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Financials Silverdell closed the last financial year with net debt of £11.2m, giving gearing of 29.4% and net debt to EBITDA of 1.8x. In our base case forecast we see the company generating £5.9m of free cash flow in 2013. It will pay out some £548k in dividends and there is likely to be £1.8m of deferred payment for EDS. After this, the company will have £3.5m to pay down debt to £7.7m, leaving it with gearing of 17%, and a net debt/EBITDA ratio of just 0.53 times (due the higher EBITDA resulting from the full year contribution by EDS). We estimate that Silverdell will become net cash positive during FY15 leaving room for acquisition spending should the company be presented with an opportunity. We anticipate a second (and final) deferred payment of £1.8m to be made for the acquisition of EDS in 2014. EDS also brings a higher level of capex since it is more capital intensive. We anticipate a gross capex of £1.5m in 2013 after £138k in 2012.

Growing the business this fast would also mean an even greater increase in working capital consumed. Arguably the company’s balance sheet is not strong enough to support this level of investment for growth. The lower cash generated (lower gross margins and higher selling costs), higher working capital requirements, and, in practice, the need for acquisitions to kick start growth in some new markets would all point to the need for one or more equity fundings. This is inconsistent with the medium-term management target of a progressive dividend policy. However, if we model this, our DCF increases to a range of 18p to 79p per share, with our assumptions on exit multiples and cost of equity giving a fair value of 41p per share. The question in our mind is not whether the opportunity exists for this revenue, but whether Silverdell is capable of winning the contracts to achieve it. If management was to aim for this high-growth trajectory it would have to generate 2014 revenues of £203m. This means it has to bring in roughly £53m greater revenues in 2014 than in the base case. Some 90% of contract work won is now on long-term framework contracts (ie 10 years in duration rather than one year), so raising revenues by £53m in 2014 means winning approximately £530m more business this year. Silverdell estimates that it has a 30% win ratio on bids, so it has to bid for additional contracts to the tune of £1,766m. The flow of work to generate the additional revenues is thus: Bid for £1,766m of work Win £530m of framework contracts Do £53m work in 2014.

opportunity to reach this level of activity. In the UK the provision made by the government for decommissioning rose from £2m in 1970 to £9.5bn in 1990 and up to £53.7bn in 2011. Of this £3bn is to be spent every year for the next four years. Silverdell would need just one-sixth of the UK spend per annum to achieve the half billion revenues. That is a high proportion, but the opportunity also exists in the rest of the globe. By the start of last year 138 nuclear power stations had been shut down in 19 countries. 2 However, only 17 had been fully decommissioned. If we then consider decommissioning of oil refineries and non-nuclear power plants this revenue level becomes realistic. In order to reach revenue of £0.5bn in our five-year blue-sky scenario management would need to achieve revenue growth of 35% per annum between now and 2017. To do this would presumably require a combination of strong organic growth and acquisitions. We make the assumptions that gross margins could fall to 20% in both the Remediation and Decommissioning divisions as bidding is more aggressive to win work. Admin costs rise by £5m in 2013 and 2014m over our base case, rising in line with sales thereafter. This equates to an additional 50 account managers over the base case to start with. We see this figure as justifiable since in this scenario Silverdell will be seeking work throughout North and South America, Europe and Asia. The effect of this additional cost is that we calculate EBITDA margins falling to 8.5% in prospect. After the explicit five-year period we assume that revenues once again drop to 2% for the remainder of the modelled period (out to 2032).

Selective investment: In January 2013 Silverdell announced that it had won a deal to decommission a redundant power plant in Quebec, Canada. To do this it bought the above ground assets for approximately £4m. It will decommission and decontaminate the power plant and sell 37,000 tonnes of reclaimable assets generating revenues estimated at £12m. After the initial purchase cost and the cost of remediation the transaction overall should earn sensible margins. To achieve higher growth rates Silverdell may need to participate in more of these types of deals that require upfront investment. This does hint at the potential need for the company to raise further funds if it chooses to pursue higher growth strategies.  Modest acquisitions: It is likely that Silverdell will continue to make small acquisitions to expand. For example, the best way to address the market opportunity in German nuclear decommissioning may be to buy a five-person German consultancy operating in that field. Perhaps the most important variables are the level of gross margin of the business and the amount of additional cost added to the admin line. We have set our decommissioning gross margin at 20% and fixed the Remediation gross margin at 1.2% points higher. With that in mind the table below shows the sensitivity of the fair value to the amount of additional admin cost and the level of gross margin in the Decommissioning division in the management targets scenario.............

management’s medium-term targets will be:  Profitability of contracts – gross margin reduced to win work. While there is plenty of business out there to win, Silverdell cannot always rely on its quality credentials to win it. In the recent bid for £200m of work on the Grangemouth refinery, Silverdell lost out on price to the company reborn after the pre-pack administration of Siteserv. This suggests that Silverdell may have to get more competitive on pricing to generate 15% revenue growth.  Admin costs – the level of overhead put into the business in order to win the contracts. In our base case scenario the cost base is the sum of the old Silverdell and the new EDS cost base with no forecast benefit to net costs from the integration of the two businesses. Despite this, we believe that in a low-growth scenario, the EBITDA margin is capable of reaching 10.5%. Management can pick and choose contracts for the greatest profitability.  Cash working capital consumed to grow: When Silverdell wins a piece of remediation work it is paid in stage payments and at the end of the contract. However, it is paying its workers on a weekly basis. So it may have to pay its employees eight to 10 times before it is paid by the client. In a company that is forecast to grow revenues aggressively this may lead to a weakening of credit terms. We model the increased cash consumed by the company for working capital, and the effect on net debt can be seen in Exhibit 7. This is initially more negative than for the base case, but the impact of high revenues, profits and cash generated by operations quickly results in a payback of net debt so that the company would still move to a net cash position in 2016.

Silverdell offers an 9.4% free cash flow yield this year, rising to 12.5% next year. This FCF yield is likely to drop if the company invests to generate high growth. Under the management target case, the 2014 FCF yield would be 10.4%, which is still reasonable but not so attractive. Valuation scenarios In order to work out what Silverdell could look like in three to five years’ time we have modelled two DCFs, which describe possible outcomes for the company. These are a base case, which assumes very low growth, and management’s target case, using the medium-term targets laid out in the recent results statement.

Valuation P/E: Silverdell has historically traded on a P/E of between 9x and 10x current year earnings. This level currently sits at 9.9x 2013 earnings. The shares have rallied from 10p/share in May 2012 to the current level (20p) while the effect of the EDS acquisition has been to boost earnings per share from 1.5p in 2012 to a forecast 2.0p in 2013. The deal has had a positive effect on the company, but this has only been reflected in the share price to the extent that our base case forecasts are correct. If the management’s medium term targets are achieved a further increase in price would be justified. EV/EBITDA: At the current price Silverdell is trading at an EV/EBITDA of 4.8x in this current year dropping to 4.2x in 2014. In 2011 the company traded on roughly a 6x EV/EBITDA multiple so on this measure the company is valued lower by the market than historically.

Progressive dividend policy In FY12 Silverdell announced its first dividend. This is a 0.175p/share dividend to be paid in FY13. This makes a 0.9% dividend yield at the current share price and will cost the company £548k. Given the low start point, achieving a dividend that is covered and that grows should not be challenging.

Unlike a manufacturing facility Silverdell does not have a natural operational gearing within its business. Most of the Remediation work is manpower, and while there is a larger capex element to the Decommissioning work, it too is heavily reliant on manpower. To justify a higher revenue growth than historically the company will need to incur some significant investment. This, in our assessment, would result in 1) a reduced gross margin as it may need to bid more aggressively, 2) increased admin costs to reflect the higher number of sales people (account managers) required, 3) increased consumption working capital needs as the company bids for more projects that have an upfront cost. In order to generate 15% of revenue growth in 2014 the company will have to bid for and win more contracts. We calculate that this could result in gross margins dropping 100bps to 23.2% in Remediation and 100bps in Decommissioning to 22% as the company begins to put in more competitive bids while still retaining a sensible profit margin. On this scenario we would increase the central overhead (in the admin cost line) by £1.0m in 2013 and 2014 (rising in line with sales thereafter). To generate the additional £12m revenues in 2014 (over the base case) rising to £87m in 2017 will require more account managers (salespeople). If we assume a salesperson earns £50k pa and has a 100% on-cost the company will be able to hire 10 more for our admin cost increase of £1m. These account managers would be spread across the three core countries. So, with this admin cost increasing in line with sales by 2017 it would rise from £23.0m to £37.4m, giving a substantial potential boost to the marketing budget.

Target at least two years’ worth of revenues on the order book One change in company strategy that will really drive future growth is the move from short-term book and bill work (non-repeating) to longer-term framework contracts running over several years (often 10 or more). Prior to this Silverdell effectively started each year having to win contracts to the value of its full revenue target. By October 2011 the company achieved a point at which 95% of its order book was longer-term framework contracts.

Silverdell is with the decommissioning of nuclear power stations – a capability brought with the EDS acquisition in June 2012. Half the world’s reactors are expected to be closed by 20301, pointing to the decommissioning of some 200 reactors, of which more than 150 are in Europe, where the opportunity is estimated at $81.5bn. The European Commission estimates the current cost of decommissioning to be between $200m and $1,150m per reactor. Geographically we continue to highlight Germany as the market with the greatest opportunity for Silverdell. Following the Fukushima disaster, Chancellor Merkel announced the decommissioning of all 17 of its nuclear power stations by 2022. €32.5bn has been set aside for this decommissioning. Any company that is capable of investing in this size of project, has feet on the ground in Germany and starts the process of preparing to win this type of work has the potential to generate significant revenues. Silverdell in our view is well positioned given its strengths operating in high-hazard, highly regulated environments, offering a turnkey solution: putting up the scaffolding, removing asbestos (and there is often plenty of asbestos in nuclear power stations), dismantling, safely disposing of contaminated equipment and finally reclaiming land.

2012 results and outlook The year ending September 2012 was a milestone for Silverdell. The company managed to double the size of its business through the acquisition of EDS. It also established a more supportive banking relationship with HSBC bank, replacing Barclays bank. FY12 results showed sales of £82.5m (+38%), EBITDA of £6.2m (+52%) and normalised EPS of 2.6p (+78%). The contribution to group revenues from EDS was modest in 2012 at £18.85m. Of this, £10m was generated in Canada and £2.77m in Australia. The remaining £6m of revenues was generated in the UK, highlighting that EDS also has a strong UK portfolio of work. EBITA margins were 16.5% in Canada, 5.8% in the UK and 5.3% in Australia, where the contract to do the first decommissioning of one of the country’s oil refineries began during the year. We estimate that in FY13 EDS will be earnings accretive and will have revenues of around £64m. Remediation revenues (60% of 2012 group total) fell 4% over the prior year, partly due to demand, partly due to timing, and partly, we suspect, due to management having to focus on the integration of EDS. By contrast the Consulting division’s revenues were up 74% to £14m, 17% of the 2012 group total, supported by acquisitions. Despite a £8.5m equity fund-raising to provide the cash element required for the EDS acquisition, the company closed the year with £11.2m of net debt. This is high compared to historic levels, but still represents a net debt to EBITDA ratio of less than one times. Group EBITDA margin of 7.5% was an improvement on the 6.8% in 2011, but some way from the 10% target the company has set itself for the future.

Silverdell is a specialist support services company that operates in highly hazardous regulated environments. It undertakes asset maintenance and recovery, decommissioning, asbestos management and consulting services to the built environment, industrial and energy sectors. The company continues to execute its strategy successfully, Management promised a buy and build approach to growth and has largely delivered that. In 2012 it doubled its size with the acquisition of EDS, a decommissioning company with operations in the UK, Canada and Australia. Management is now completing the integration of this acquisition. It will continue to identify small bolt-on acquisitions, but it now has the right platform (both in scale and function) from which to deliver strong organic growth. This growth is likely to be based predominantly around the key UK, Canadian and Australian operations. Silverdell has now issued medium-term KPIs, which, if delivered, support its growth ambition...........

Valuation: Price factors in little success Our base case forecast scenario is moderately negative in outlook, assuming just 2% revenue growth in the future. Even on this basis our DCF suggests a fair value of 23p a share. If management is successful in achieving its medium-term targets then this would add 35% to our valuation of the company, at a fair value of 31p/share. On our base case forecasts the company trades at 9.9x earnings, within its 9-10x trading range, and on an EV/EBITDA of 4.8x, below its historic 6x range. This suggests that the market does not think the management will have success in hitting its targets.

New medium-term targets are ambitious Management has laid out ambitious new medium-term targets founded on revenue growth of 15% pa and a sustainable EBITDA margin of 10% (7.5% in FY12). We believe these are a stretch, but achievable. The remediation division had a poor 2012 and will need to be returned to growth. These targets preclude material additional investment or acquisitions; if these were to occur, higher growth and eventual higher payback would be a possibility.