|Shares Out. (in M):||125||P/E||5.8||0|
|Market Cap (in $M):||117||P/FCF||0||0|
|Net Debt (in $M):||41||EBIT||20||0|
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PTSG is a high-quality business growing at 30% p.a. trading at less than 6x this year’s after-tax earnings. The business is recession-proof, highly profitable, has a sustainable competitive advantage, a strong balance sheet and owner-managers with an excellent track record both as operators and capital allocators. This translates into attractive financial characteristics with high margins, low capex, high returns on capital and a progressive dividend policy. PTSG has a strong track record of growth and the outlook for continued growth is very promising, both organic and acquisitive.
Over the past 12 months, the share price of PTSG has declined from over 200p to 68p. The company reported good results and announced acquisitions with the potential to create significant value. A capital raise at 156p, Brexit, non-recurring expenses obscuring the true earnings power, rumours of a large seller in an illiquid stock are possible explanations for the first wave of weakness to 130p. After the release of the 2018 results, the stock dropped another 50% as a short seller, Lombard Odier, highlighted a number of weak aspects of the business such as the lack of cash generation, large receivables, non-recurring income and related-party transactions. While these concerns are valid, we believe the bear case has been overstated at this point. In our view management has underestimated the importance of transparent governance and should have communicated more clearly about related-party transactions and consultancy fees. However recent actions indicate these issues will be addressed in the right manner.
PTSG provides regulated and safety-related specialist building services in the UK and focuses on the most complex and lucrative services of facilities management. Regulatory bodies require property owners to arrange for safety-related inspections on a regular basis.
Today, 72% of PTSG’s Gross Profit is derived from testing/inspection and repair/maintenance (T&I), revenues that are mandatory and recurring. The balance comes from more cyclical installation revenue. In the T&I business, scale and route density allow PTSG to be the most cost-effective solution. PTSG services 180,000 properties in the UK and has strong market positions in access and safety, lightning protection, mechanical fire and electrical testing. Margins are consistently high, reflecting the specialist nature of activities, the strong focus on cost control and the Group’s leading operating model, whilst remaining competitive on pricing.
The company estimates its market share at 5% to 12%, depending on the segment, in a very fragmented market that is growing 6-7% p.a. supported by increased regulation. A growing market combined with market share gains and a successful acquisition strategy resulted in EPS growth of 30% p.a. over the past 5 years.
PTSG is a niche specialist service provider of the following services:
1/ Electrical Services (34% of revenue): lightning protection, fixed wire testing, portable appliance testing, fire alarm and extinguishers, dry risers, steeplejack services
2/ Access and Safety (15% of revenue): safety testing & installation, cradle maintenance and installation
3/ Fire Solutions (46% of revenue): dry riser installation and maintenance, sprinkler installation, test and maintenance, install and test fire alarm and emergency lighting, supply and test fire extinguisher
4/ Building Access Specialists (5% of revenue): steeplejack services, high-level installations, reparation and cleaning
PTSG’s services focus on providing safe building environments. Its operating model has the following characteristics:
Customer Diversification: PTSG services 20,000 customers and 180,00 assets with no customer representing more than 5% of revenue.
National Coverage and Staff Utilisation: PTSG is the only truly national player in its chosen markets. It has 31 office locations including the Castleford head office from which it deploys service engineers to client sites more or less nationally within a regional structure. Relatively local engineer resources reduce travel time and cost, theoretically increases the number of jobs that can be serviced (and revenue earned) and facilitates high service levels and competitive pricing to customers. The keys to generating attractive profitability are client density and high engineer utilisation levels. Trained engineers specialized by service and workflows are split into installation or scheduled service/maintenance streams. PTSG is growing fast and growth improves route density. Staff costs account for 40-45% of revenues.
Use of Technology: Clarity, a self-developed integrated ERP software system, is used to schedule, monitor, certify and invoice jobs and provide a workflow audit trail. The software includes workforce management, performance dashboards, real-time tracker and a secure client portal.
Repeat Business: High annual client renewal rates (88%+ in T&I in 2017) provide a good recurring income revenue base, increasingly under 3-5 year agreements. The business is recession-proof because the testing and maintenance/repair work is non-discretionary and needed for compliance. Taking into account the recent Guardian and Trinity acquisitions, which we will discuss later, compliance work represents 72% of the Group’s gross profit. Installations, except for retrofitting, is driven by construction activity and is more cyclical. The widening of the service offering and a nationwide offering drive cross-selling opportunities.
Accreditation and Training: PTSG has 133 accreditations including ISO 9001, OHSAS 18001 and ISO 14001.
PTSG generates significant shareholder value through organic growth, including cross-selling, and through complementary acquisitions. Although the Company believes that the Group is already a market leader in a number of its UK segments of operation, it has less than 12% share of each of its principal markets and they believe that there is significant scope for continued growth. Many of PTSG’s customers are streamlining their businesses through supplier rationalization, moving to single source supply, which is benefitting the Group and is expected to continue.
Historically, PTSG has achieved strong levels of organic growth by improving processes and efficiencies in both existing businesses and those acquired. Central to the Group’s strategy is leveraging its significant and expanding customer base to create value in the acquired businesses. Furthermore, through the successful acquisition and integration of acquired businesses, the Group has demonstrated its core competence in delivering value not only for its shareholders, but also for the vendors of acquired businesses through the agreement and achievement of financial targets relating to elements of deferred considerations. Management believes that the reputation of the Group as an attractive acquirer positions the Group favourably for completing acquisitions on attractive terms where owner-managers are interested in playing a role in the enlarged business. Management is committed to pursuing acquisition opportunities in existing and adjacent markets with a view to cross-selling services and leveraging the existing client base. Only around 5% of customers currently receive multiple lines of service, with considerable scope to improve this and increase profitability. A sales team looking at cross-selling opportunities is currently doing £8m of new business per year on total run-rate sales of almost £ 80m (pro-forma GBP120m incl. Trinity).
The Company has an in-house acquisitions team and a strong pipeline of opportunities comprising both bolt-on to the existing divisions and businesses with activities in new and adjacent sectors. Acquisitions will be considered that allow the Group to:
Market opportunity and competitive environment
The markets in which PTSG operates are highly fragmented, with many local players lacking the scale, breadth of service and geographic coverage to compete effectively. PTSG is now the market leader in a number of its specialist niches although its market share does not exceed 12% for any of its businesses. This strong market position, as further described below, is due to a number of factors, including:
Some other providers in, for example, access and safety do not provide ongoing testing and maintenance post installation. The beauty of the PTSG business model is that, due to the small ticket size of the typical maintenance visit, competitors are largely focused on the ‘big ticket’ prestigious installation business, the complete opposite of the PTSG strategy. This allows PTSG to service not only its own installed base but to offer a differentiated after-market offering that can pick up share by servicing the installed base of its competitors.
Whilst PTSG primarily competes with many small, local players, there is a large competitor in each of Access and Safety’s and Electrical Services’ markets. In safety installation, the largest competitor and industry leader by sales is HCL, a division of Latchways plc. Latchways is a global leader in the design and manufacture of fall protection systems and access solutions. As well as competing with Latchways through HCL, the group is a customer and accredited installer of Latchways’ products. Latchways was acquired by MSA Safety in October 2015.
In electrical services, the main competitor and market leader in lightning protection is Omega Red, which is part of the SSI Services division of South Staffordshire plc. Omega Red claims to be more than three times the size of its largest competitor.
An analysis of each of the Group’s markets by estimated size, the Group’s market share and the Group’s ranking is shown in the table below from the 2015 IPO document:
Today the situation is as follows:
Safety Testing: 6ml in revenue versus HCL number 2 with 2ml
Cradle maintenance: 3ml revenue versus number 2 at 1,5ml
Cradle Installation: 4-6ml with CoxGomyl number 2
Lightning Protection: installation, testing and maintenance and some specialist power services, PTSG is # 1 with GBP30ml revenue, #2 does 17ml and more competitors do about 5ml
Electrical Services Testing: PTSG is #5/6 but climbing rapidly
Building Access: cleaning, abseil works, a very competitive business and a small activity for PTSG
Fire: a business PTSG entered into 2,5 years ago (after IPO and therefore not in the above table). The market of extinguishers, smoke detectors and general fire systems is competitive with a few companies doing 100ml revenue at low single-digit margins. PTSG focuses on mechanical fire (dry risers, pipes and valves) and currently does 20ml revenue at 20-25% operating margins. In January 2019 PTSG announced the acquisition of Trinity Fire and Security Systems, a GBP40ml business with a 5% operating margin.
Organic growth has historically been high at 16%, 24%, 20%, 11% and 19%* over the last 5 years.
Underlying markets are growing at 6-8% p.a. driven by increased regulation. Further market share gains are pursued by cross selling supported by a dedicated sales team, nationwide coverage, increasing service offering, high customer satisfaction rates and competitive pricing.
* (10% if you don't adjust for cyclicality in access & safety installs)
PTSG’s acquisition model is clearly focused on applying its efficient practices (on scheduling and utilisation) to improve revenue and gross margin contribution while using central services to control opex. We believe the company has clearly demonstrated an ability to both acquire complementary businesses on sensible initial multiples and deliver meaningful uplifts in profitability under PTSG’s ownership.
Aggregating the pre-acquisition financials from the 23 acquisitions since 2007 results in revenue of £42ml and £5.1ml EBIT. Pro forma FY17 revenue (ie adjusting for full-year effects of acquisitions in that year) is £60ml with EBIT of £12ml.
In the first 10 years of the company’s existence, PTSG delivered organic growth in excess of 40% in revenue and more than doubled the profitability of the businesses acquired during this time. Based on a total consideration of £40ml overall this acquisition cost is equivalent to 0.67x revenue, 3.33x EBIT based on FY 2017 results.
These figures confirm that the PTSG model is able to materially drive down initial acquisition multiples, which are low on an absolute basis and relative to its own multiple, and generate good returns for shareholders.
PTSG has made two further acquisitions in 2018, M&P Fire Protection and Guardian Electrical Compliance, and announced the Trinity acquisition in January 2019.
M&P Fire: PTSG initially paid £1ml cash for a business that generated £2.1ml revenue and £0.2ml PBT in its last financial year. Deferred consideration of up to £2.5ml over the next 5 years is contingent on unspecified profit targets. This looks like a typical PTSG deal structure and adds complementary installation and maintenance revenue streams (in sprinkler and wet and dry riser systems) in the South East of England. The strong increase in revenue and PBT since acquisition bring down the acquisition multiple from 17.5x PBT to 3.7x. This is driven by the growth rate of the business (>20% p.a.), sales growth initiatives from PTSG, the elimination of non-business expenses and other efficiency improvements.
Guardian: PTSG initially paid £12ml (for a business that generated £8,3ml in revenue and £1.8ml PBT in its financial year prior to acquisition, with 1ml cash on the balance sheet). Deferred consideration of up to £4.0ml is also payable over the next three years, in cash or shares at PTSG's discretion, subject to Guardian meeting stretching performance targets. (PTSG issued 12,7ml shares at £157p to fund the Guardian and Trinity acquisitions). Guardian contributed GBP 3.14ml to sales and GBP1.12ml to operating profit for the 2.5 months since acquisition. This implies significant growth driven by the >20% growth rate of the business and some added value from PTSG. Efficiency improvements also included the elimination of expenses such as sponsoring of 2 local football clubs, a director’s box etc.. The strong increase in revenue and PBT since acquisition bring down the acquisition multiple from 8.3x PBT to 3.1 x.
Trinity: PTSG initially paid GBP10.8ml, GBP7.7m net of cash on the balance sheet, for a business with a run-rate revenue of GBP40m and EBITDA of GBP2.2ml. Deferred consideration can be a max. of GBP5m based on certain milestones. In FY2018 PTSG revenue was GBP69ml so the Trinity acquisition is significant. As a national provider of fire and security services concentrated on testing and compliance services, the acquisition is complementary with PTSG’s existing national presence. The CEO sees substantial cross-selling opportunities and applying PTSG’s efficient practices to Trinity should boost its margins from 5% to 15%. Based on their track record the odds are good that they will achieve their goals. With an acquisition multiple of 3.5x, our downside seems limited if they don’t.
Acquisition strategy and pipeline
PTSG has a big pipeline of potential targets they have approached directly and they have been talking to for a while. The size of these businesses ranges from 1ml annual sales to 40ml and a purchase price from 1ml to 16-17ml, so substantial businesses as well.
Momentarily they are looking at deals around 5x pat. PTSG is the most effective solution as a buyer in the market, they create a repay model mostly a pound for a pound (1 pound of maintenance revenue for 1 pound of inspection revenue) , they have a strong renewal model with renewal rates close to 90%, they have a very aggressive sales model where they can grow sales rapidly and a very streamlined operational performance of the business where PTSG monitors KPI’s on a daily, weekly and monthly basis. So, PTSG does not only want to buy low, but they also want to do a lot with the acquired company.
What drives the sellers of the businesses PTSG acquires? Sometimes the seller wants to de-risk, take chips off the table but they are not ready to finish their working life. Then they come to PTSG and have access to 18,000 clients and how PTSG does things, then effectively they take a decision whether they can make more money with PTSG than without, so it can be attractive for them to go to PTSG. Any deferred consideration has always been self-funded, so these attractive targets pay for themselves. So far, PTSG has never missed a milestone target in all the deals they have done, so that’s also a good reason to sell to PTSG.
Historically, PTSG has tapped the equity markets on regular occasions, an option that is currently unavailable because of the large drop in the stock price. Management are large shareholders and they have told us that they will not raise equity at the current valuation. Recently, the company’s credit facility with HSBC was increased to a GBP 10m term loan and a revolving credit facility of GBP 30m.
Further details on the current acquisition pipeline are available in the FY2018 Results Presentation on pg. 27.
Margins are consistently high, reflecting the specialist nature of activities, scale advantage, the strong focus on cost control and PTSG’s leading operating model, whilst remaining competitive on pricing.
The operating margins are protected by barriers to entry described by PTSG as follows:
In addition to the above list, we believe that Clarity, PTSG’s proprietary IT system, is a source of significant competitive differentiation vis-a-vis smaller competitors bringing both internal management and client interface advantages.
Three of PTSG’s four divisions generated EBIT margins over 20% in FY18 while Access & Safety’s FY18 EBIT margin was still a very respectable 16.7%. Over the last 5 years, the average adjusted Group operating margins were 20.9%. The margins are expected to decline in FY2019 to approx. 16% when the 5% margin business of Trinity will be included.
PTSG has a strategy to improve Trinity’s margins from 5% to 15% by exploiting cross-selling opportunities and by implementing its operating model. Trinity represents 30% of PTSG’s revenue, therefore the upside is substantial.
RETURN ON CAPITAL
PTSG’s business is an asset-light business that requires a lot of working capital (WC/Sales 37%; net capex/sales 1.1%). Large working capital requirements are typical for the UK construction industry. In the UK, the customer withholds 5% until the project is practically complete. When the project is delivered, 2.5% is withheld for the defects period, which for PTSG’s businesses can take between 1-2 years from completion.
PTSG generates 50% of the revenue from its Testing & Inspection business with facility management companies. These large customers get more favourable payment terms.
The change in the business mix during the period 2015-2017, with an increase in installations and revenue from facility management companies, explains the increase in working capital/sales. With the recent acquisitions, sales from installations will drop to 42% (52% in 2017) and this, together with other initiatives, will help the company to lower working capital requirements.
That being said, PTSG’s business is profitable enough to generate attractive ROIC despite the high working capital requirements.
We adjust reported earnings for amortization of intangibles and non-recurring expenses such as restructuring costs, contingent payments for acquisitions and share options to determine the earnings power of the business. Share options expenses in 2018 and in earlier years are related to the service agreement with Roger Teasdale. The company confirmed that there will be no further share options expenses related to Roger’s compensation from 2019 onwards as the final milestone target was reached in 2018.
For our 2019 forecast we assume 5% organic growth on PTSG 2018 revenue and adjusted operating profit excluding the 2018 acquisitions and consultancy fee from Trinity. To this we add run-rate revenue from M&P & Guardian (contributed period in 2018, annualised) and the contribution from Trinity. This gets us to £ 124.3m revenue and 20.2m adjusted operating profit for 2019. We assume 5% revenue growth to be conservative vs the company reported 18% organic growth rate on average for the past 5 years. The adjusted operating margin of 16.3% assumes no improvement in operating margins despite the fact that management has identified opportunities to improve Trinity’s operating margins from 4.4% run-rate to 15%. On 40m run-rate revenues from Trinity this potential impact is significant.
On these forecasts PTSG trades at a PE multiple of 5.8x this year’s earnings. This is a very attractive valuation for a highly profitable recession-resistant business with the characteristics we described above, that has grown EPS at 30% over the last 5 years and with the potential to maintain high organic and inorganic growth over the medium term.
The recent share price performance indicates that PTSG has, at the very least, a perception problem. This has been reinforced and exploited by short seller(s) who have been successful at highlighting the weaker aspects of the business and who have created doubt about the trustworthiness of management and the reported financials. At least part of the damage has been self-inflicted by a management who have underestimated the potential impact of certain decisions on investors’ perception of the company. The poor communication on related-party transactions and a large unannounced consultancy fee are good examples of this.
Investor concerns are related to 3 main issues: a) reconciliation of the income statement with the cash flow statement b) related party transactions and c) the consultancy fee.
PTSG has not generated operating cash flow in aggregate since 2015 despite strong earnings growth as a result of the increase in working capital as a percentage of sales. We explained above that this is the result of the change in their business mix with the increased weighting of installations and business with facility management companies. Taking into account the 3 recent acquisitions the current business mix should result in an improvement of working capital with a relative decline of installations and business with facility managers. Recent events have also convinced PTSG’s management that working capital and the receivables in particular should be a management priority. Several initiatives have been instigated to become more aggressive in collecting receivables, to deal faster with queries and variations to the initial agreement etc..
The Board did not see any harm in the Chairman and the CEO buying property from, and leasing back to, PTSG. A fast-growing company has better use for the cash than investing it in property is the main explanation offered by management. This has not been a major issue until a combination of events led to the current negative sentiment and the related party transactions were raised as a concern. The company has now instructed an independent valuation expert to review these rental payments. If they conclude that the rent is above market, the rent will be adjusted. Also, management has decided that there will be no further property transactions with related parties.
While the 2 previous issues existed when the stock price was at 200, a consultancy fee in the 2018 results might have been the catalyst for the loss of confidence. The 2018 operating profit was boosted by a GBP 1.6ml fee for consultancy services provided to Trinity, a company that was acquired in January 2019. This led to speculation that PTSG used this to artificially boost earnings. Management explained that they were in conversation with Trinity, a potential acquisition target, since the start of 2018. PTSG’s track record and profitability convinced Trinity to sign a consultancy agreement to help them improve profitability, with a payment dependent on realized results and no commitment for a sale of the company. During 2018 Trinity’s profit margins improved more than 2% and a consultancy fee of GBP 1.6ml was paid to PTSG.
We believe this explanation to be credible but communication has been terrible. The fee was accounted for in “Other Operating Income” and increased adjusted operating income, what management claims to represent the earnings power of the business. A brief explanation of the consultancy fee was given in the notes of the annual report. The market concluded that PTSG’s management could not be trusted. Our view is that this was poor judgement by a management that lacks experience in investor communication with public shareholders. Including a one-off consultancy fee in operating income should have been communicated clearly and not hidden in the notes.
Based on our conversations with management we were satisfied that they have learned some valuable lessons. It will likely take some time to restore credibility but we have the impression that management is responding in the right way to all the concerns that have been raised.
PTSG’s founders, chairman John Foley and CEO Paul Teasdale have each founded other specialist service businesses, MacLellan Group and TASS Europe respectively, and worked together when TASS acquired MacLellan in 2004. COO Roger Teasdale and CFO Mark Watford worked in the same divisional team at Smith & Nephew prior to joining PTSG towards the end of 2014, but ahead of its IPO the following year. As well as obvious relevant experience in building companies in this space, the board has very strong finance oversight. We note that the directors mentioned above are significant PTSG shareholders, together they own just under 40% of the issued share capital. John and Paul’s combined annual compensation is below £250,000. Paul’s twin brother Roger was persuaded to leave a well- paid job to join PTSG in 2014 on the basis of a higher compensation package (£400,000) and an options package subject to certain milestone targets being met. The last of 4 milestones was reached in 2018. Management confirmed to us that no new stock option plans are expected to be introduced.
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