An intro writeup for The APi Group (APG)
I was introduced to APi Group (disclosure: long) a few weeks ago and after doing some initial work on the name I wanted to post a short bullet-point style writeup outlining the opportunity and the key points of the investment idea. The stock is up over 30% since the business was first brought to my attention, and as the management team does the work to communicate the story I believe the valuation discount could close in a short period of time. As a result I wanted to put some thoughts down now, before following up with a longer writeup.
As a [mostly] microcap investor, APi is one of the larger businesses I’ve owned for client portfolios ($2B market cap) but the opportunity is compelling as APi represents a high quality business trading for a cheap valuation with a management team capable of generating shareholder value for many years.
While some of the initial reasons for the large discount are no longer present (including illiquidity, trading as an OTC ticker (JJAQF) pre-deal close, clearing DTC and no sell-side coverage), I believe the market has still not priced in the quality of the business or the long runway for future value creation. As management executes, additional coverage is initiated and the story is communicated by the company, I believe shares could rise closer to fair value within a short period of time.
So let’s get into it – and again, I will be following up with a more detailed writeup at some point.
The APi Group is a holding company. They are a market leading provider of commercial safety services, specialty services and industrial services with a US focus and small operations in the UK and Canada (less than 5% of revenues). APi was founded in 1926 by Reuben Anderson, the father of former Chairman/CEO Lee Anderson. APi started out as a a small insulation contracting and distribution company and has now grown to be one of the largest specialty contractors in the US. This near 100 year old business is now a holding company to more than 40 independently managed life safety, energy, specialty construction and infrastructure companies with more than 200 locations worldwide. In addition, the track record of organic growth and accretive M&A has been phenomenal.
Today, APi operates three segments, Safety Services, Specialty Services, and Industrial Services responsible for 44%, 31% and 25% of revenues. The company performs service and maintenance related work for large facilities, with Lodging, Office and Commercial buildings being their primary end markets. Safety Services (and within that, Life Safety) is the company’s golden goose segment, driving 58% of EBITDA with acyclical characteristics and an entrenched market position. The majority of safety services businesses consist of fire protection services such as sprinkler installation, emergency suppression systems, alarms and backflow devices, among others.
To briefly highlight the safety services segment consisting of what the company calls the ‘life safety’ market, this is an industry expected to grow a shade under 10% per year through 2025. Market growth drivers include statutory driven safety regulations, fire damage risk prevention, commercial building complexity, and large building damage costs and civilian injuries. APi has a differentiated business model (discussed a little more below) consisting of targeting service related work first (where each dollar of service work sold leads to leads to 3-4x more service dollars and ultimately relationship based new construction opportunities) that is not dependent on new facility construction activity given their focus on non-discretionary maintenance spend. As a result, a large portion of Safety Services revenue mix is recurring at 40% up from just 21% in 2008. Management has called this recurring revenue high margin business. This helps insulate APi from downturns and gives visibility into revenue/earnings. Furthermore, company filings mention Fire & Security end markets as acyclical. Management said on a recent call that Life Safety is a strong backbone to the business and enjoys a strong margin profile. Their EBITDA margin target for this segment is 12%. For acquisitions and increasing margins, APi will continue to focus on executing more life safety deals moving forward.
In addition to the above, consider the below points as parts of the investment thesis for APG:
UK SPAC with Martin Franklin as the sponsor
In 2019, APi was sold for $2.9 billion (<8x EBITDA) to J2 Acquisition Corp., a SPAC sponsored by Martin Franklin. Billionaire Martin Franklin of Jarden fame. I believe that Martin Franklin has the opportunity to create similar returns with APi as he did at Jarden utilizing the same model of organic growth and margin expansion combined with accretive M&A. Management has called APi the ‘industrial version of Jarden’ and feels as though the opportunity set could be even larger. From 2001-2016, investors in Jarden stocked received an overall return of 5,353% or 32% IRR over 15 years, culminating in the sale of the business to Newell Brands.
Superior business to comps with an entrenched market position and recurring revenue profile
As mentioned above, APi has grown to become one of the largest specialty contractors in the US which includes being the #1 provider of fire safety systems in the US with strong market positions in each of their business segments due to their differentiated business model. Unlike non-pure play comps and other mom and pop specialty contractors, APi Group has a wide range of blue chip customers and serves a diverse set of end markets limiting their contract risk (no contract accounts for >5% of revenues). They also have an outstanding reputation given their near 100 year history and track record, leading them to low contract loss rates (less than 1.5% of revenues) and plenty of repeat business. In addition, APi targets service revenue first which leads to relationship based new facility contracts, while other specialty contractors go through the RFP process in order to win new business, all of which is tied to new facility activity.. APGs operating model has allowed them to grow revenues from $1.2B to over $4.0B during the past 10 years.
High free cash flow conversion as an asset light services business
Capex has typically been in the 2.0-2.5% of revenue range, although this might be a bit high moving forward. This results in high free cash flow conversion, lining up with management’s goal of 80% moving forward. Given that APG generates a ton of cash in all market environments, the business has never needed to rely on the debt or equity markets to fund growth. Currently levered at >3x EBITDA due to the acquisition, I’d imagine we see some debt reduction over the next few years as well.
Portions of the business are acyclical having generated cash flow through economic downturns and recessionary scenarios
While APi revenues declined 15% and 9% in 2008 and 2009, the business remained cash flow positive and even grew revenues slightly during the 2015-2016 ‘industrial recession’. During these market conditions, APi can rely on working capital to generate cash, and revenue growth isn’t tied to non-residential newbuilds as there is a large portion of recurring service revenue in the business model. Management has pointed to numerous tailwinds that should support all business lines, including much needed infrastructure investment, supporting new non-residential construction activity, providing retrofit and upgrade services to existing buildings, delivering the services required for new technologies such as 5G, and supporting the growth of life safety service contracts for existing customers. In addition, as outlined above, Life Safety recurring service revenues were only 21% in 2008 and have now grown to 40% of that segment, enabling APi to withstand recessionary environments.
High free cash flow yield
At a current price of $12.30 and $174mm shares outstanding, APG has a market cap of $2.1B. Per the most recent investor presentation, APG did $371mm in Adjusted EBITDA during TTM 2019. At a 70% free cash flow conversion, this would put UFCF at around $260mm, giving investors a current free cash flow yield of 13%. This number drops to 8% on an EV basis. This number is set to grow at a high single digit rate moving forward, and management is targeting 80% cash conversion rate moving forward.
Large discount to comps on a conservative basis
In addition to the above, APG trades at a discount to every reasonable industrial and security peer/comp that I could find on an EV/EBITDA basis, P/E basis and FCF yield basis, despite their strong market position, and above average revenue growth and EBITDA margins. While its difficult to pinpoint an exact comp given APi’s revenue mix, the closest comp in my opinion, Emcor Group (EME), trades at 9.6x ‘19e EBITDA, 15.2x ‘19e EPS, and a 3.8% FCF yield. Other comps trade at around 9.5x EBITDA and 15-16x earnings with lower free cash flow yields. APi’s cash generative nature, potential to increase margins and runway for accretive acquisitions should help to bridge this gap moving forward.
Short term catalyst with beefed up IR efforts and continued sell-side coverage
Recent positive developments have included the management team embarking on investor engagement initiatives, including conference participation, conference calls and webcasts. As a hardly followed ‘prove it’ type of story right now, these are positive developments. In addition, APG has picked up sell-side coverage with UBS and Citi, both who have price targets on the shares above $12.00.
Free options for continued M&A, buybacks
Back of the napkin valuations on continued organic growth, cash flow generation and some M&A through 2022-2023 result in a share price significantly higher than today, using a below market multiple of EBITDA or FCF. What isn’t priced in is the runway for continued accretive M&A where Jarden-like returns could be achieved over the next decade. In addition, given that cash generative nature of the business, management will have the option to buyback significant amounts of shares should they choose to do so.
I’m still digging in, but even following a 30%+ share price increase, APG is still undervalued. Investors have the opportunity to purchase shares in a regional business with a market leading position in fire safety, a strong percentage of their business with acyclical characteristics (and cash generation) high single digit organic growth, with a continued runway for roll-ups, and a proven management team known for creating value in similar business models. In addition, APi has no major customer concentration, diverse end markets, a US-concentration (no geopolitical event exposure), low project loss ratios, and recurring revenue characteristics. Sign me up.
There of course are numerous risks to the investment including lack of clear comps, potential conglomerate discount, future dilution and recession/COVID related concerns, which I will outline in more detail in the coming weeks, but there appears to be a decent margin of safety given the cash generation, discount to comps and management alignment. More to come on APi Group.