Description

Opportunity: Marlowe plc (MRL LN/ £2.5mn ADV) is an under-appreciated, increasingly high-quality business that is well placed to grow underlying earnings/ FCF at ∼20%+ CAGRs over the medium-term, which paired with multiple expansion (from current 8x RR EBITDA/ 14X FCFe) can deliver >30% IRRs over the next 3-5 years.  MRL provides an asymmetric opportunity as this strong upside is paired with strong downside protection, with the embedded 'put option' of selling one/ both of their divisions to PE/ strategic buyers available to management should they decide to realise the inherent SOTP value. Management have signalled their openness to reviewing the ‘portfolio of businesses with the aim of seeking to maximise shareholder value’ (although no decision has been made in respect of any potential strategic action at present). The option to divest either or both of Marlowe's divisions means that fundamental downside is minimal here in our view.

We believe the stock is well positioned to perform over the coming years as the company continues to grow organically, expand margins, improve cash-flow generation and complete attractive bolt-on deals which should set the stage for multiple expansion. The bear case should also continue to be disproved as one-off costs decrease and Marlowe continues to prove its growing cash-flow potential.

To summarise, we believe Marlowe is a highly asymmetric situation (heads I win, tails I don’t lose much) which we believe should perform well over the coming years.

Background: Marlowe was previously written up on VIC by ‘ThatDu04’ in 2022, with a high-quality write-up (+ comment section) profiling MRL as an ‘emerging buy/ build compounder’. Since then, Marlowe has continued to compound with recent FY23 results showing 47% revenue growth (10% organic) and 52% EBITDA growth YoY. From FY17-FY23 Marlowe has compounded EBITDA/ share at an impressive ∼30% CAGR.

Marlowe is a >£500m revenue/ ∼£100mn EBITDA business, with leverage running at 2x ND/ EBITDA. We calculate that Marlowe are close to their £100mn EBITDA target and management will likely set new medium-term targets at a Capital Markets Day later this year.

Business: Marlowe’s business is comprised of two decentralised segments, GRC (Governance, Risk & Compliance, 40% of revenue/ 60% of profit) and TIC (Testing, Inspection & Certification, 60% of revenue/ 40% of profit), with a ∼10-person team at HQ responsible for capital allocation.

Marlowe provides service and software to customers in areas ranging from the fire safety and water & air hygiene services in the TIC division to health & safety, employment law/ HR, compliance software, occupational health and more recently ISO certification (through the acquisition of IMSM) in the GRC division.

(Source: FY23 Results Presentation)

While this write-up is largely focused on the asymmetric opportunity in the stock, Marlowe’s business is attractive and well positioned to grow at scale.

The main characteristics that these businesses share is that the services provided are essential and non-discretionary as they are required by law owing to an increasing regulatory burden on companies. This leads to predictable, annuity-type recurring revenues (85% recurring revenue) and long-term customer relationships (12+ years) for Marlowe’s businesses as these services are relatively resistant to changes in the economic environment. Marlowe focuses on providing highly skilled, specialty services that share a common route to market, which customers prefer to outsource due to their technical nature and because the risk/ costs of non-compliance outweigh the costs of the service. These are fragmented markets that are ripe for consolidation resulting in economies of scale and route density, which in combination for healthy structural market growth and increasing market share for scaled providers (customers prefer to outsource to large suppliers with national footprint and in-house capabilities) allows Marlowe to grow revenue organically at ∼HSD rates (high single-digit) which when combined with margin expansion and attractive cash conversion provide for an attractive financial model.

Marlowe’s M&A model which was previously addressed in ThatDu04’s write-up is largely focused on acquiring the long-tail of accretive bolt-ons in their markets at <7x EBITDA which tuck into the larger platforms, with Marlowe just retaining the fee-earners/ crucial admin staff leading to increased route density, organic growth, efficiencies, and margin expansion. Marlowe typically funds these deals from a mix of internally generated cash-flow and incremental debt utilisation (∼2x ND/ EBITDA).

Management: Marlowe is led by Alex Dacre (35) who owns ∼5% of the company. Alex earns a below market salary/ yearly bonus, in exchange taking part in an incentive plan, currently in place that requires the stock to be >£11.11 by 2026 before any value accrues to the CEO/ management. Character references for Alex have been positive, with former colleagues viewing him as driven, intelligent, and ambitious. We believe that Alex is the right person to continue to run Marlowe over the coming decade and that the management team should increase per share value meaningfully.

Deconstructing the Bear Case: While the bear case for Marlowe previously revolved around a wider number of points, the debate has narrowed to mainly focus on two related points, one-off/ restructuring costs and FCF generation both of which we believe will be proven out further over the next year.

• (1) One-Off/ Restructuring Costs:
• Bears believe that Marlowe’s one-off costs in relation to acquisition and restructuring costs are recurring and won’t go away.
• We believe that these costs are necessary costs to achieve efficiencies in acquired businesses, which Marlowe incorporate into their acquisition model pre-acquisition. Improving these businesses requires staff restructuring, integration resources, software/ system upgrades, property rationalisation etc.
• Management spent a lot of time explaining role of integration in 2023 CMD earlier this year.
• APi Group (APG US), a comparable business to Marlowe’s TIC segment is incurring restructuring costs at a 1:1 cost/ benefit ratio to achieve $100mn+ of synergies in the recently acquired Chubb business.
• Management have guided for a reduction in acquisition and restructuring costs to £10-12mn in FY24 after incurring £24mn in relation to these costs in FY23 (related to the exceptional level of acquisitions in FY22).
• These costs will decrease further in the back half of FY24 and into FY25.
• ‘And just picking up on that restructuring cost point, yes, we've indicated £10 million to £12 million. That's with a bit of extra restructuring costs and the £15 million we completed in the first few months of this year. In terms of timing of that, the majority is going to be in the first half. 
• So, it's just sort of £8 million or £9 million in the first half and the remainder is for the second half as we do sort of those smaller bolt-on M&A that we've done at the beginning of this year, we'll be going through those in the second half of the financial year.’ (Adam Councell, CFO @ FY23 Results)
• (2) Free Cash-Flow Generation:
• This is the ultimate investor debate point around Marlowe with bears believing that Marlowe will just never produce meaningful cash-flow.
• We believe that Marlowe will produce an increasing amount of FCF due to the combination of increasing profitability and reducing one-off costs.
• Marlowe produced £46mn of net operating cash (pre restructuring costs) in FY23 on £83mn of EBITDA. Restructuring costs in FY23 amounted to £24mn with net CAPEX (2/3^rd of which is software) accounting for £15mn, resulting in £7.5mn of free cash-flow to equity in FY23.
• FCF was £17mn in 2H23 as working capital movements in 1H23 reversed in the second half.
• In FY24, £100mn of EBITDA should convert to around £60mn of NOCF (pre-restructuring) with restructuring costs guided to being £12mn at the high-end of the range and net CAPEX which should amount to around £18mn for about £30mn of FCFe.
• On a normalised basis (excluding further acquisitions) Marlowe should clear £40mn+ of FCFe on the run-rate EBITDA of £100mn.
• ‘We're a business that's generating around about £40 million of free cash that we can reinvest into selective bolt-on M&A and that's where we're focused at the moment.’ (Alex Dacre, CEO @ FY23 Results)
• (Source: Internal Estimates, Marlowe 2023 CMD Presentation)

Valuation: Investors, whether public or private typically value businesses like Marlowe’s at high multiples with public and private comps typically trading at 15x-20x EBITDA or 20x-30x FCF. Marlowe itself had traded at similar multiples until 2022 when fears around leverage (impact of rising rates on Marlowe's floating rate debt), one-off costs/ lack of FCF as well as a general market decline caused a significant de-rating.

 (Source: Tikr.com) 

Within Marlowe, the GRC division should probably trade at a higher multiple as this division should grow at a higher rate than the TIC division, earns higher margins and comes with a software component (close to £50mn in ARR at >40% EBITDA margins) with peer valuations reflecting this.

In the recent Sky News article about the potential sale of the TIC division (doesn't seem that deal is imminent, likely open to offers at right price), it was reported that ’based on recent transactions in the sector, a sale of the unit could yield a valuation of up to 16 times its annual profit, equating to roughly £650m.’ If the TIC division, which accounts for 40% of group profitability is worth £650mn (<15x IFRS-16 EBITDA on our RR numbers) then the total SOTP accounting for the GRC division (which would likely fetch a higher multiple) and the HQ costs at the same multiple as the TIC division would result in a total SOTP value of about £1.5bn for an equity value of around £1.3bn, or >£13 per share.

(Comparable Transactions, Source: Internal Estimates)

On a cash-flow basis, if we run a reverse DCF on Marlowe’s >£40mn of FCFe currently it becomes clear that the market is MRL as a zero/ low growth business. We believe that as Marlowe continues to prove their model and roll up these fragmented industries through bolt-on acquisitions at attractive returns that investors should re-rate the stock back closer to its historical range and towards fair value, with a valuation of 11x EBITDA/ 20X FCF+ justifiable based on our assumptions. We think Marlowe’s current business (excluding future M&A opportunity) is worth >£10 using reasonable assumptions.

Summary: While the option to sell one/ both divisions exists and provides strong downside protection (TIC business alone could justify current market cap) we believe that the most likely path is that Marlowe continues as a public company, operating in both the TIC and GRC divisions, with continued organic growth, margin expansion and reduced one-off costs leading to substantial improvements in free cash-flow generation which should ultimately serve as the catalyst for Marlowe to re-rate in line with peers resulting in a £10+ stock in the coming years. We think the combination of low downside with the possibility of a double or triple on the upside in the coming years combine to provide a particularly attractive, asymmetric opportunity.

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.

Catalyst

• Continued growth of business and improvement in free cash-flow generation
• Potential sale of division/ company
• CMD in 4Q23 with updated medium-term targets