Thread by @DownunderValue

East 33 $E33 $E33.AX is a premium Sydney Rock Oyster company that recently IPO’d. Substantive performance rights for management with a colourful history will likely drive a debt-fueled acquisition binge and short term shareholder returns.

Let’s take a deep dive. 👇

1. Investment thesis: Special situation.
✅Fast top-line growth driven by acquisitions.
✅Strong market conditions.
🚩Performance incentives for EBIT and share price growth.
🚩Debt financed.
🚩History of poor management.

2. East 33 farms native Sydney Rock Oysters – a premium product.

Vertically integrated, they have an export approved facility, export certificate, 195ha of farming licenses, and a nursery.

3. Sydney rock oysters are substantially different to Pacific oysters.

They take a lot longer to mature (meaning typically higher inventories and cost of production), but also have more appeal in the export market.

4. Global oyster production and exports have been growing rapidly. It’s partly due to premium product, but they’re also very efficient (near zero food inputs required).

5. Australia is a minor player in the global oyster market.

Most the production comes from France, and most the consumption is in Asia. Therein also lies the opportunity.

6. Australian oyster market is highly fragmented: There are over 250 permit holders for Sydney Rock Oysters in NSW alone. Most are small producers. There’s no really economies of scale on the production side.

7. Processing and wholesale however provide economies of scale.

All of this leads itself to a market that is ripe for roll-up strategy, and in particular acquisitions for East 33.

8. East 33 has a well considered acquisition strategy. Indeed, ‘acquisition’ was used over 260 times in the IPO document itself.

9. A total of nine acquisitions have already taken place from 2019-21. The most recent (CMB) funded by the IPO was the largest, worth a total consideration of $17m + stock options.

10. So that's the lay of the land for oysters, let's look more into the capital structure.

When looking through the prospectus, what jumped out to me was the big gap between the undiluted and diluted shares on issue.

11. While the word ‘acquisitions’ may have been used 260+ times, the figure “407,561,987” is used three times, and only on page 161 is it fully explained.

12. Here you can see who are the beneficiaries of those performance rights.

13. And here you can see what the vesting conditions (read:incentives) are for the Directors.

14. This is what Grant Thornton had to say about the amount of performance rights – seems I wasn’t the only one to think it may have been high. 🤷

15. There’s nothing inherently wrong with the performance rights – they will drive EBIT and share price appreciation, many shareholders will be happy.

Generally, I prefer FCF, NPAT, even book value..

16. I have taken the liberty to use their own outlook to forecast their EBIT going forward. And from existing acquisitions and new potential acquisitions, they’ll get close to their EBIT target if margins are as high as they hope.

17. The incentive is to ramp up acquisitions – almost at any cost, for the more you pay, the higher the debt, the higher the market cap, the higher the EBIT. As it is, their cash flow is already looking weak and their debt with NAB is currently maxed.

18. One risk that is apparent are the EBIT margins.

They’ll need to beat the best margins in Australian aquaculture (Tassal) by +50% to get there. If it was me, I’d just massively reduce SG&A and CAPEX in FY24 – problem solved.

19. The other risk is that they need a high multiple to get to $1 by FY24. Based on the market, the EV/EBIT for aquaculture is actually not so high.

20. The implied EV/EBIT required for East33 to vest Tranche 4 performance rights would require almost double the market EV/EBIT of the top performing aquaculture firms – you’ll note most don’t even earn EBIT or NPAT.

21. Spitballing here.. but if I was trying to drive up the multiple, I’d be inclined to call myself a premium product and associate with other premium products like LMVH (proposed director) or Moet (“master collaboration”).

Here’s the front cover of the financials - premium.

22. No doubt the next few years could see some dramatic share price increases (not advice).

Here’s what two of the three director’s were able to achieve with their previous vehicle, Mission New Energy, prior to it’s collapse and delisting in 2019.

23. Overall, this is not my type of investment.

The long-term debt risk seems too high; I don’t like shareholder dilution; and I don’t have confidence in the management / capital allocation structure. Besides, I prefer Pacific to Sydney Rock Oysters.

Others like it though👇

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Questions and feedback always welcome. DYOR.

Disclaimer, I have no position in $E33