[Nick Hargrave]

Another idea that we are completing DD and our memo on that we wanted to highlight early – Hudson Technologies.

“Hudson Technologies, Inc. is a refrigerant services company. The Company provides refrigerant products and services to the heating ventilation, air conditioning and refrigeration industries. The Company’s products and services are primarily used in commercial air conditioning, industrial processing and refrigeration systems, and include refrigerant and industrial gas sales, refrigerant management services consisting primarily of reclamation of refrigerants and RefrigerantSide services performed at a customer’s site. RefrigerantSide Services consists of system decontamination to remove moisture, oils and other contaminants intended to restore systems to designed capacity.”

What this boilerplate description doesn’t highlight is that Hudson is the largest reclaimant of refrigerant in the US with a 35% market share – by far the largest player in a fragmented market. Where this gets interesting is that the US passed the AIM Act (American Innovation and Manufacturing) in 2020 which mandated the reduction of virgin refrigerant usage to combat climate change. In 2024 there is a mandated virgin refrigerant step down of some 40% from the base line, dramatically reducing the supply in the market. The thesis, therefore, is that not only will the reduced supply support pricing, but also increase the use of reclaimed refrigerant where Hudson is the clear market leader and can reclaim and recycle all varieties of refrigerant. The company’s investor presentation provides a good summary of the dynamics:

https://www.hudsontech.com/pdfs/investor-relations/HDSN-Investor-Deck.pdf

The company is reliant on the sale of refrigerants, which are a commodity subject to cyclical pricing, weather patterns (i.e. hot weather requiring air conditioning) and supply from a small number of large players (e.g. Honeywell). However, they benefitted in 2022 from a high price environment and low-cost inventories (the company uses the FIFO accounting method) leading to exceptionally high gross margins of 50%. The management have been clear that those margins are unsustainable with inventory costs catching up to pricing that is easing but nonetheless, the company was able to retire a significant amount of debt (see below re the historic acquisition) with the resulting cash flow, putting the company on a more stable and flexible footing.

The company provided long term gross margin guidance of 35% in a Nov-22 investor presentation and despite achieving a 50% gross margin for the full year in 2022, the Q4-22 gross margin came in at 32%. Q4, for obvious weather-related reasons, is the lowest demand quarter with Q1-Q3 being the selling season. The market, however, took this to mean that the recently provided long term margin guidance wasn’t achievable and the share price came down significantly following the results. Part of the rapid decline was driven by investor caution on the management team which executed a $209m acquisition in 2017 that over-leveraged the business at just the wrong time. There is also some fear that with the increased financial flexibility the management may once again embark on M&A rather than fully retire their debt.

There are certainly risks to consider both on market cyclicality and capital allocation, but as we finalise our DD we don’t believe that the current valuation reflects the opportunity now ahead of the company with the regulatory tailwinds in their favour.

Valuation assumptions: Our preliminary modelling is pointing towards a Thesis Price of c.$12 (based on modest top line growth, a 32% gross margin and just an 8x OE multiple) – 50% above the current price, with a Risk Price around the current price i.e. where the market currently appears to be, baking in consistent revenue declines, gross margins of 30% and a 6x OE multiple.

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