www.globeandmail.com

The Globe and Mail
leaftheglobeandmail

  GSE's niche market problem

BENJ GALLANDER and BEN STADELMANN

Monday September 14, 2015

When an enterprise describes itself as “evolving” in the first sentence of its profile, it's a good bet it is struggling. It suggests the market niche the company occupied is being challenged by a changing business environment.

This appears to be the case for Maryland-based GSE Systems. We purchased this thinly traded enterprise last December at $1.31 (U.S.), very close to its current price.

For three decades, the software provider dominated the market for simulators in the power industry, primarily nuclear plants, with more full-scope installations than all other competitors combined. It has more than 1,100 simulators installed in plants in 50 countries.

Despite that pioneering reputation, GSE's profitability has been spotty. The firm's fortunes have been closely tied to large utility contracts, and those don't make for a steady diet of revenues. Instead, it's more like a python eating a pig: Capacity gets stretched to the maximum to digest large projects, which inhibits the ability to track down the next meal.

For five years, CEO James Eberle strove to diversify the customer base, building training simulators for gas and coal-fired utilities, along with other industrial plants from petrochemicals to desalination. The strategy helped to grow the top line, with annual revenue topping out at $52.3-million in 2012, and the proportion of non-nuclear work grew to 39 percent — but margins remained thin. Worse was to come: A downturn in buying behaviour from customers put revenues in reverse, limping in at $38-million last year with a net loss of $6.7-million.

Mr. Eberle's run ended abruptly this past July when he stepped down to “pursue other opportunities.” That euphemism always sounds something like being forced to walk the plank. He was immediately replaced by Kyle Loudermilk.

As Mr. Loudermilk takes the reins, he is fortunate to have manoeuvring room. Last quarter, the backlog grew briskly to $57.5-million from $52.4-million at the end of the previous quarter, so there is a solid chunk of work in the pipeline. Furthermore, the corporate coffers hold $9.8-million in cash and there is zero debt on the balance sheet. With Japan moving slowly toward restarting reactors after the Fukushima disaster, there is finally a realistic prospect of making sales there.

GSE is a haven for hard-core engineers from various disciplines. Previous management tended to have moved up the ranks from nuclear operations; Mr. Eberle came from the U.S. Navy, where he served as a reactor operator on nuclear submarines. Mr. Loudermilk is a chemical engineer, as well, but he has spent much of his career in performance optimization software providers with a global reach and is a seasoned technology executive.

This looks like a good fit, as the company has tried to build up recurring revenue by broadening its portfolio of training and optimization tools and branched out into short-term contract staffing. This bid for diversification outside of its native niche means the corporation is butting heads with large, sophisticated competitors.

GSE has made headway in evolving to a version 2.0 of itself, but it's not there yet. If Mr. Loudermilk can complete this transition, we believe the upside is huge. Our initial “sell” target is $5.74.


back