Velan, a turnaround play with potential for acquisition

(TSX: VLN) is a leading Canadian manufacturer of high-performance industrial valves.

Disclaimer, I am a shareholder of Velan.

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Introduction

Velan (TSX: VLN) is a leading Canadian company specializing in the manufacture of high-performance industrial valves. Founded in 1950, Velan has established itself as a key player in various sectors, including nuclear energy, the petrochemical industry, and utilities.

Potential Catalysts

1. Growth Potential in the Nuclear Sector: With increasing demand for clean and sustainable energy solutions, Velan is well-positioned to capitalize on the growth of the nuclear sector, where it holds a significant market share.

2. Potential Acquisition: The possibility of a buyout by a strategic buyer, particularly a French or European company, could offer a significant premium to shareholders and boost the stock price.

3. New Contracts: Securing new contracts, especially in the nuclear or petrochemical sectors, could significantly increase revenue and enhance Velan financial visibility.

4. Strategic Partnerships: Forming new strategic partnerships, similar to the agreement with Bruce Power, could strengthen Velan market position and open new growth opportunities.

5. Reduction in Legal Costs: A favorable resolution of ongoing litigation could reduce legal costs and improve the company’s net profitability.

Market Position and Competitive Advantages

Velan holds stringent quality and safety certifications, such as ISO 9001 and ASME, which enhance its credibility and appeal to demanding clients. With manufacturing facilities in nine countries and clients in over 60 countries, Velan benefits from a global reach that allows it to diversify risks and capture growth opportunities across various markets. The quality and reliability of its products, used in critical applications such as nuclear power plants and petrochemical facilities, are widely recognized. Velan continually invests in research and development to improve its products and maintain its market leadership. Additionally, high customer loyalty, due to the company’s ability to meet the stringent demands of critical sectors, translates into long-term contracts and a stable customer base.

Nuclear Sector

Global demand for clean and sustainable energy sources is increasing. Many countries are investing in new nuclear power plants and upgrading existing infrastructure. Velan, with its strong presence in the nuclear sector and high-quality products, is well-positioned to capture a significant share of this growth.

Velan nuclear valves are preferred worldwide due to their exceptional reliability and proven performance. Velan valves are installed in two-thirds of the world’s nuclear power plants, including 100% of the plants in Canada, France, and South Korea, and 90% of the plants in the United States. This widespread adoption demonstrates the trust that nuclear plant operators place in Velan products to ensure the safety and efficiency of their operations.

Velan is one of the largest manufacturers of valves for the nuclear sector, with over 50 years of experience in providing valve solutions for nuclear power plants. Since 1971, Velan has held nuclear accreditation from the American Society of Mechanical Engineers (ASME), underscoring its commitment to the highest quality standards. Velan nuclear quality assurance programs are monitored by ASME and regularly audited by entities such as the Nuclear Procurement Issues Corporation (NUPIC), Newport News Shipbuilding, the Defense Contract Management Agency (DCMA), nuclear utilities, and other regulatory and quality assurance entities.

Velan remains at the forefront of motorized valve qualification testing to address issues raised in the U.S. Nuclear Regulatory Commission’s (NRC) Generic Letter 89-10. This proactive approach to addressing regulatory and technical concerns reinforces Velan position as a trusted supplier in the nuclear sector.

The company has specialized marketing, sales, engineering, and quality control teams that work closely to meet each client’s specific needs. These specialized teams enable Velan to provide tailored solutions and ensure top-notch technical and commercial support. Velan ability to innovate and adapt to the evolving demands of the nuclear sector makes it a strategic partner for nuclear power plant operators.

Velan products, including ball valves, gate valves, and control valves, are designed to withstand extreme operating conditions, offering increased durability and reliability. This robustness is crucial in nuclear environments where safety and operational continuity are paramount.

Financial Performance and Growth Prospects

1. Positive Cash Flows: Velan cash flows from operations have been positive, with modest growth projected in the coming years, reaching approximately CAD 30-36 million by 2027.

2. Improved Profitability: Restructuring and cost optimization efforts have led to an improvement in adjusted EBITDA, demonstrating the company’s ability to enhance profitability even under challenging conditions.

3. Cost Reduction: Velan has implemented cost reduction measures to improve operational efficiency and profitability.

4. Prudent Debt Management: The company maintains prudent debt management, allowing it to retain financial flexibility for future investments.

Research and Development (R&D) at Velan

Velan invests significantly in research and development to enhance its products and develop new valve technologies. This commitment to innovation helps the company maintain its market leadership. Velan portfolio of cryogenic products, including control valves and isolation valves suited for cryogenic applications such as LNG and hydrogen, is a key area of its R&D investment.

Excerpt on the Cryogenic Segment: "What we liked about Velan was that they were better positioned with some of their technologies and products than we were. So, the M&A work to expand this cryogenic valve portfolio will continue into 2024 and beyond." - Robert Rowe, Flowserve Corporation - Q4 2023 Earnings Call.

Flagship Products

Velan offers a wide range of high-performance and reliable industrial valves. Here are some of Velan flagship products:

1. Globe Valves

2. Metal-Seated Ball Valves

3. Butterfly Valves

4. Control Valves

5. Cryogenic Valves

   • Description: Designed to operate at extremely low temperatures, these valves are essential for liquefied gas applications and other cryogenic processes.

   • Applications: Liquefied natural gas (LNG), hydrogen storage and transportation, and industrial gas industries.

   • Features: Manufactured from specially selected materials to withstand cryogenic temperatures and ensure perfect tightness.

6. Safety Relief Valves

7. Manual and Actuated Valves

Key Clients

Velan serves a diverse clientele across various industrial sectors. Here is an overview of some of Velan key clients:

1. Bruce Power: Bruce Power is one of Canada’s largest nuclear power operators. Velan has a strategic partnership worth $50 million with Bruce Power to supply high-performance valves for their nuclear reactors.

2. Nuclear Energy: Velan supplies valves to several nuclear power plants worldwide, including reactors in North America, Europe, and Asia. Its clients include utilities and nuclear power plant operators such as EDF (France), Rosatom (Russia), and other key players in the nuclear sector.

3. Petrochemical and Refining Industry: Major petrochemical and refining companies are also among Velan main clients. This includes giants like ExxonMobil, Chevron, Shell, and BP, who use Velan valves for their production and refining facilities worldwide.

4. Liquefied Natural Gas (LNG): Velan supplies cryogenic valves for LNG projects, meeting the needs of industry leaders like Cheniere Energy, Qatar Petroleum, and Gazprom, who require high-performance equipment for the transport and management of LNG.

5. Chemical Industry: Companies in the chemical industry, such as BASF, Dow Chemical, and DuPont, use Velan valves for their production processes due to their reliability and ability to operate in demanding environments.

6. Power Generation: In addition to nuclear power plants, Velan also supplies valves to other power generation facilities, including fossil fuel and renewable energy plants.

7. Maritime and Offshore Sector: Velan serves the maritime and offshore sector, providing valves for ships, oil platforms, and offshore installations. Companies like Transocean, Maersk, and Petrobras use Velan products for their maritime and offshore needs.

8. Water and Wastewater Treatment: Municipalities and water and wastewater treatment companies, such as Veolia and Suez, use Velan valves to ensure effective management and treatment of potable water and wastewater.

Major Competitors

Velan direct competitors in the industrial valve sector for critical applications like nuclear energy, petrochemical, and energy infrastructure include:

1. Flowserve Corporation (USA): Flowserve is a leading manufacturer of valves, pumps, and mechanical seals. They offer similar solutions to Velan for the energy, oil and gas, chemical, and water industries.

2. Emerson Electric Co. (USA): Emerson, through its Emerson Automation Solutions division, manufactures valves, regulators, and control instruments. Their products are widely used in the energy, oil and gas, and chemical industries.

3. Cameron International Corporation (USA): Cameron, a subsidiary of Schlumberger, is a major provider of valves and flow control solutions for the oil and gas, energy, and petrochemical industries.

4. Pentair plc (Ireland): Pentair offers a wide range of valves and control solutions for the energy, water, and industrial markets. Their product range directly competes with Velan.

5. KSB SE & Co. KGaA (Germany): KSB is a global manufacturer of pumps, valves, and related services. They provide solutions for the energy, water, wastewater, and general industry sectors.

New CEO: James A. Mannebach

James A. Mannebach brings extensive leadership experience in the industrial sector, having held senior executive positions at several leading companies before joining Velan. Mannebach is known for his strategic vision and ability to drive complex organizational transformations, which is crucial for Velan future growth. Under his leadership, Velan could intensify its research and development efforts, fostering innovation and new product development. Mannebach has a solid reputation for improving operational efficiency, which could help Velan reduce costs and increase profitability. With his extensive network and experience in managing business relationships, Mannebach is well-positioned to strengthen Velan strategic partnerships and explore new market opportunities.

Potential Risks

1. Ongoing Litigation: Velan is involved in several asbestos-related lawsuits, which could result in additional costs and affect profitability.

2. Dependence on Large Contracts: Velan reliance on large contracts with major clients can lead to significant revenue fluctuations based on contract renewals and new contract acquisitions.

3. Intense Competition: The industrial valve market is highly competitive, with well-established players like Flowserve, Emerson, and Cameron. Velan must continue to innovate and improve its products to maintain and grow its market share against this fierce competition.

4. Regulatory Challenges: The failure of the Flowserve acquisition due to regulatory approval issues in France highlights the risks associated with regulatory compliance across different markets.

Improvement in Backlog and Sales

Velan financial results and analyses show a notable improvement in their backlog and sales during the fiscal year ending February 29, 2024, and the first quarter of fiscal year 2025.

Backlog

End of fiscal year 2024:

• The backlog reached $491.5 million, up by $27.2 million or 5.9% from $464.3 million the previous year.

• 73.4% of the backlog ($360.7 million) is deliverable within the next 12 months, compared to 66.3% of the previous year’s backlog.

First quarter of fiscal year 2025:

• The backlog continued to grow, reaching $528 million as of May 31, 2024, compared to $491 million as of February 28, 2024, and $506 million as of May 31, 2023.

Bookings

End of fiscal year 2024:

• Bookings for fiscal year 2024 reached $374.5 million, up by $21.3 million or 6.0% from the previous year.

• This increase is primarily attributable to strong orders in the oil and gas sectors in Italy and higher orders in North America.

• Currency movements had a positive effect of $7.0 million on bookings during the year.

• The book-to-bill ratio for fiscal year 2024 was 1.08, compared to 0.95 the previous year.

First quarter of fiscal year 2025:

• Bookings for the first quarter of fiscal year 2025 reached $109.8 million, up by $18.0 million compared to $91.8 million for the same period the previous year.

• This increase is due to higher bookings in North America, Germany for refinery projects, and France for the nuclear energy market.

• The book-to-bill ratio for the first quarter of fiscal year 2025 was 1.42, compared to 1.36 for the first quarter of the previous year.

Velan has shown significant improvement in its backlog and bookings during fiscal year 2024 and the first quarter of fiscal year 2025. These increases, combined with a diversified geographical sales distribution, indicate a strengthened market position and positive growth prospects for the future.

Turnaround Potential

If Velan succeeds in its strategic turnaround and reestablishes itself as a market leader in industrial valves, the company could experience significant improvements in operational and financial performance, leading to attractive investment returns.

Velan has undertaken several initiatives aimed at improving operational efficiency, reducing costs, and innovating in its products. These initiatives include:

1. Optimization of Production Processes: By modernizing its facilities and adopting advanced technologies, Velan can improve productivity, reduce lead times, and lower production costs.

2. Investments in Research and Development: Continuing to invest in R&D, Velan can develop innovative products that meet the evolving needs of the industry, particularly in the nuclear and cryogenic applications.

3. Strengthening Quality Management: Maintaining strict quality standards and obtaining recognized certifications, Velan can enhance its reputation as a reliable manufacturer of high-performance industrial valves.

4. Acceleration of Growth in the Nuclear Sector

5. Geographic Expansion and Diversification

   • Penetration of Emerging Markets: Increasing Velan presence in emerging markets in the Asia-Pacific, Africa, and Middle East regions, where investments in energy and industrial infrastructure are growing.

   • Localization of Production: Establishing local production capabilities in strategic markets to reduce costs, improve delivery times, and respond more effectively to local customer needs.

   • Partnerships and Joint Ventures: Forming strategic partnerships and joint ventures with local companies to strengthen Velan presence in these regions.

Winning Contracts in the Nuclear Sector

The nuclear sector represents a major opportunity for Velan. The company is already well-positioned with a significant presence in nuclear power plants worldwide, particularly in North America, Europe, and Asia. If Velan can secure more contracts in this sector, it could have several positive impacts.

If Velan succeeds in its turnaround and strengthens its position in the industrial valve market, particularly in the nuclear sector, the company could see significant improvements in its stock performance. Current and future strategic initiatives, combined with effective management and continuous innovation, are essential to realizing this potential and generating attractive returns for investors.

Potential Markets

1. Renewable Energy

   • Wind Energy: With increasing global investments in onshore and offshore wind farms, Velan can develop and supply valves and control solutions tailored to wind infrastructure.

   • Solar Energy: Solar thermal power plants require robust valves for high-temperature fluid management. Velan could capitalize on this need by offering specific products for solar installations.

2. Hydrogen

   • Production and Distribution of Hydrogen: With the energy transition towards cleaner fuel sources, hydrogen is becoming a viable option. Velan can develop cryogenic valves and control solutions for the production, storage, and distribution of hydrogen.

   • Hydrogen Mobility: Hydrogen vehicles and refueling stations require specific equipment. Velan can partner with vehicle manufacturers and refueling station operators to provide tailored solutions.

3. Liquefied Natural Gas (LNG)

   • LNG Infrastructure: With the increasing global demand for LNG, Velan can strengthen its presence in this sector by providing valves and control equipment for liquefaction terminals, regasification facilities, and LNG carriers.

Impact of the Contract with Numaligarh Refinery Limited (NRL) (2024)

Although the exact contract amount has not been publicly disclosed, it is estimated that such a contract could be worth between $20 million and $50 million USD, depending on the scope and complexity of the equipment provided. If the contract is spread over three years, Velan could generate between $6.67 million and $16.67 million USD per year from this contract.

Profit margins for industrial products like valves typically range between 20% and 30%. Assuming an average profit margin of 25%:

With annual revenues of $6.67 million to $16.67 million USD, the annual net profit could range between $1.67 million and $4.17 million USD.

Hypothetical Financial Impact Scenario

Assumption:

• Contract Value: $30 million USD

• Contract Duration: 3 years

• Profit Margin: 25%

Total over 3 years:

• Total Revenue: $30 million USD

• Total Profit: $7.5 million USD

Other Projects

• Contract with Bruce Power

• Dangote Refinery Expansion Project (Nigeria)

• LNG Canada Project

• Modernization of Nuclear Power Plants in France

• Pengerang Refinery Project (Malaysia)

Acquisition Potential

The Velan family controls approximately 72% of the company’s voting shares, giving them significant influence over strategic decisions and opening the door to potential buyout offers. The family has expressed interest in selling the company, which could attract potential buyers interested in a strategic acquisition. During the previous sale process, interest from 101 potential buyers, with 65 non-disclosure agreements signed and 11 initial offers, indicates an active market for acquiring Velan. French companies like Schneider Electric or Vallourec might be interested in acquiring Velan to strengthen their product portfolio and global presence. An acquisition by a European company could create significant synergies, combining Velan strengths with the resources and expertise of the acquirer.

List of Potential Acquirers

1. Siemens (Germany): Siemens is a German multinational conglomerate specializing in engineering and electronics. With a strong presence in the energy, industrial, and infrastructure sectors, acquiring Velan could complement its portfolio of industrial and energy solutions.

2. Vallourec (France): Vallourec is a global leader in the production of premium tubular solutions primarily for the energy markets, including the oil and gas industry and power generation. Acquiring Velan could diversify its product offerings and strengthen its position in the industrial valve market.

3. Technip Energies (France): Technip Energies is a major player in engineering and technology for the energy sector, with a strong focus on the energy transition. Acquiring Velan could complement its capabilities in energy infrastructure and industrial solutions.

4. Mitsubishi Heavy Industries (Japan): Mitsubishi Heavy Industries is a Japanese industrial giant operating in various sectors, including energy, aerospace, and machinery manufacturing. Acquiring Velan could enhance its capabilities in industrial valves and energy equipment.

5. Hitachi (Japan): Hitachi is a Japanese multinational corporation that operates in various sectors such as engineering, electrical equipment, and infrastructure. Velan could complement its industrial product offerings, particularly in the energy and infrastructure sectors.

6. Voith Group (Germany): Voith Group is a German company specializing in energy, hydroelectricity, paper production, and industrial automation technologies. Acquiring Velan could expand its product portfolio and strengthen its position in the energy infrastructure market.

7. Sumitomo Corporation (Japan): Sumitomo Corporation is one of Japan’s largest trading companies, with interests in various sectors such as infrastructure, energy, and industrial materials. Acquiring Velan could diversify and strengthen its offerings in industrial and energy equipment.

These companies have the financial resources, industrial synergies and strategic interest to consider acquiring Velan, which could enable them to strengthen their position in the global market.

Potential Gain in Case of Acquisition

The potential buyout of Velan Inc. represents significant gain potential for shareholders, depending on the price offered by the acquirer. Currently, we examine two buyout scenarios: a purchase price of $10 per share and a purchase price of $13 per share, compared to the current share price ($5.87).

Velan shareholders should closely monitor developments regarding any new buyout offers. Regardless of the final offer, the potential gain remains significant, highlighting the attractiveness of a Velan acquisition for current investors.

Conclusion

Despite challenges, Velan presents a solid investment opportunity based on its market position, resilient financial performance, and growth prospects in critical sectors. The prospect of acquisition by a European buyer, driven by the Velan family’s willingness to sell, adds an attractive dimension. The arrival of James A. Mannebach as chairman brings new energy and strategic vision for Velan future. Potential investors should, however, closely watch developments related to ongoing litigation and regulations. With a prudent strategy and attention to risks, Velan could offer attractive long-term returns.