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Capital Ideas for Capitalize for Kids

Guy Gottfried, Rational Investment Group

(647) 346-0464 guygottfried@rationalig.com
Investment Idea: Tree Island Steel Ltd. (TSX: TSL)
Building Products Manufacturer
*All financial figures pertaining to Tree Island are in Canadian dollars unless otherwise stated
32.5 million

Recent Price

Market Cap
$57 million*

One of largest manufacturers of steel wire products in North America
One plant in BC, three in California; annual capacity of 355,000 tons

Historically profitable business: strong earnings for at least 15 years*
prior to financial crisis

Nearly went bankrupt before being recapitalized by investor group
led by building products industry veteran Amar Doman
Installed himself as chairman, replaced former management

After economic downturn, spent years preoccupied with balance
sheet, cost-cutting and generally staying afloat
Only in past couple of years has it been able to shift focus to sales growth
*Going back as far as results are available
Why is Tree Island Worth Your Attention?
Trades at 3.6x normalized free cash flow (FCF)

Material organic growth potential for years to come with little
incremental capex

Exceptionally well-run

Considerable insider ownership and recent buying
Why is It So Cheap?
Small, closely-held company

Underfollowed: until less than a year ago, had no
earnings calls or analyst coverage

Business has been under-earning for five years, obscuring
its true earning power
Competitive Advantages
Richmond, BC plant (accounts for bulk of Tree Islands capacity and
sales) has important cost advantages

Purchasing: due to location (by Fraser River/Pacific Ocean) and scale,
can source steel wire globally at dramatically lower all-in cost per ton
than competitors whose size and/or location forces them to buy locally
Imports from low-cost producers in China, South Korea, Australia, Chile etc.

Sales: location in rail/truck backhaul market enables it to ship products
cheaply from BC to Eastern Canada, Midwest and Western US
At same time, protected on its home turf from rivals in above regions (since much
more expensive to ship from there to Western Canada than vice-versa)
Capacity Utilization and EBITDA
Profitable even with miniscule ~30% utilization,
extremely leveraged to incremental sales
*Amounts in millions
0.1 1.3
2010 2011 2012 2013
EBITDA Capacity Utilization
Organic Growth Case Study: Geographic
Company leveraging its rail cost advantage to expand
significantly in Illinois

Added approximately 6,000 tons in annualized sales

Room for continued expansion; Illinois still a small
market for Tree Island
Organic Growth Case Study:
Exploiting Competitor Weakness
Agricultural fencing: won share from rival in Western Canada
by offering farmers more frequent shipments of lower-volume
orders while competitor insisted on full truckload deliveries

Rival recently withdrew from Canadian market, handing Tree
Island even more business

YTD added approx. 4,000 tons annualized
Organic Growth Case Study: Customer Wins
Won fastener business with Lowes Canada in past year

Growth potential: Lowes still has small presence in Canada,
seems intent on expanding (e.g. bid for Rona in 2012)

Opportunity to penetrate Lowes account and become supplier
in Western US

Case studies illustrate strides Tree Island is making despite little
help from macro environment; sales gains will accelerate
if US (its main market by far) continues to rebound
Further Evidence of Sales Traction
From late Q1 through Q2, grew production staff in Richmond
by 27% and at California plants by 13%

Adding labour cost-effectively; latest round of union deals
provided for much lower wage rates for new workers

Results actually hurt in Q2 due to training costs, inefficiencies
associated with spike in new employees; benefit from
expanded workforce yet to be seen in financials

Staff additions suggest management anticipating
continued pickup in volumes
Management Case Study: 2012 Debt Repurchase
When Tree Island faced financial difficulties, it obtained forbearance
agreements on its payables from its two main steel vendors
Instead of being immediately due, amounts would be repaid on installment
basis at 7% interest

In 2012, renegotiated these agreements as follows:
Vendor #1 (owed US$16.7mm): debt fully extinguished in exchange for
US$5mm payment; 70% haircut
Vendor #2 (owed US$15.8mm): no payments for six years, principal will be
repaid from 2018 to 2028 with interest at 4%, non-compounding and due
from 2024 to 2028; approx. 60% haircut on PV basis
Eliminated companys biggest liability at combined discount of ~65%
without resorting to bankruptcy and with no equity dilution,
creating tremendous shareholder value
Insider Buying
CEO, CFO and VP Sales have all paid between $2.30 and $2.40 per
share in past half year (31% to 37% premium to current price); CEO has
bought shares in seven of last nine quarters
Insider purchases since July 2013 2,115
Diluted shares outstanding 32,530
Purchases: % of shares 6.5%
*Amounts in thousands
Seven insiders have bought 7% of company on
open market in past 15 months
How Much Can Tree Island
Make in Normalized Environment?
From 1998 to 2002 (prior to onset of US housing bubble),
annual EBITDA ranged from $23mm to $34mm,
averaged $28mm*

EBITDA of $25mm in 2006* despite Southwestern US
housing market beginning to cool that year
*Before foreign exchange gains in all years and one-time gain from wire rod price drop in 1999. Without
these adjustments, EBITDA totals would would be substantially higher.
Operating earnings should return to $25mm range and could
exceed that level Tree Island has generated millions of dollars
in fixed cost cuts since Doman came aboard
Normalized FCF Multiple
At FCF multiple of ten, even if it took five years to attain
normalized results, investors would still earn CAGR of 23%
*Amounts in millions
EBITDA $25.0
Maintenance capex (1.5)
Interest (2.3)
Taxes (5.3)
FCF $15.9
Per share $0.49
P/FCF 3.6
Continued sales traction
Earnings, FCF will soar as capacity utilization rebounds from 30%-range

Tuck-in acquisitions
Will add complementary products/relationships, enhance earning power

Dividend resumption
Doman has history of favouring dividends at investee companies
Low capex requirements, closely-held nature of shares (making buybacks
difficult) support rationale for dividends
Materially undervalued
Excellent management with major skin in the game
Clear strategy toward restoring former profitability,
strong evidence of successful execution
Investment Idea: TerraVest Capital Inc. (TSX: TVK)
Diversified Holding Company
*All financial figures pertaining to TerraVest are in Canadian dollars

18.6 million
Recent Price
Market Cap
$115 million*
$0.40* (6.5% yield)
TerraVest Today: Three Parts
RJV Gas Field Services
Manufactures wellhead processing equipment for oil and gas
industry in Western Canada

Gestion Jerico
Manufactures items such as propane dispensers, residential and
commercial liquid containment units, bulk propane trucks

Diamond Energy Services
Service rig operator in Saskatchewan
Formerly a conglomerate with six divisions

Struggled as several subsidiaries underperformed, culminating in
dividend suspension in 2009
Activist investor took control of company

From 2010 to 2012, divested four of its six divisions, used
proceeds for special dividends, share repurchases
Reinstated regular dividend in 2013

Earlier this year, acquired Jerico and began to pursue
consolidation strategy
Why is TerraVest Worth Your Attention?
FCF multiple of 6.7 based on run-rate of current business
Investors paying nothing for serious growth prospects

Valued at just 3.6x estimated FCF including likely acquisitions
Aggressively pursuing consolidation at RJV and Jerico; numerous
targets available at low-single-digit EBITDA multiples
Can double FCF in next three years

Record of excellent capital allocation

Considerable insider ownership and recent buying
Why is It So Cheap?
Underfollowed: no analyst coverage or earnings calls before August

YTD results understated because Jerico acquisition closed mid-year;
absent from 1.5 out of 3 quarters* including seasonally-strong Q1

Underappreciated growth potential: TerraVest in early stages of
acquisition strategy after years of shrinking
*TerraVests fiscal year ends on Sep. 30
Consolidation Opportunity: RJV and Jerico
Both divisions in fragmented industries with many small operators
Numerous targets available at low valuations (4-4.5x standalone EBITDA)

Both RJV and Jerico have inherent advantages that enable them to
create sizeable cost synergies
RJV: in-house manufacturing capabilities allow it to cut out costly contractors,
earn much higher margins than peers
Jerico: can source steel at meaningfully lower prices than competitors (this
also helps RJV, which sources from Jerico)
Combined, RJV and Jerico have opportunity to deploy
$100mm-plus at 2.5-3x EBITDA after cost-cutting
Capital Allocation Case Study: NWP Industries
RJV competitor, first acquisition under new consolidation
strategy; deal closed in August

Paid 4.25x EBITDA based on current results

Major cost-cutting opportunity from exploiting RJVs and
Jericos cost advantages and from overall efficiencies
Management has knack for finding way to remove costs

NWP not anomalous; multiple transactions with similar
economics being explored by both RJV and Jerico
Capital Allocation Case Study: Substantial Issuer Bid
In 2012, TerraVest offered to repurchase 5mm shares (25% of
shares outstanding) through substantial issuer bid at $2.75

Shareholders tendered 7.2mm shares; instead of pro-rating
them, company elected to accept entire amount

Bought back 36% of its shares at low-single-digit FCF multiple
and less than half of current price
Insider Buying
Not included above: Charles Pellerin (runs Jerico) received his portion
of Jerico acquisition price entirely in stock, aligning his and
TerraVests interests; now owns 12% of company
Nine insiders have bought 8% of company on open market
since February at average cost of $6.21 per share
Insider purchases since Feb. 2014 1,426
Diluted shares outstanding 18,594
Purchases: % of shares 7.7%
*Amounts in thousands
FCF Multiple: Current Business
Modest valuation even ignoring acquisitions; investors
paying nothing for TerraVests sizeable growth prospects
EBITDA run-rate $30.0
Maintenance capex (4.0)
Interest (3.1)
Taxes (5.7)
FCF $17.2
Per share $0.92
P/FCF 6.7
*Amounts in millions
FCF Multiple Adjusted for Probable
Acquisitions in Next Two to Three Years
In longer term, significant chance of additional transactions beyond
level assumed in this calculation, making stock even cheaper
Present run-rate $17.2
EBITDA from RJV acquisitions 13.3
EBITDA from Jerico acquisitions 20.0
Incremental capex, interest, taxes (12.3)
FCF $38.2
Diluted shares outstanding: present 18.6
Shares issued for acquisitions 3.6
Adjusted shares 22.2
FCF per share $1.72
P/FCF 3.6
*Amounts in millions. Assumed $40mm and $60mm in acquisitions for RJV and Jerico, respectively,
funded 75% debt and 25% equity, at 3x EBITDA after synergies.
Further acquisitions
Large pipeline of deals available at bargain prices
Will result in rapid growth for foreseeable future

Monetization of Diamond only segment not targeted for growth
Stable earnings, leading share in its region; would be attractive addition
for larger energy services firm
Would provide significant capital to redeploy into RJV and Jerico
Anomalously cheap
High degree of insider alignment,
record of impressive capital allocation
Investors havent caught on to enormous growth potential
TSL and TVK: Important Commonalities
Misunderstood: market ignoring fundamental changes at
each business

Demonstrably cheap; compelling margin of safety

Strong management and substantial insider buying