Share price: 510 GBX($WATR)
Market capitalization: 80M USD
1. Elevator Pitch:
Water Intelligence is a plumbing-like services company leading a growing niche that operates both through corporate and franchise locations. This asset-light business has grown systemwide sales while acquiring its own franchisees at 3 to 5 EBIT multiples. A promising insurance B2B channel and a big acquisition runway on top of a growing and recurring royalty stream make WTR a compelling opportunity in the long run.
2. Company overview
Water Intelligence came to the Aim market in 2010 through the reverse takeover of Quonnectics, at that time Quonnectics was a bankrupt telematics and IT services provider to the utility markets; in January 2010 Patrick J. DeSouza saw in Quonnectics the opportunity for a cheap listing of American Leak Detection, and the renamed company started trading in the Aim. Water Intelligence is composed of two wholly-owned subsidiaries, American Leak Detection (ALD) and Water Intelligence International (WII).
ALD: represents the bulk of WATR and it is a leader in pinpointing and repairing water leaks without destruction. ALD technicians use special equipment such as acoustic devices to pinpoint, detect and repair water leaks (instead of trial and error plumbing solutions ALD takes a non-invasive approach to water leaks).
These types of service businesses rely on SEO optimization and online marketing on top of local word of mouth and reputation in the area to get leads. American Leak Detection has been operating in the USA for more than 30 years and akin to renowned franchises like Roto-Rooter reputation and local presence are their biggest assets.
Aging houses in the U.S. increase the chances of a water leak and thus an expensive flood if the leak goes undiagnosed for an extended period. Verisk Analytics highlights that one in 50 households filed a water-damaged claim each year between 2013 and 2017. The 2.05% frequency rate has increased from 1.44% annually between 2005 and 2009.
The company is focused on both the residential and B2B markets (commercial and insurance). ALD is generating 125M USD worth of system-wide sales via corporate-operated location and indirect sales from franchisees, which produce royalty income to the company.
ALD was founded in 1974 and in 2006 was acquired by Mr. DeSouza who instead of milking the business for cash, deleveraged the company and embarked on a journey that transformed the business focusing on reacquisition of corporate operations and new revenue lines like B2B operations.
WII: is a UK-based business that WATR acquired in 2016, it focuses on municipal solutions and owns the water detection corporate locations in Australia and Canada, leading the group's international expansion efforts.
Franchise royalty income: WATR has 103 leak detection franchises (the bulk of this number are USA franchises over 46 states) and it earns a 6% royalty fee on their franchisees´ sales. This represents a recurring, high margin, asset-light revenue stream that can be reinvested into acquisitions. Despite the growing number of franchise reacquisitions (which subtract from this line) royalty income has steadily grown throughout the years.
B2B: the company has created an insurance channel by signing contracts with 6 major insurers in the US (the 6th national contract was signed 1 month ago) and a Fortune 500 home services company. This channel allows them to provide additional jobs to their franchisees, and insurers win a trusted partner to pinpoint water leaks and minimize collateral damage claims from residences and businesses. The jobs are dispatched from corporate administration allowing them to earn a small profit on the channel and assuming liability and payment risk. Insurance jobs have jumped from 2k in 2016 to more than 50k in 2019 since the beginning of the channel in 2017.
On top of this and akin to other franchisors ($MTY e.g.) the company sells equipment to their franchisees, and by leveraging its scale earns a small profit on these sales.
US Corporate Locations(ALD): this line represents the revenue from corporate-run locations(18 owned locations in Q2 2020) giving us a hint of the store economics; corporate operations are quite easy to set up, usually requiring a van and equipment available from 60k USD, average operating margins hover around 20% with some thriving franchisees getting close to a 30% operating margin.
WII: Canada and Australia corporate locations (4 locations in Australia and one in Canada) represent the bulk of this revenue stream, on top of this the UK municipal income is also included in this group.
After deleveraging the company in 2014, system-wide sales have jumped from 50M USD to 125 USD due to the new B2B channel, reacquisitions of non-performing locations, and organic growth. It is relevant to point out that the company has barely spent 5.2M USD in order to acquire almost 15M USD worth of corporate sales(2015-2019); this is due to the fact that WATR has acquired several non-performing locations and substantially increased their revenues. Shares outstanding have grown from 10M to 15M, but this dilution has been offset by the increase in profits and every single acquisition has been accretive.
The company is reinvesting its profits into more corporate reacquisitions, these acquisitions are usually carried out at multiples ranging from 3 to 5 times EBIT, WATR has already acquired 5 locations in 2020( 5.35M spent implying a blended EBIT multiple of 4.5 times).
The Covid pandemic has barely impacted the business, WATR has kept growing (even though the pace has slowed down a bit due to the lockdown restrictions in Q2), and they ended H1 with a net cash position of 1M USD despite several acquisitions.
The company recently announced another equity raise and the company is currently sitting on a 6M net cash position. These share placements have been fundamental to fund the aggressive growth of Waters and shareholders have benefited from multiple arbitrage ( Waters usually acquires their franchisees at 4.5 EBIT while they have raised capital at a much higher valuation)
The company is led by Patrick DeSouza(61 years old) who has been the chairman since 2006 and owns near 30% of the company, Patrick has been instrumental in the company´s success and he has executed flawlessly throughout the years.
The recently appointed executive director, Bobby knell was the former owner of an ALD Dallas multimillion franchise, now operated by his son. The fact that the company is led by successful franchisees it is in my opinion an excellent decision.
3. Risks and opportunities
Related transactions: In 2019 the company invested 1.2M USD in Seen PLC (former EAI, where Patrick DeSouza is both a director and a shareholder) in order enable prospective customers to purchase water-related products directly from a video. This is a red flag and something to monitor in the future.
Competition: as far as I’m aware, there are few other water leak detection companies at a national scale, competitors tend to be small mom-and-pops with no brand or insurance contracts; however, the residential business competes locally against these businesses.
On a national level Roto-rooter ($CHE owned) with more than 657M USD in 2019 revenue(vs 363M in 2012) is the most similar company and has been executing the same franchise reacquisition strategy for more than 30 years. Roto-rooter is focused on plumbing and restoration, and also provides leak detection services, but they lack know-how and reputation in this area. WATR has been operating for more than 30 years in the industry and its reputation and know-how are their biggest assets.
Angi HomeServices: marketplaces like Angi could commoditize service businesses in the future, but given the scarcity of qualified technicians and the low probability of fixed priced initiatives getting traction in the leak detection industry( leak detection technicians bill their services by the hour, sometimes leaks are hard to find and the customer fee changes if repair services are provided) this is not a huge threat.
Customer relationships: given the nature of the business there is not a lot of repeat work so customer relationships are not sticky in the residential markets and the company relies on local reputation and word of mouth in order to get an increasing amount of leads.
The management has stated its desire to double Systemwide sales to 250MUSD in a 3 to 5 years’ timeframe; even though this may not be achievable in such a short time frame I think there are compelling opportunities in the future :
Upselling and one-stop-shop ambitions: ALD seeks to leverage its customer base to provide them with additional products that prevent water leaks or monitor water quality, these type of products are a win-win for both the customer and the insurance company, given that insurers charge lower premiums to these customers. The company is rolling out a proprietary sewer diagnostics product as well as a residential diagnostic tool in Q3 2020. WII currently offers municipal solutions that can be sold by existing ALD locations, as a result, WATR can cross-sell this solution throughout their national footprint.
Corporate reacquisitions: WATR is bumping up its acquisition efforts, and given that franchisees can’t sell their operations without corporate approval, I think it is plausible to assume that WATR could follow the successful playbook of bigger plumbing franchises like Roto-Rooter($CHE owned).
B2B channel: the insurance channel serves as a valuable asset to the group, motivating all of the franchisees and providing some customer stickiness to the company. This insurance channel is difficult to replicate by smaller competitors that don’t have the required national footprint on top of security and data requirements in order to win these types of contracts. In the future WATR insurance revenues could get closer to Boyd Group who operates a collision shop roll-up and derives a bigger portion of their revenue from insurance companies. Roto-Rooter derives close to 30% of its revenue from commercial customers).
Excluding intangible amortization and including recent acquisitions WATR is operating at a 3.3M GBP FCF run rate alongside a 78M market cap; the company has a 6M net cash position which implies a 21 EV/FCF multiple.
The business is by no means cheap, but I think that given the great unit economics, the promising insurance channel, the corporate store margin expansion, and the acquisition runway ahead of us ( 18 own corporate locations vs 103 franchises), I can estimate +15% returns over the long run as long as the management keep executing on the same strategy.