July 20, 2020 - 5:47pm EST by
2020 2021
Price: 102.45 EPS 0 0
Shares Out. (in M): 186 P/E 0 0
Market Cap (in $M): 2,924 P/FCF 0 0
Net Debt (in $M): 2,229 EBIT 0 0
TEV ($): 5,154 TEV/EBIT 0 0

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Thesis Summary

1. Competitively advantaged, recession resistant, compounder


2. Discounted valuation due to temporary headwinds

ISS trades at a ~8.5x normalized P/E, versus its 14x to 17x NTM P/E historically, and versus its closest peers at 13x to 18x normalized P/Es


3. Tailwinds going forwards given increased emphasis on cleaning services after Covid, and headwinds from tight labor markets should dissipate post Covid


4. Strong FCF generation will be used for more accretive purposes once target leverage is reached


5. Potential takeout target in a few years, especially with a new CEO starting in Sept ’20 from Danske Bank



ISS A/S (ticker: ISS DC) is global facilities management company based in Denmark.  Primary services include cleaning (~50% of sales), property maintenance (e.g., light handyman work, like changing lightbulbs) (~20% of sales), catering (~15% of sales) and other functions like security, space management, etc.  Geographies served include Continental Europe (~40% of sales), Northern Europe (~30% of sales), Asia (~20% of sales) and Americas (~10% of sales).


ISS’s value proposition is that it can save customers typically ~10% to 20% of their cleaning and maintenance costs by outsourcing.  ISS uses its procurement scale and operating efficiencies to provide the service at a lower cost than the customer can replicate on their own.  Customers’ end markets include Business Services & IT (34% of sales), Industry & Manufacturing (12%), Healthcare (11%), Public administration (10%) and Other (33%), which includes Retail, Transportation & Infrastructure, Energy, Hotels/leisure/entertainment, Food & beverage and Pharmaceuticals. 


The company focuses on large key accounts, for whom cleaning is less commoditized and thus higher margin.  There are only a handful of players that can provide consistent (between customers’ various sites), professional, and regulatory-compliant (e.g., not employing illegal immigrants) cleaning and maintenance services to these large multinational corporations: ISS, Sodexo (SW FP), CBRE Group (CBRE) and Jones Lang LaSalle (JLL).  Key Accounts comprise ~2/3rds of sales.  However, customers are still relatively fragmented, with the top 10 comprising ~10% to 15% of ISS’s sales.


ISS is differentiated in that it employs a self-delivery model for ~90% of its sales, meaning ISS directly employs staff to better control quality.  CBRE and JLL are both vendor-managed, and so outsource the actual work to third parties.


Customer contracts are ~3 to 5 years for larger customers, with margins increasing through contract life. Retention rates are ~90% across the business, and 93% to 95% for larger key accounts.  Industry calls suggest that the business is very sticky, with customers switching providers only if there is some large event (e.g., the company is purchased) or there is a contract mis-execution.


Labor represents ~70% of costs (excl. D&A), and labor churn per annum is ~40%.


The company was taken private by EQT Funds/Goldman Sachs in 2005, before IPO’ing in March 2014.  Apax and G4S plc each separately were in discussions to purchase the company in 2011, but could not get there on price (in Apax’s case) or the business diversity it would cause (in G4S’s case). 


Thesis Detail

Competitively advantaged, recession resistant, compounder. ISS has been a historical compounder, exhibiting consistent organic growth and margins.  This is enabled by (1) a limited competitive set for providing services to large key accounts, (2) high customer retention rates, and (3) a steady trend towards outsourcing cleaning services given cost savings.


As a testament to ISS’s ability to historically compound, organic growth from 2004 to 2019 is as follows:




Margins (excluding restructuring expenses) from 2004 to 2018 are as follows: 



Free cash flow has averaged ~100% of adj. Net Income historically.


Competitive advantages exist for large players like ISS, relative to smaller players without regional/ national/ international reach.  Customer calls confirm that only a handful of players are even invited to bid for larger account business, given the importance of quality and consistent service between sites.  Also, ISS is beginning to incorporate increased technology into its services, such as tracking which areas have been cleaned and when, something that smaller players cannot provide.  


The company’s recession resistance is demonstrated in that it grew at 0.6% during the Great Financial Crisis.  There is not a 1:1 sensitivity of cleaning services to employment, given even if a company cuts its staff by -30%, the building still needs to be cleaned largely to the same degree it was cleaned previously. 


Discounted valuation due to temporary headwinds.  We believe ISS trades at discount to its mid-single-digit% EBIT growth potential, its historical valuation (14x to 17x NTM P/E), and peers (Sodexo trades at 13.4x P/E on a normalized EPS ~2 years out, and ABM trades at 18x this P/E, versus ISS at ~8.5x) for the following reasons:


1. Covid

Most recently (April/May ’20), organic growth has trended at -12% as customers pulled back on required services due to Covid


In addition to revenue headwinds, there are margin headwinds in FY ’20 due to Covid.  Some customers whose buildings have completely shut down due to Covid (i.e., the entire building is on work-from-home) have agreed to cover ISS for the cost of keeping its cleaning staff employed, in order to enable an easier start up once things normalize.  On this business, ISS makes 0% margin, but is able to secure wages for its staff


Incremental margins on lost sales, incorporating this margin compression, are ~25%


Additionally, there are restructuring costs in FY ’20 as Covid has made requisite staff cuts in some regions for some of the more Covid-impacted business lines (e.g., serving airports, etc)


We won’t attempt to argue our case here for how long Covid will last as a headwind, but our view is that once businesses get their staffs back to work, the headwind should entirely reverse.  Even if companies stage in employees during different days of the week, or increase their work-from-home staff, as long as a majority of employees come back, you still need the entire building cleaned.


2. Malware

In Feb ’20, ISS’s IT systems were hit with a Malware attack.  The majority of this issue has since been dealt with (the company shut its infected systems down early, and has created a new platform to which it is transitioning), and it didn’t impact the majority of the company’s core operations (cleaning staff still showed up daily to where they needed to go).  However, the attack did make more discretionary, one-off work more difficult (e.g., coffee needed for a recently scheduled meeting).


Additionally, the Malware attack pushed back IT integration/productivity measures originally expected when onboarding a large client (i.e., for its new Deutsche Telekom win).  Large contracts are onboarded with cost savings in mind and the contracts build in sharing some of these savings with the customer.  Given the Malware attack delayed these cost savings in H1 ’20, it has led to margin compression versus expectations


3. Equity issuance perceived risk

Despite the CFO repeatedly mentioning he would not issue equity, there is still a narrative amongst a few sell-side research analysts that the company may issue equity in order to optically lower its leverage


There is no need to issue equity.  The company has $1.5bn to $2bn of liquidity compared to an enterprise value of $5bn.  The company should generate positive free cash flow in 2020.  ISS has no debt covenants.  A major shareholder (Kirkbi, the owner of LEGO) owns ~15% of equity with board representation, and we assume would not want to be diluted for no reason other than to manage optical leverage


The only argument used to issue equity is that leverage will look high given EBITDA declines during Covid.  However, this would only be optical and temporary, given the company would have no need for the raised proceeds and EBITDA is expected to bounce back significantly in 2021.  The CFO, rightfully, believes that issuing equity at these disrupted prices, in order to show a lower leverage ratio that is not necessary given the company has no debt covenants, just does not make sense.  Even sell-side analysts who argue that equity should be issued to lower the stated leverage state that unlike in other cases where rights offerings have resulted in the stock price responding favorably given liquidity concerns, without such an overhang here it is likely to drop. This would seem to argue the opposite point that the analyst is trying to make!


4. A few large, new customer onboarding issues created temporary margin compression in FY ’19, which was expected to reverse in FY ’20 before Covid/Malware become issues

Danish defense

The customer understated the scope of work, and usually ISS can change economics if scope is misrepresented, but this was a rare case in which the contract couldn’t change b/c it’s tied to the Danish budget which is set annually


The company expects this contract to be breakeven starting H2 ‘20


Hong Kong subway

Protests in Hong Kong made this contract unprofitable


The company took charges that essentially make this contract breakeven over the next few years


We believe ISS is being discounted for what are essentially temporary headwinds  

At some point, the world will get back to normal, and Covid headwinds will dissipate.  For ISS in particular, recovery only requires some portion of people to return to work, given the entire building must be cleaned even if a minority of the original staff is on site.  


The malware headwind is also temporary, as the company is close to having all systems to their prior levels.


Equity issuance is a low risk given the company’s liquidity, lack of covenants, FCF generation and current management team that is against issuing equity.  Even in a scenario in which equity is issued, the stock is so discounted that returns would still be meaningful from here and the overhang would be removed.


The customer onboarding issues are isolated, given the company’s multiple decade history of consistent organic growth and margins.  Industry expert calls suggest nothing has changed competitively.  The issues have been largely caused by drivers outside of ISS’s control and are not indicative of any long-term structural issues (e.g., demonstrations in Hong Kong, customer misrepresentation (which is rare, and usually easily fixable by reconstructing the contract), Covid-19).



Tailwinds going forwards given increased emphasis on cleaning services after COVID-19 and headwinds from tight labor markets should dissipate post COVID-19. Given COVID-19, there has been increased demand for deep cleaning and sanitation. This business is apparently up over 100% year over year.  We believe it is likely that there will be heightened levels of cleaning demand for some time.


Strong FCF generation will be used for more accretive purposes once target leverage is reached.  Once the company reaches its target leverage (~2.8x), which should happen in the next few years, ISS may begin using FCF for buybacks.


Potential takeout target in a few years, especially with a new CEO starting in Sept ’20 from Danske Bank.  This is more speculation, but given the company’s low valuation, strong FCF generation, high leveragability potential (levered at ~6x during its previous PE ownership), and business quality, ISS is a potential takeout target for private equity.  Historically, the company has been approached by private equity for these reasons.



We believe that once the market becomes comfortable that the world will begin to normalize post-Covid, ISS can begin trading closer to its previous valuation and current valuations of its closest peers, and return a 50%+ internal rate of return over the next 2 to 3 years.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Performance post Covid

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