|Shares Out. (in M):||174||P/E||8.7x||7.5x|
|Market Cap (in $M):||1,722||P/FCF||10.1x||8.2x|
|Net Debt (in $M):||1,250||EBIT||0||0|
|TEV (in $M):||2||TEV/EBIT||9.3x||8.4x|
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J2 Acquisition Ltd is a blank-check company run by Martin Franklin of Jarden fame, who recently completed their business acquisition of APi Group, a large conglomerate of regional fire safety, specialty contracting, and industrial businesses. J2 (which is now effectively the APi Group) trades at an extremely attractive discount (124% upside to our base case PT of $22.19) on conservative forward estimates with expectations for generating massive amounts of cash, caused by liquidity structure in SPACs and technical selling. This allows an unbelievable opportunity for investors.
Exhibit 59: Risk/Reward Framework
The key high-level points are
As discussed in more detail below, there is a supply/demand imbalance in the stock due to technical reasons surrounding the UK SPAC structure (listing, liquidity, management engagement with the investment community, sell-side coverage, and position trimming/profit-taking) that is creating the valuation discount, all of which should clear up by the end of 1Q20. Starting a position now give investors the opportunity to get ahead of this re-rating when supply dries up and demand increases, investing alongside (and indeed at a discount to) management and prominent investors Viking Global in an extremely cheap and cash generative security.
We use multiple valuation methodologies [DCF, P/E, EV/EBITDA, and FCF Yield] under multiple cash deployment scenarios [cash building on the balance sheet, debt paydown + accretive M&A, debt paydown + share buybacks], and our base case scenario is a PT of $22.19, +124% from last. The cash flow protection on the downside, ability to generate cash in recessionary environments, and discounted valuation provide downside support at ~$8.40 [-15.2% off last]. This creates a base-case reward/risk of 8.0x, one of the most attractive situations we have ever seen.
On 9/3/19, J2 announced they were acquiring APi Group. APi Group is a market-leading provider of commercial life safety solutions and industrial specialty services. By acquiring JJAQF, you are initiating a position in pro-forma APi Group. APi Group is organizing itself into 3 separate business units for it’s life as a public company, which we will discuss in more detail below
These businesses represent an amalgamation of multiple regional fire safety, specialty contractor, and industrial construction products and services. Their largest segment, Safety Solutions, is mostly fire detection and protection, where APi Group is the leading independent integrator of safety systems and the #1 fire protection and sprinkler provider. In Specialty Services they are a top-5 specialty contractor in the United States. 95% of their revenues are in the US and they operate under the regional brand names while providing the expertise, resources, backing, and technology of a multi-billion dollar company.
A quick note on the tickers. J2, which currently trades only in the US under JJAQF, is the ticker of the blank check SPAC business. They have already completed their acquisition of APi Group, and thus are one and the same now. When the full listing process in the US is complete, the ticker will change to APG, representing the completion of the process into a NYSE-listed, multi-billion dollar company.
Safety Solutions [~44% of LTM revenues as of 6/30/19; Implied $1.76bn in ‘19e revs based on same contribution]
Business Description: Safety Solutions is APi Group’s largest segment, containing market leading positions and is the most homogenous business segment. Almost all of the companies in this segment consist of fire protection companies. They offer both products and services including life safety, emergency communication systems, mechanical services, and a full suite of alarm and detection systems from engineering and design to fabrication and installation to back-end work such as inspection, repair, monitoring, retrofitting, and upgrading. While the majority of the companies in this segment are commercial fire protection companies, it is worth noting that they do have other businesses in this group, including Grunau (offers HVAC, temperature control, electrical, refrigeration and more), Twin City Garage Door Co (garage doors), Metropolitan Mechanical Contractors (large-scale design and construction contractor who worked on Target Field and Mall of America among others), Tessier’s (HVAC), and more.
Exhibit 1: Safety Solutions Businesses from Investor Presentation
Market Position: As mentioned above, APi Group is a leading independent integrator of safety systems and the #1 fire protection and sprinkler provider.
There are 65 separate regional companies in this segment, and APi mention that the large installed base drives significant recurring revenue through service and monitoring agreements. And that is a significant theme for much of APi’s strategy. They focus on getting the contract work, which drives success in multiple ways. (1) This is a recurring revenue stream that is typically much higher margin, which can be seen in APi groups strong margins compared to comps and (2) It creates a client relationship allowing for higher margin business on new project work. Typically a client will be looking for sub-contractors for work, and puts out an RFP that receives multiple proposals mainly competing on price. This drives margins lower as it’s a race to the bottom. However, by establishing that relationship, APi Group can often get exclusive work which drives less price competition and increases margins.
Life Safety’s revenue mix is ~40% recurring service work, up from just 21% in 2008. Management has called this recurring revenue “high margin business”. This helps insulate from downturns, gives visibility into revenue/earnings, and drives the benefits mentioned above. The deal presentation also mentions Fire & Security end markets as acyclical. In fact, management said on the deal call that Life Safety is a strong backbone to the business and enjoys a strong margin profile. In meetings, they have said this is a ~12% EBITDA margin business.
As the #1 fire protection company in the US, APi Group companies in this segment benefit from national scale and sophistication that regional providers can’t match. Due to local ordinance and building codes, as well as the smaller scale nature of the work, much of fire safety is still a regional business. However, with the strength and sophistication of a multi-billion dollar organization behind them, APi Group companies have access to technologies and offerings local firms can’t compete with, such as specialty foams, hazmet, different fire suppression options, and more. And being number 1 in market share, as well as strong relationships, also means they are typically first call on many projects.
Market Characteristics/Growth: Management also expects growth here to be driven by non-discretionary regulatory spend, providing a stable annuity stream of revenues. Management cites the National Fire Prevention Association as showing the US Fire Safety Market growing at a CAGR of 7.8% from 2018-2025.
Exhibit 2: US Fire Safety End Market Growth from Investor Presentation
Management’s presentation notes the significant damage from inadequate fire protection (citing statistics from the NFPA), which is leading to increasing public awareness and related regulation, which they say creates growing tailwinds for APi.
Other third party research firms generally agree with the view laid out by management
While it’s difficult to put too much emphasis on any single research report, here we have multiple sources corroborating similar market growth expectations, as laid out below. This includes industry trade groups (NFPA), management, and multiple third party research organizations. We can see these growth rates coalesce around a high-single digit CAGR over the coming years, and while the different periods and geographic markets /product markets make it impossible to do an average, it is telling that all the different periods and methods seem to confirm the solid growth rate in this end market.
Exhibit 3: Third Party CAGR’s in Fire Safety
Specialty Services [~31% of LTM revenues as of 6/30/19; Implied $1.24bn in ‘19e revs based on same contribution]
Business Description: Specialty Services is the APi Group’s other core focus market, together a leading provider of infrastructure services and specialized industrial plant solutions. Service offerings include installation, maintenance and repair of critical infrastructure such as underground electric, gas, water, sewer, telecom infrastructure, specialty construction projects, and diversified civil construction. They mention customers as public and private utilities, communications, industrial plants, and government agencies.
Exhibit 4: Specialty Services Businesses from Investor Presentation
As seen above, there are ~14 companies in this segment:
Management has described this business as more “institutional” with MSAs.
Market Position: The PR and investor presentation bill Specialty Services as a “leading” provider of infrastructure services and industrial plant solutions. As noted, APi Group is a top 5 specialty contractor.
They also mention that their competitive moat is that they have regional leading businesses, suggesting attractive positioning in end markets here. APi Group overall has only a 1.5% project loss rate, with recurring customers of 85% as noted above. Between the above facts, and organic growth greater than their end markets and competitors, it is clear this is a successful business for APi.
They view this as an attractive business, and mention this business line also has ~12% EBITDA margins.
Market Characteristics/Growth: The presentation discusses tailwinds in general for the company, and some applicable to this segment include evolving regulation (water quality/pipeline upkeep), a $2.0bn US infrastructure plan, 5G broadband capex, aging infrastructure base in the US, a shortage of skilled craft labor, and market consolidation. Management mentions that this business is “positioned to capitalize on secular industry tailwinds”.
J2 and APi Group mention in their presentations that they have “favorable market dynamics” and show end markets of US Infrastructure Spending and US Non-Residential Industry Growth by End Market:
Exhibit 5: US Infrastructure Spending CAGR by end market from Investor Presentation
Exhibit 6: US Non-Residential Industry CAGR by Industry from Investor Presentation
As would be expected, given the business is described as more “institutional” and clearly involves large amounts of specialty contracting and construction services, these end markets seem extremely relevant to the growth of this business line. They also appear to line-up well with the 7% organic growth seen at APi Group from 2010-2018 as a whole. Total Construction dollars in the US grew at a 6.2% CAGR over this period, while Non-Residential construction grew at a more tepid 4.0%. However, APi’s key end markets of Lodging (13.3%), Office (8.8%), Commercial (11.4%), Manufacturing (7.0%), Communication (4.2%), Education (1.3%), and Health Care (1.0%) grew at a faster rate on average. In fact a simple average of those end markets resulted in a non-residential CAGR of 6.7% from 2010-2018, very similar to APi Group’s overall organic revenue growth rate (noting that their other large segment also has similar growth).
Exhibit 7: US Non-Residential Industry CAGR by Industry from 2010-2018 (data from US Census Bureau)
As seen above, using a similar method implies a similar expected forward growth rate. The presentation shows Lodging with growth at an 11% CAGR from 2013-2022 (implying a slight downtick from the above), Office at 10% CAGR over the same period (implying a slight increase from the above), Commercial at 8% (implying a slightly higher 340bps deceleration from the above), Manufacturing at 6% CAGR (a slight downtick), Communication at 5% (slight uptick), Education at 4% (implying a large uptick of 300bps), and Health Care at 2% (mostly inline).
Given the high correlation between these end markets, the business strategy, and the past results, it makes sense to expect a similar performance going forward, especially with roughly similar growth expected through at least 2022.
Industrial Solutions [~25% of LTM as of 6/30/19; Implied $1.00bn in ‘19e revs based on same contribution]
Business Description: Industrial Solutions is APi Groups smallest market, and they specifically have pointed to the other two business lines as their focus going forward, with plans to de-emphasize this business. They describe this business as being a niche specialty contracting service to diverse end markets, a leading transmission and distribution specialty services contractor, providing a full suite of solutions to midstream oil and gas to build new pipelines and perform integrity management + maintenance. They also provide other specialized services such as steel fabrication.
Exhibit 8: Industrial Solutions Businesses from Investor Presentation
As seen above, there are ~12 companies in this segment
Management has stated this business line has ~50% exposure to oil and gas (which is expected to decrease over time), with the remainder appearing to come from steel fabrication, silencers, and large construction support from Northland.
Market Position: There isn’t a ton of discussion around APi Group’s position in the industrial market, but guidance is that margins in this segment are much lower, and the oil and gas business is notoriously difficult for construction/supply firms. Management has pegged this business at closer to ~8% EBITDA margins, and as noticed it is not one of their key “focus” divisions going forward.
Market Characteristics/Growth: Given this market is mainly levered to construction equipment, construction support, and pipeline construction, it is easiest to focus on those end markets. While US Census data shows the “Power” market grew at a 2.3% CAGR from 2010-2018, it peaked in 2015 and actually grew at a -8.8% CAGR from that 2015 peak to 2018. This lines-up roughly with a study done by Deloitte which reflected midstream capex at a CAGR of -7 to -11% from the period of 2014-2018.
Exhibit 9: Midstream CapEx 2014-2018 per Deloitte
Despite this, APi Groups presentation shows US Oil & Gas Pipelines growing at a 1.9% CAGR through 2024. This is the only end-market they showed through 2024e though, which raises the question if it was chosen to reflect a better growth rate then what is expected through 2022e.
This may be due to the mixed outlook on the space, with many reporting “caution”, with very mixed drivers. While some have credited Donald Trump’s election with increasing activity, it also may have resulted in certain projects being pulled forward ahead of a 2020 election. Per North American Oil & Gas Pipelines, “Long-term, the prospects for both the pipeline and distribution markets are solid and will continue to exhibit growth. Both the Interstate Natural Gas Association of America (INGAA) and American Petroleum Institute (API) are equally bullish.” They also mention how the pipeline construction segment is (naturally) tied to the prices of crude and natural gas. This was responsible for the downturn in 2015/2016, when “the typical U.S. pipeline contractor saw revenues fall between 40 percent and 60 percent since the 2013/2014 peak.” They show growth of ~4-5% going forward for this segment.
Offsetting some of the negatives above is the large backlog and current construction activity of pipelines, whether the Dakota Access, Rover, Mountain Valley, Permian, and more.
With oil & gas comprising roughly 50% of the segment, and 2% growth going forward, as well as overall US infrastructure spending at 3%, it’s hard to expect much more than low-single digit growth out of this segment, with large amounts of volatility. Thankfully as the smallest revenue and lowest margin segment, the impact on the larger APi group from lower growth here should not cause material impacts to the company.
Exhibit 10: US Transmission & Distribution CapEx from 2007-2022 per NAOGP
M&A History + Sponsor Track Record + Expectations
APi Group has a strong history of successful bolt-on M&A, and is the result of multiple, accretive roll-ups. This is apparent in their strong top-line growth, over and above an already impressive organic level:
Exhibit 11: APi Group’s M&A History per Investor Presentation
As seen in the graphic above, APi Group reports having completed >50 acquisitions since 2005, around when current CEO Russ Becker took the helm. This impressive, targeted acquisition strategy has allowed APi Group to grow it’s topline at more than double the rate of its organic growth rate, giving APi Group an additional $1.6bn in revenues, which equates to ~$160mm in additional EBITDA at average 2019e Adj EBITDA margins.
Most impressively, is that they have done this at multiples of 4.0x-5.0x on average. This should equate to roughly $410mm in value creation conservatively assuming they are still trading at 7.6x ‘19e EBITDA (far below our price target), with no margin pick-up from these businesses. That corresponds to a 51% ROIC in the deals completed between 2010-2018, an incredibly impressive use of capital.
And what is the most incredible part of all of this? They funded this all out of internal capital! This is a company that has generated enough cash to more than double their top-line growth rate and create hundreds of millions in value, all without tapping the debt or equity markets. That is an unbelievable story.
And what is so exciting about this opportunity is that Martin Franklin and team are just as excited about the opportunity going forward. See the APi framework below for why this disciplined strategy works, and fits so well with J2’s pedigree. Franklin described the M&A pipeline as just as exciting as the organic growth prospects, with large markets that remain extremely fragmented. APi Group gets a look at every Fire Safety deal due to their market positioning, and the regional managers being empowered means that APi Group managers can also source deals.
Exhibit 12: APi Group’s M&A Criteria per Investor Presentation