you want to add anything there?

Kyle: No. Well said.

Andrew: I think you guys hit on a lot of the stuff, the questions that people are going to jump out, like, the first question that's going to jump out to people is, hey, these guys are pictured pitching a structural growth, story, supply, demand all that, but they're going to say, there's been no free cash flow here. Historically, earnings have kind of capped out. And this does seem like aside from specialty, which seems very nice. But overall, this whole thing just seems like a generic commodity business, that there's never really a pot of gold at the end of the rainbow there. So I want to talk about that overall view. And then I want to talk about the earnings inflection point, because I do think that's another separate issue, but just do either one, or you want to talk just a little bit more about that generic commodity concern that I think is going to be top of mind for a lot of investors.

Kyle: Sure. Look, the rubber black business is a cyclical business in which you should earn your cost of capital over time. It's not a growth business. It's a GDP-type business. You know, look, the tire business has been going onshore, for many of these manufacturers, there's certainly security of supply and associated contract pricing, but we're not arguing that the multiple there is wrong. For the specialty business, we do think the multiples wrong half of this business is a specialty. And by the way, they're growing in electric vehicle battery materials. Neither specialty, which they're the number one volume producer globally, especially carbon black, nor the seedling carbon black, which is in the wire cable and electric vehicle battery markets. Those are not five times businesses.

So what I think the market is currently missing with this multiple that's being assigned to these earnings are this company is not going off the cliff with the broader industrial economy, they're entering a growth spurt, their 2023 will be the second year of growth for the rubber black and a multi-year growth stage based on the industry getting back to return on investment capital pricing. And then you've got this specialty investment coming on. And growth from those volumes. So this business in the last specialty cycle in 2016, traded for eight to nine times EBITDA. Now the footprint is far larger, there are more facilities, and they're more efficient. And quite frankly, the new-ish, you know, Corning painter has really focused the company on the right metrics, which is instead of just revenue and pushing volume, as previous CEO did, was just focused on profitable growth, profitable volume and really taking this industry is all oligopoly and structure and taking it to the next level in terms of getting a return and getting free cash flow. And so once that free cash starts hitting, we think investors are going towake up in a big way.

Jake: Yeah, I mean, just if you look at the magnitude of the growth, right? I mean, they're going to nearly double EBITDA up from 2021 to 2025 run rate, and that's per the numbers given on the management analyst day, earlier this year. And the only thing you really have to believe for that growth to happen is that they execute on these high ROI investments, which are already in progress. And in some cases, near completion, and you have very modest pricing and volume growth, which we think is going to be pretty conservative, particularly going into 23. So, haircut the numbers however you want, do your own work, haircut the numbers have you won, it's a pretty cheap stock, an exceptionally cheap stock really, on any reasonable outlook.

Andrew: Jake kind of stepped on my next question, but just to lay the numbers out. So right now OEC trades for around $16 per share, which gives them an enterprise value of between 1.8 to 1.9 billion. And I think a lot of people look at this and say, Hey, trailing earnings is 285 in EBITDA, they're not really doing any free cash flow for a lot. Because of the EPA and growth investment we talked about, they'll do about 300-315 million EBITDA this year. So people are saying, oh, that's about six times. That's about right but management has said by 2025, we'll get up to 500 million in EBITDA which you start running, that's now we're talking less than four times EBITDA. That EBITDA goes way up, EPA investments come down free cash flows gushing out of the business.

I just want to push back on one quick point, because it jumps out at me. I know the management team knows it, they even mentioned it on their investment, right? Historically, this business had never really gone beyond it was about a 270 million EBITDA that they said in the investor day, I think they got a little bit above that. But that was about where the business would peak, right? And now they're saying, hey, by 2025, just because of these industries, just step changes, and some small growth investments, but nothing crazy, we're going to be able to do 270 million in the specialty business, and 250 million in the rubber business.

So each segment is doing what the combined company had kind of capped out previously. And obviously, you guys believe something like this is possible. You've talked about some of this, but I just want to give you a second to address that. Because that's the second thing that as an investor, you see that much of a step change without like, four new plants opening or something? Yeah. Oh, wow. That's a really big step change there.

Kyle: So yeah, let me address that. So there, there are three new plants. Okay. There are three new plants in that 500 midcycle number there's Ravenna, Italy which came up last year, that's a specialty plant. There's FWAB a China that is scheduled to come at the end of 2022 and ramp into 23. And that would also include the battery materials the cap a conductive sir what we're calling a single-income black in LaPorte, Houston, Texas. So those three plants, plus, you get a return on the 300 million $300 million dollars invested into the US plants for NOx and SOX. So you get a return on that. So that's not a plant, but it but on a return-based pricing grid. Those are kind of the steps that gets you from the previous midcycle company never disclosed what midcycle was, we thought it was kind of like 250 to 275, say in like 2016. And now there's a line of sight to that. 500. Those are the big buckets in terms of midcycle.

Andrew: Perfect. Jake, do you want to add anything to that?

Jake: No, I mean, the only thing I would add is that he talked about the three plants. One's done, the other ones are almost done. The seedling plant is really exciting. No problems obviously on the CapEx side really, exceptionally high ROI, and we think they're just getting started there.

Andrew: Okay, so we've talked about a supply-demand imbalance. I mean, I think especially obviously, that requires more knowledge, more investment, and a little more specialized skills. But on the rubber side, which right, like, basic Carbon Black has been around for decades, you would think if you've got this big supply-demand imbalance coming like it would be pretty easy, hey, somebody goes built a new plant or something, obviously, it's a little more. It is a regional market, it's a little more complex than, hey, let's just go build a new plant they've discussed before, but I just want to talk to you guys. There's the third thing, you're forecasting this big supply, demand, and balance in commodities, supply always can come on a lot quicker and a lot more supply comes in line. And you kind of lead to a glut when you think you're going tohave shortages. So can you talk about the supply-demand picture there?

Jake: Sure. Like I said, these are normally annual contracts that are negotiated at the end of the year. Right now negotiations are actually in progress for the pricing there which is pretty and they have been for a couple of months. That's pretty unprecedented. That's not something that the company has ever seen or that we were ever familiar with. The company's talking about multi-year contracts. So again, that's not something that we've ever seen. It's hard to know exactly what pricing is. We hear industry chatter, just like everyone else. But pricing should be very, very strong on those contracts.

In terms of supply, it's just a lot more expensive to build supply in the US with these EPA mandates coming on. You have some carbon mandates and carbon prices in Europe, so you just need really strong pricing to justify the new supply. The companies that do that just have better uses of their capital at this point. So I don't think new supply in that segment is really a material risk. And if it were, it takes several years to build, so it's not going to be something that's going to impact next year or even 24.

Andrew: I've done a lot of work on the refiners, and one thing the refiners say is for a variety of reasons. Now, one of the reasons being a lot of people think oil and gas have a terminal value issue, right? Whether it's 10 or 30 years, there won't be any, but for a variety of reasons. They say a refinery will never be built in the US again, including a lot of nimbyism, right, with OEC and carbon black, I could see kind of similar arguments, I don't think they've come out and said, we don't think a new carbon black facility will ever get built in the US. But I was just wondering, like, what would the process for building a new plant in the US or Europe look like? What would the timeline and especially in the US, do you think there will be new plants built at some point?

Kyle: There effectively have not been new plants built in the western world for like 50 years. That's on the complex side. And then on the tire side, there have been new plants. So you have that that supply-demand imbalance exists? I think that if you look at this industry, historically, the returns have been poor. And we think that's in the process of changing and then you flip to carbon questions, emission questions, these are all real alternatives. What we've done is gone and studied all the other ways to make carbon black.

The most prolific what's coming online is a business in Nebraska called monolith materials. Monolith is primarily a producer of hydrogen, liquid hydrogen for the power markets. So H2, but carbon black is a co-product of that process. But that is much smaller in size. Even with monolith coming on North America is set to be structurally short carbon black. And these are regional oligopoly markets because the product is heavy and hard to move as Jake mentioned.

So there's another business called origin materials that are working on commercializing some things but there are ways off from commercial carbon black, we think about it. If I got two little kids, I put them in the car. I want those tires to be as good as possible and bio-based materials thus far have not been SPECT in there's some recycled carbon black that has been in certainly, but environmental aspects and whatnot. But those have not been mandated by governments yet, nor have they been interesting from the voluntary markets from the consumer side. So we don't see, look, some industries are dirty and yet need to exist. And we think carbon black fits that, at least for the next decade.

Andrew: Let me pull back to a basic question I should have asked earlier and you kind of lose their carbon that carbon black this way. There's origins trying to do a carbon black through biomass if I remember correctly. Outside of just alternative ways to make carbon black, is there a replacement for carbon black? Like I think people have mentioned some silicon in some of the more EV stuff, but can you replace carbon black at all? Or I'm thinking like prices really squeezed, were super short, is there alternative materials or anything, or is this just so basic you can't replace it?

Kyle: Jake, you want that one?

Jake: There's not a replacement at anything close to current prices, even kind of double current prices. So I don't see that as a material risk. The other interesting point just on the demand side, I think you mentioned with EVs is that you know EVs actually help the commodity carbon black side, EVS generate more torque, and that requires more rigid tires, which just require more and higher quality carbon black per tire. So that's actually something that's going to help the demand side.

Andrew: If I remember correctly, EVs also tend to be heavier so they wear down the tires faster so you kind of get the replacement cycle going quicker.

Kyle: Yeah, it's about half the life of a tire for an EV versus ICE. Also, I would say Orion, I know we keep calling it a commodity product. And that's probably pejorative, even within the commodity grades, they are in the higher end, they're in more technical tires, mechanical rubber goods, it's still on the higher end side of this, and with cars getting larger and heavier, even on the ICE side, and certainly on the EV side, but that is helpful to them. This plant that they're bringing up in China is a technical tire plant. So you see China is a carbon black, that seems commodity, but maybe not so much, right? Because there's a lot of carbon black capacity in China, and yet the company is bringing this facility up, because of requests for high-grade products from their customers.

These guys are truly world-class in terms of research and development, working with customers, and speaking in specialty grades. They bucket for public consumption, public markets, investors, and commodity business, which they call specialty business but the reality is there's a spectrum of grades, and you go all the way from gas, black, all the way down to the cheapest tire black fillers into plastics or whatnot. There's a range of technical specifications. And as you walk down, that range, margin goes down and competitors increase, but even within their "commodity side business", that's much higher than competitors. It's one of the reasons we do believe the business is a specialty, more than is being perceived by the market. So that's a dramatic Delta in our perception of the company versus the markets, as implied by the pricing today.

Andrew: I think one of the things they said at the investor day as they're like, look, we've got some stuff that's in our commodity business, but it's so technical, it actually carries margins higher than the specialty things. And I can't remember if this was the same thing, or if it was something different, but they said, look, think about an F1 tire. Obviously, that's not a massive market. But the F1 tire requires like they went tires that are so heavy, that doesn't bounce at all like they're just always touching the ground, so they can go as fast as possible. But that's us, right? We make a really hot, I think that would be on the commodity side, technically, but that's a really high margin really technical product that they made.

Speaking of tires, Kyle, I think you mentioned recycled tires. This is a dumb, dumb argument. But I think if you haven't done work in the industry, it's something that you'd be interested in, like, Hey, we've been making tires for what, 100 years in America, we've made a lot of them, why can't we just go recycle all the old tires, once they're done, like kind of Spruce them up a little bit and put them back on cars? And we'll never have to make you know, I think tires are what it was 65% of commodity 45% of the commodity. I can't remember the exact number. But why doesn't that go to zero? Because we're just recycling tires constantly.

Kyle: Yeah, there's always going to be a loss of the chemical binds with the rubber and how the chemicals all interact together. When you have a product that can't fail, and tires fall into that category, as do many things, you're often going to be focused on a version for just a simple quality argument. So that's what you've seen historically, is, is a focus on virgin carbon black. And it's not just tiring, but it's mechanical, rubber, it's belts, tubes, hoses, and all these things that power the industrial economy that we use kind of every day without realizing it. And so those all have to be pure, they have to be expected, they have to work within other formulations of chemicals, right? Basically, nothing that Orion sells is used by the consumer or the end market user without being a part of a larger product. Usually, it can be as small as 1%. It could be as much as 40% in the range depending on the product. But that just hasn't been industry-wide, something that's really going on.

Andrew: Jake, did you want to add anything there?

Jake: No, nothing of that sort.

Andrew: Okay. So we've talked about the EPA CapEx cycle, right? Starting about four years ago, they have to invest about 300 billion into CapEx for from the EPA. And I think one of the quotes they said in the in an investor day was they said, Hey, Orion hasn't lacked for ops, we've lacked for cash, and a lot of that was driven by the EPA. I want to focus on two pieces there. First, anybody who's familiar with regulation would say most of the time you have regulation, and there's more regulation that comes on the back end, right? So we're seeing this big cat cash cycle coming in as the EPA mandates go down. Say the EPA is not going to kind of increase the mandates going forward or say, hey, you guys, like there are lots of emissions that go into making your product you have to go cancel those emissions out to or something even though you're eliminating the emissions that your product does, like eliminate the inputs to so why aren't we just going to see continued regulation that results in continued It's CapEx and this, you're never going to see it go away.

Kyle: Jake, you want to take a stab you want me to do it?

Jake: Yeah, I mean, listen, I guess that kind of comes in as anything can happen. But you know, they've already taken out the harmful chemicals here. We don't see anything material on the horizon, and we've done a lot of work, especially as it pertains to possible issues in Europe or anything. There's nothing on the horizon, you would really be just, singling out a particular industry for arbitrary reasons if you were to do that, I suppose.

Andrew: Kyle, did you want to add anything there?

Kyle: Yeah, I mean, if you look about decarbonization, and decarbonization is actually a big theme in a lot of what we do. If you look at the carbon footprint of these products, overall, the carbon black process can be dirty. That's true and that's globally true on a furnace black process. That's the best in Europe, the best in US, and less in certain developing markets as well. But the impact because the majority of products have such a small impact of carbon black, that you don't actually go after carbon black to go after something broader like the transportation industry has gone after higher gasoline miles per gallon. That's a better way of bringing down the carbon footprint of products, as opposed to the carbon black in a tire and belts and tubes and hoses.

So is it a possibility? Yes. The thing that we're looking at the most closely as the breath set of discussions in Europe that really, based on what we're seeing, is it going to come on before 2026, if even then, and COVID kind of back that up. But I mean, you look at this, you have businesses in the United States that didn't make the last investment cycle into NOx and SOX. So you've got the demand going up and the supply going down. I mean, it's possible that the government wants to put all these businesses out of business and then try to import from China and or Russia, it would be the other swing, but now Russia is politically unstable in such a way that the tire manufacturers don't want to deal with them, certainly in the US and Europe. Then the Chinese, the quality is lower and the emissions are higher. The quality is getting better, but it's still lower than Cabot, which is a big public company, the biggest commodity producer globally, or Birla or Riot. So, do we want to produce things in this country and or Europe so far? I think the answer is yes, and these guys do it in the most environmentally friendly manner possible.

Andrew: I think we already discussed why this is a regional market, it's difficult to transport carbon black. And you guys also said, which I think is certainly true. People are looking saying, hey, if we're getting our carbon black from China, not only is it expensive to import but it's probably getting made with less environmental standards. So even if the government wasn't mandating that I think GM does think about their overall footprint and for a small piece of it. So I think we've addressed the China risk on that, but let me take the other side of suppliers, right? I said earlier that Orion is not lacking for ops, we've lacked for cash, and some of the ways they're investing that cash as they kind of roll off the DPA cycle are these really attractive de-bottlenecking investments.

And I think one of them gave the example. It's like less than two-year paybacks. 10 million in CapEx to free up five to 6 million annualized DPA, like these are really attractive and it does just strike me like hey if this is an Iranian thing then it's probably an across the industry thing like Cabot has their big publicly listed us peer. Why isn't like Orion doing this, Cabot doing it, every person is saying, Hey, we've got all this cash flow as EPA rolls off, we've got all these de-bottlenecking opportunities and it comes back to that first thing I said were all of a sudden you've got all this supply from these de-bottlenecking opportunities and you've kind of ruined the industry outlook, oversupply, all that type of stuff.

Kyle: Yeah, I'll take that. So remember Cabot is the number one volume producer of rubber black, the number two specialty volume producer globally, they run a furnace black process that's 99% of carbon black globally is on furnace black. All their facilities are basically the same globally. So they've run them really well optimized. Most of those plants have cogeneration, which is creating energy and actually feeding back into the grid. The OEC plants in Germany do have cogen but not all the plants here have cogen. That's certainly an opportunity for cogeneration and putting back into the grid.

But on the de-bottlenecking, since you call that out specifically, that is specific to the proprietary gas black production at Cologne, Germany that only OEC has. OEC is the only manufacturer of gas black globally that is shipped globally. It's used primarily in automotive paint to make paint sparkle because it disperses really well it has to do with the carbon compound and how the structure of that and how it disperses into paint and solvents and makes it very even. So it's used in high-end automotive paint. So if you're driving a BMW, and the paint is sparkling, that's Orion gas black, right?

Andrew: I can literally see it in my head as you're saying it, yeah.

Kyle: Yeah. So those are they're very specific to Orion.

Andrew: Yeah, I think that covers the de-bottlenecking. You mentioned energy so I'll just go there next. The other thing, anybody who's falling, especially in Europe, there is an energy crisis, right? There's no doubt about it. Making Carbon Black is mainly you putting gas into the plant to power the plant up. So a lot of people's not first thought here, but when they start exploring the industry, one of the risks they're going tosay is, hey, are they going to get cut off of all of their energy? Like, yes, there are Europe imports of carbon black, but who cares if you can't run your plants and these are going to zero? So how is especially the European energy crisis going to affect OEC?

Jake: Sure, so I'll start on that one. Obviously, that's one of the reasons the stock is so cheap right now and similar stocks. So the first part I would say is just on the cogeneration as Kyle said. So there actually isn't a risk here from higher energy prices. Higher energy prices actually lead to higher earnings for these guys, because they sell electricity into a grid. But yes, if there are reductions, such that it impacts product, it impacts their ability to produce, that will impact the business, the company actually gave some really interesting metrics on the last call, and even at a 40% reduction to German gas. The stock is still super cheap, I mean, you're getting a kind of mid to high teens cash flow yield here. There's no risk to any of the growth CapEx and certainly not any risk at all, to the solvency even in a case where there would be zero EBITDA in Europe.

I mean, we don't have any particular insight into what happens there, of course, but we are pretty confident that even in the worst case, a complete shutdown of the German economy, which we see is unlikely, these guys are not going to have to cut investment. There's not going to be any kind of solvency issues or anything like that. And obviously, that's not going to be a permanent state of the world where the European industrial economy freezes up forever. So we feel fine here, it's obviously a risk, and it's obviously something that's priced into the stock, but they're taking the right steps here, they're getting off some of the gas, they're able to substitute fuels, and a lot of their plants, and they're working on that now. So there's a lot they can do and even in a pretty bad case, they'll be just fine.

Andrew: Jake, correct me if I'm wrong, but if I remember from the call, they said, look, the EU asked people to cut back by 15%. And we've already done that. They say, hey, if we have to cut back by 20%, which is kind of their base case. And I think what they've already done, it's a very small hit to earnings. If we have to go up to 40%. It's a hit, but it's not material, and hopefully, that will be temporary. And then the other thing they said was, hey, we don't think we get there, because as both you and Kyle said, we're a preferred supplier, because we do Cogen. So we actually supply energy to the grid. So they like that. And be also Hey, if you shut us down and you shut down, you're shutting. We are a critical input to industries, you're shutting down 100 other tack-on industries. Is that all correct, or am I missing?

Jake: That's exactly correct. It's probably a better way than I said it. But that's what I was trying to say. And I'm more sustained.

Andrew: You did the heavy lifting, just making sure I was thinking about it correctly. Kyle, did you want to add anything on the energy risk there?

Kyle: Just that management here is exceptional. They've been in front of this issue. They've been on the ground. They are on the ground in the spring and early summer getting in front of this issue, and they're going to address it as well as anyone can. The other thing is yes, the crown jewel is in Cologne, Germany. However, the second largest specialty facility is in South Korea and the third largest is here in the United States. So they have the ability to shift production around their global footprint, their South Africa, there's Italy, there's China, etc. in addition to the EU and the US. So for a billion-dollar market cap company, this is a vastly international and global business.

Andrew: I don't know, I don't have the earnings number from Europe off the top of my head, maybe one of you does, but I'm just looking at their 2021 10k, less than 50% of their sales are coming from Europe. It's 1.5 billion in sales, about 650 to 670 million in Europe. So even if that went to zero, yes, there is a lot of overhead and stuff that does that. But you've got earnings elsewhere, you've got everything else elsewhere. Did I miss anything on that piece?

Kyle: No. We went and dug through the German subsidiary filings and our best guess because there are a lot of intercompany dealings. But our best guess is that Germany facilities about 120 million of EBITDA, now management guide to the at the midpoint for this year is 325. So yeah, it's, it's about a third maybe a little more than a third of the business. The crown jewels in Germany, let's not sugarcoat this. However, we think it's wildly manageable. certainly, as Jake was saying, even in this 40% reduction of natural gas, right, even if Nordstrom stays shut down, and in the EU, Germans can't figure out how to get natural gas.

By the way, natural gas is one of the most widely used chemicals, the most ubiquitous chemicals on the planet, right? It just has, they just have to figure out from a political standpoint, how to move it around, and how to get it there and do a cost-efficiently, but the costs are going toget passed through to the customer. You have a situation in which we think we're going tobe okay. And even if that negative 40, down 40% natural gas occurs, our modeling for next year is still 17%--

Andrew: I think we lost Kyle there. Jake, are you still with us?

Jake: Yeah.

Andrew: Hey, Kyle, we lost you there for one second. Jake, maybe you can just...?

Jake: Yeah, I think what Kyle was saying is that even in that 40% gas reduction scenario, you still have about a 17% free cash flow yield before any growth CapEx there. So the stock is still cheap stock even in that scenario.

Andrew: The last risk I want to talk about you guys talked about earlier, we've talked about the supply-demand imbalance. But again, this is especially historically has been a cyclical commodity company, the first risk that's going to jump to everyone. Everyone thinks we're going into a recession. Do you want to buy cyclical right in front of a recession? So I just wanted to give you guys a chance to talk about the recession risk here because it's going to loom off the top mind of everyone.

Kyle: Cabot got that question at a conference last week. They said they think they can grow earnings through a broader economic recession because of the supply-demand imbalance in rubber black and the way that the contracts are structured pass through energy, but right now those contracts which historically were as Jake mentioned annual those contracts used to the discussion started after labor day they started before Memorial Day this year which the earliest the industry has ever seen these contracts begin because of the supply-demand imbalance and the Russia situation the human tragedy that it is also forced these western suppliers the Western tire manufacturer to say oh my gosh, we need to get this supply we need to get it locked in now and so what you're seeing is the return on invested capital for the industry is working up in lockstep based on these imbalances.

Andrew: Yeah, and we've talked about it a little bit but when you take Russian carbon black of the market, I think they had a slide in their most recent earnings and you guys have retweeted it. Europe is so unbelievably short carbon black it reminds me of what's happening with coal LNG everything like these guys are saying hey, this is it's not a massive piece of our cost structure but it is we can't have a business without it we need to lock in long term supply just so we're not shut down because this thing that makes up on a car, how much is carbon black of the car it's almost nothing but if you don't have it, you don't have the car.

You mentioned Cabot, Kyle, that's a great segue. You guys are obviously very bullish on the industry overall, but they do have big publicly listed competitors, Cabot big US listed. They're a little bit more diversified but the majority is carbon black if my kind of scan of the 10k. There's Birla which I believe trades in Thailand. So maybe that's off limits for a lot of people but why choose OEC over Cabot or kind of a similar competitor?

Kyle: So Cabot has done a great job telling their story. They trade at a higher multiple currently 6.7 times on the 2022 street midpoint of EBITDA. That's a ton and a half higher than OEC. Cabot has done a great job. They've had two analyst days and Orion's only had one and it came literally the week before Putin shut down the pipeline. So that wasn't helpful for perception or narrative type of understanding. Cabot has been very open about their growth in carbon nanotubes and they bought a business in China that makes carbon nanotubes that are about 4% of their earnings are carbon nanotubes and carbon nanotubes are electric vehicle conductivity materials. Orion makes seven and a half percent of their EBITDA from these similar types of materials but they haven't been as broad about telling that story in terms of the EV battery. There are a couple of years later than Cabot. So the big investment for Orion is Greenfield in Texas is going to generate $50 million of EBITDA but it's not going to be up for a couple of years. So you have this situation where Cabot became a "backdoor way" to play EV batteries. And Orion yet hasn't had that in their narrative.

Although the technology is exceptional for Orion and earnings growth, I mean 50 million $50 million in EV battery materials, what's the right multiple on that? It's not 5.2-5.5. That is the market should trade for a much higher multiple than now they still have to build it. But Orion in terms of going Greenfield got SPECT in with the battery manufacturers globally, they can announce that because the battery manufacturers are very specific about the secrecy around what their formulations are. But Cabot has done a great job getting into that it's a secularly growing industry. Look at the Cabot slide, it's up to the right on that business. And it's up into the right for all the EV battery materials, whether it's lithium, or any of the nickel, cobalt, all these materials, it's up into the right for all of them. But when you have two suppliers of acetylcholine, carbon black, it's Orion and Danca out of Japan, you have a situation in which the profitability should be there. So that is certainly an area that the market we believe will begin to value Orion over time on this and see what they are already seeing in Cabot. We think Cabot does a great job. But we think that mispriced security here is Orion.

Andrew: Perfect. Jake, did you want to add anything to that?

Jake: No, nothing on that.

Andrew: I have one or two more questions on Orion and then we can turn to a little bit of a longer the longer CoVest talk we promised at the start. I have to ask this question on every podcast but I think it's particularly relevant now to share buybacks, the past three appearances that I believe Ryan made. So the CSAA reference, Q2 call, and their very long investor day, someone has asked them, hey, you guys are pitching this great secular growth story. You guys are really cheap, as I hope we've laid out really well on this podcast, five times current EBITDA and or six times current EBITDA and way less if you give them any credit for the growth story, free cash flow is about to come gushing and your balance sheet is looking solid. And everyone asks, why aren't you buying back shares? And their management's answer has been, hey, we think we're undervalued. But they basically say, recession, Russia, lots of risks out there. We can't buy back shares. And it does strike me as a little strange. They're saying how undervalued the story is, they're saying, don't worry, secular growth story. Recession, yeah, our earnings are going toeven going togrow through a recession due to just this great supply-demand imbalance we have, and they won't buy back shares. So I just don't actually like the capital allocation, why are they buying back shares? What do you guys think about the capital allocation here?

Jake: I mean, yeah, I think we would say that it's coming. In the next couple of years, there's going to be pretty significant free cash flow, even after the growth CapEx that they have planned. I guess there's not a lot of current cash on the balance sheet today. I don't think they're just conservative guys. I don't think they want to just choose the leverage right now to do more buybacks. But it's coming. We'd like to see them do some buybacks and also they have some really high ROI on investments so that's going to be a really good problem for these guys to have in a year or two. But I think it's going to be a yes and kind of story. You're going to see buybacks and growth investments from the cash that's coming down to the part.

Andrew: Perfect. Go ahead, Kyle.

Kyle: Just to put a bow on that, the CEO is an engineer as a conservative engineer. He's got these headlines, but he himself is buying stock. The CEO has bought $6 million of the stock himself out of his own pocket over the last couple of years. Secondly, they added a board member this summer, and they also in their charter, they opened up the charter so now they can legally buy back stock. So as the seasonal working capital ebbs into the winter here, I'd be surprised if they don't buy back stock going tobe because they're concerned about the EU, the energy situation, demand, etc. But the balance sheet's great management team is exceptional. And now with the board member who is a significant owner of the stock, the alignment is there. So, as Jake mentioned, we have high hopes here.

Andrew: I'm laughing because you front ran me. As you said, he's bought back shares several times in the past. He's bought shares several times in the past year, and as recently as August he buys $500,000 worth of shares at just under 17. The CFO bought a couple of $100,000 of shares in May, you had a bunch of board members buying back all in probably $700,000 worth of shares at the start of this year. And all of them are at prices in the 15 to 16 range. So right around here for people who are asking, I guess just on that, I do want to quickly ask insider ownership like that share the share purchases on the open market are really nice. Insider ownership. Nothing special here. There are no huge activists or anything. Do you guys look at insider ownership, as kind of shareholder focused? Do you all have any concerns there?

Jake: No.

Kyle: Perfect running buybacks, he's bought $6 million out of his own pocket.

Andrew: One last question, OEC, and then we'll turn to CoVest. This is a really hard-hitting question so I want you guys to think about it seriously. At the investor day, they had specialized rubber balls and I think one of them was engineered to bounce higher if you throw it on the ground. So they said people could play with it after the breaks. Did you guys get to play with the specialized rubber balls?

Jake: Yeah, I played with it. And I brought it home from my kid. And it's probably somewhere in that house with all his other junk. So yeah.

Andrew: Okay, I told you the hard-hitting questions are coming. Well, hey, that was great. That was a really interesting overview of OEC, and I know you guys have done a lot of work on his super interest. Now, let's just turn to a longer CoVest talk, I guess you're the founder. So I'll flip it over to you if you just want to do a high-level overview of what CoVest is. And then I've got some questions, which hopefully won't make this sound like too much of an infomercial because I can guarantee you guys and pay me I'm just excited. But do you want to start Kyle?

Kyle: Yeah, we built CoVest to solve our own problem. So I've been running GrizzlyRock. Now, we're in our 11th year, small-cap. Long-short, can't talk too much about it, obviously, because of the private vehicle. But one of the things we recognized was from time to time, there were these ideas that were exceptional. We were right for the right reason and we had earned the right to be right. And there were a number of our friends who had very similar experiences. And those of us who run businesses or just invest in personal capital, whatever it is, maximize the position size for your strategy. And that might be 5%, 10%, 20, 30, 40, whatever it is for each fund or each person. But those ideas deserve more capital because they are that compelling.

So we have pursued a number of SPVs at GrizzlyRock historically. We wanted to provide a platform for not only our own ideas but also for managers, friends of ours, lesser-known managers who maybe don't have a full-time investor outreach person, they don't have someone asking who cares in the institutional investor community about investing in small caps that are reflecting and telling that story and crafting and curating a story. It's nuanced, right? We're not activists, we're not investors in private markets for the bulk of what we do. We are constructive collaborative, small-cap investors, and we're looking to curate these small-cap ideas at the right time. So it's 12-18 months, maybe 24 months, but you're right. Entering a catalytic path where we think we can really get paid, right? It's isolating that sprint within the Marathon of the investment and taking that, and taking it out in a way that institutional investors can understand and appreciate and then invest that capital in the idea. So it's no extra work other than telling the story for us.

So we wanted to set this platform up, and we realized we'll have one On probably once a year for the GrizzlyRock team, but there are a whole bunch of our friends who are asking, well, how can I do this? Can I do this with you? Help me along. So we decided to build a platform called CoVest Select. It's covest-select.com, there's all the information. So what we're looking for is managers to partner with and grow their businesses. And there's no, there's no, ask for the manager, there's no upfront, you got to scratch a check. If this works, we scratch the check to the manager. And if not, then, no harm or water under the bridge, and we move forward. So we're helping to grow. We're helping to grow each manager's business and grow their business profile and make them money. That's really one plus one equals three was the goal.

Andrew: One of the reasons I was so excited about this is because I think it's an awesome idea. One of the reasons I think it made sense for you guys to come on is because this is a podcast, where we dive deep into stock for an hour like the audience is probably going to be the type of people who maybe could have a CoVest-worthy idea someday, but just I know why. But if you're somebody who's listening to this, and shaking, Kyle come to you and say, Hey, we've got this great product, you've got a great idea, give us the great idea. And we're going to help raise an SPB I think someone younger and a little more naive, might think, Oh, my idea is so great. I can just go out and do this myself and like not have anyone else to share or not have to share the idea, all this type of stuff, right? So why should somebody who's got this great idea come and work with CoVest instead of doing all of this themselves? I'm good. I know the answer. But there are going to be some naive people who think, it would be easy to do on their own.

Jake: Yeah, I mean, I think we just have a great relationship with allocators who are looking for these types of ideas. Public co-investments is still definitely a growing area, but it's still a small area on the co-investment side, you really still see it more on the private side. So we really know, and especially small cap, public co-investments, it just still kind of is a niche market. So we really have those relationships, and we are able to get in front of those people and get in front of them in a way that they like to see it. We have a standardized template, and we've invested a lot in how the look of our documents, the branding, etc. So, we can get in front of those decision-makers and get it in front of them in a way that they're going to be receptive to, which is someone who's managing a fund by themselves as a one-man shop, or as a two-man partnership probably doesn't have the relationships and bandwidth to do.

Andrew: Not to step on your toes, I think relationships is number one. But I also think the reason in my head, almost 1-A and 1-B is also the structuring, right, like the structure. And if you go and try and do this, like creating the wheel from scratch, you're going to be spending all of your time dealing with lawyers, docks, all this type of stuff. And you guys can correct me if I'm wrong, but you've done these in the past. So you're going to be able to help, you've got the template like it's just going to be so much faster. And for the manager, they're going to be able to out kind of mentally outsource 98% of all the structuring and the docks and everything. So again, not to pitch to you hard, please tell me if I was wrong on anything I just said there.

Jake: No, that's absolutely right. We have the auditors and the lawyers and the structure already in place so it's really plugged and play at this point.

Andrew: If I'm an investor, I'm listening to this podcast and I hope we have a broad range of investors, people who like to invest in compounders, people who like to invest in cyclical, energy focus people, consumer-focused people, people who want to go run an activist campaign on a $750 million company, you guys just pitched a cyclical? Can anyone come and pitch this? Like, are you guys going tobe open to all sorts of different investment ideas? Are you guys going tobe open to all sorts of different investors? Like we've got a 27-year-old petroleum engineer, a Ph.D., who's done a lot of work on a $500 million market cap oil and gas company, he has no experience running an investment. Should he send his in his idea to you or should it really only be small cap focus funds?

Kyle: We'll take everything and we sign an NDA upfront with the investors. We're not doing this to try and steal people's ideas. We're trying to build our business at CoVest alongside other people's businesses or profiles. We're not going to do all the deals, we probably won't do most of the deals that were shown because we're curating the ideas for the investor community if the idea is exceptionally risky. That probably doesn't fit our profile. I know because of the public nature of this. We can't talk about the GrizzlyRock story and our fund and what we do, but we're value investors, we're focused on free cash flow. And when you get that right, you're not going to have these major drawdowns so we're not shooting for the stars always but we're just saying, from time to time there are securities that are wildly mispriced and misunderstood for a certain reason. We're going tounderstand why that's the reason. If we can do that, we can build out these CoVest dossiers.

It's usually 125 pages, not because we're trying to wow people with how many slides we can create, like a banker. It's just about doing the diligence and presenting in such a way where no, we've got the risks taken care of. We understand the corporate governance, we understand the incentive, and we understand the industry. And we're saying yes, all of that, and here on a platter to the right investor. Our full-time business development person knows who wants to see cyclical, who will look at something with commodity exposure, and who wants to see a hedged series. And we can give a hedged version from an industry factor perspective, from a market perspective, right? Like, we can toggle all these dials and truly offer the investor what they're looking for. That's why folks should think about us as they try and grow their business. So

Andrew: Somebody's coming to you with an idea. I think the base level is like, you've got the industry nailed down, you know the company, like those are the basics for anyone pitching an idea these days. You could come on this podcast and do an hour-long podcast talking about the company. So that's the basic, but just one quick thing. It's fundamental research, all that sort of stuff. What's the timeline for these? Like, should someone be coming on this and pitching, hey, I think within the next year, this is a takeout candidate, we're going to be wrapped up in 366 days. Are they coming on in pitching, hey, this is a two to four-year story? Hey, this is a compounder that I think we're going to private equity style buy and hold for seven to 10 years. So what should the people kind of be thinking along the thoughts of that timeframe?

Kyle: Our investor segment or the profile that we believe works in public co-investments are things that are entering a catalytic path or a catalytic window. So we want to be isolating 12 to 18 months. So we have things that are compounders that we have not yet taken out as SPVs? Because how and when are you going to get paid? I don't know. But we think we will, that probably fits really well within a fund. And probably makes a great podcast as well. And happy to come back and talk about some of those to the extent your interest is in.

Andrew: You're getting nailed to that Kyle, you said the magic word you're getting nailed to it.

Kyle: No problem, but what the investor community is looking for in public co-invest is something... So historically, they're active ideas, right? We're going to go active, we need to raise another 100 million dollars to go pound down the good.

Andrew: 5%, file a 13-D, run an activist campaign, yep.

Kyle: We've filed some 13-Ds in the past, but we've found a better way that works for us. And that is being collaborative and constructive, working with management, showing them or information showing them, your stock is here, it shouldn't be here, and here's the discrepancy. It could be narrative, it could be corporate governance, it could be capital allocation, whatever it is, and really trying to get a focus on that. And whether it's an analyst day or communication of corporate governance, or speaking with a lead independent director, these are all things that could be part of that catalytic path. And those would make really good public market co-investments. But and look if something is just that cheap, and the numbers are reflecting the markets missing it. That's fundamental small-cap investing, right? And that may or may not work for certain investors too. So well, all we're saying is as a platform, the platform exists. You work with guys that have been doing this for a long time, Jake and I the backgrounds are, you can see it online. We're trying to grow our business alongside others businesses. We're pretty well known in the small-cap community.

Andrew: I don't disagree as we just connected in the past month, but I've known you guys for years. So, no disagreement there. I'll remind everyone, I'm going to have a link in the show notes too. But if you want to find it, it's CoVest Select. They've got CoVest Select as the Twitter account, you can google CoVest Select and find the website there. But guys, I think we've covered a lot on OEC. I think we've covered a lot on CoVest Select. I'm sure we could keep talking about these for a long time. But anything else you guys want to talk about before we kind of wrap this up?

Kyle: I really appreciate it. I've been a longtime lurker, listener, and consumer of your content so I'm glad. Hopefully, this is informative and helpful for you and your team, and your listeners. I appreciate your time.

Andrew: Hey, I appreciate it. As you said, I was really excited about CoVest Select when you guys launched it. I'm glad to have you guys on. It's exactly the type of product I want to be talking about thinking about. And the pitch is exactly the type of thing I'd love to have on this podcast. Jake, did you want to say anything?

Jake: No, just thanks for having us. Please reach out if there's something you'd like to talk about.

Andrew: Well, Jake, Kyle said the magic words that he's coming back on but I'm going tohold you to that too. I really appreciate it, really appreciate you guys coming on. Again, CoVest Select, the link will be in the show notes. You can find it pretty easily if you Google but appreciate you guys and we'll chat soon.

Kyle: Thanks, Andrew.

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