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Value Situations' Conor Maguire shares Marlowe plc $MRL.L thesis + TIC segment catalyst (podcast #193)
Conor Maguire, Founder and Editor of the Value Situations Newsletter, joins the podcast for his second appearance to share his thesis on Marlowe plc (LSE: MRL), provider of a broad range of compliance software and services in areas which pose a high risk for businesses.
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Transcript begins below
Andrew Walker: All right. Hello and welcome to Yet Another Value Podcast. I'm your host Andrew Walker. If you like, this podcast, it would mean a lot if you could rate subscribe, review it wherever you're watching or listening to it. With me today, I'm happy to have on from Value Sets for the second time, my friend, Connor. Connor, how's it going?
Connor: Good, Andrew, how are you?
Andrew: I'm doing great, man. I'm really excited to have you on. As you know I'm an avid fan of yours. I'm a day 1 subscriber. I have been meaning to have you back on, and then you put out the idea we're going to talk about today, which I instantly hit you up and said, "Hey, I think this is perfect." But we'll get there in a second. Let me just start quick disclaimer, remind everyone, nothing on this podcast is investing advice. Please do your own research, consult a financial advisor, all of that jazz that always holds, but maybe particularly true today because my audience is largely domestic, and we're going to be talking about a international London listed stock.
That all out the way. Let's turn to the company we're going to talk about. The company is Marlowe. The ticker over in London is MRL, and I'll just toss it over to you. What is Marlowe and what's so interesting about them?
Connor: Hey, yeah, thanks Andrew, and thanks for having me on the podcast again, so Marlowe is an interesting situation. I think it's a small cap. It's about 580 million pound sterling market cap, so about 720 million US dollars listed on the AIM exchange in London, which is the small cap exchange, and I suppose essentially what the business does, it's a roll-up or serial acquirer business, and it has an interesting ownership profile in that it was basically set up by the CEO Alex Daker.
Who was a protege of the main shareholder, this guy called Lord Michael Ashcroft, who's a former conservative party treasurer in the UK, so he's an interesting character, but he's a guy he's...
Andrew: Lord Ashcroft the former conservative party treasury member, that sounds like a like low grade novel invented villain. Does it? Just like Lord Ashcroft, the former treasure. I always laugh when I hear that. I don't know, I didn't know much about him till then, but that's just his name would always float around and I would always think that.
Connor: Yeah, so I suppose he is an interesting character in terms of, I suppose the best way of I'd describe it is he has a habit of making money in that he has backed a number of listed companies, probably one of his best known wins in business was that he sold the ADT security business to Tyco International, I think for over 5 billion, some time ago, so his focus has been on business support services, and certainly Marlowe really fits that bill in terms of what is Marlowe.
It's essentially 2 businesses today based in 2 complementary sector, so the first segment is really the testing, it's in testing, inspection certification business, so that's basically around fire safety and security, water and air filtration and testing and so really a business business to business services business focused on premises and buildings, and it serves a lot of government departments in the UK, that National Health Service, the boots retail chain.
Walgreens boots, part of that business in the UK, and really across a whole range of sectors, so that's one side of the business that's about 60% of revenues and approximately the same in terms of the run rate EBITDA. Then the other side of the business is in the GRC, or governance risk and compliance, and that's really focused around people within businesses rather than the premises, so that's about 40 balancing about 40% of revenue and earnings.
What that really is focused on a number of key sub-sectors, so occupational health, HR compliance data management. Those kinds of middle and back office functions in businesses, and so I suppose initially Marlowe started out focused on the TIC or the testing inspection certification, and in more recent years, it's built up the GRC side of the business and focus maybe more on that, so I suppose at a very high level that's what the business does.
Why is it interesting? I suppose after this business was originally set up, it was initially a cash shell or like similar to I suppose what you call a SPAC in the us, and Lord Ashcroft backed it initially, and then hired the CEO Alex Daker at the age of 27 to lead this business, and this is really Dakers project, I suppose, in terms of from his previous roles in previous Ashcraft backed businesses, he spotted an opportunity for a roll up private equity type model, but focused on instead of traditional maintenance and service type.
Maintenance service type business, maybe focus more on business. I suppose, how would you describe it? Kind of more professional services type related business lines, so from a cash out in 2015 to today as I said, 580 million market cap, it was briefly, I think over a billion before the share price has declined, about by about 30% in the last twelve months, and that decline is unusual in that there's been no real negative news around the business, and when you think about it, they've hit their targets in terms of their target was to hit 500 million in run rate revenues, and a 100 million in run rate EBITDA by I think by 2024.
They did that. They've done that this year effectively, so they're on target produce very strong results, good organic growth, underlying organic growth of about 8 to 10% across the business in terms of revenues, and then obviously the headline growth because of the roll-up model is much higher. I think it's growing at a 38% revenue over the last 5 years, so they're doing what they said they would do, and yet the market, the public markets at least, it seems to fallen out of favor, and maybe part of that is maybe attributable to just UK equities are out of favor generally, they're unpopular.
This is also a small cap, so it's less liquid, there is I suppose on the one hand, there is high inside ownership, which is attractive in terms of between Alex Daker, the CEO and Ashcroft. They own about 18% of the company, but on the other hand maybe there's a question or perception of full shareholder alignment, potentially. I don't really see that because as I said a Ashcraft has a habit or a track record and making money.
I think based on previous experience that an exit, or a liquidity event of some kind is how he and the CEO will make make their money and monetize what they've built, so it is an interesting backstory or backdrop to that to the business, and I suppose, why is it interesting to me? I think for 2 reasons. Firstly, it's just fundamentally, it's cheap at the moment. It's as I said, it's down 30%, it's trading at about 9 times, LTM EBITDA, but that's really about 7 and a half times run rate EBITDA when you factor in the full year effect of recent acquisitions.
That compares to sixteen times LTM EBITDA for listed peers in the UK and in Europe, and that compares to an average of about twenty times EBITDA, that's Marlowe's own historic multiple over the last 5 years, and then similarly then, when you look at the private market, multiples for comparable assets. That those multiples are in the range of fifteen to thirty three times EBITDA, so at 7 and a half times the run rate EBITDA, this is just very cheap, and which seems odd just given that there's no negative news, there's no profit warnings, so that jumped out at me.
Then what really interests me in this is recently there's been media reports around management exploring the sale of the TIC business, which is as I said earlier 60% of the revenues, so when you think about that and what would that would be worth, that's probably worth north of 600 million pounds sterling, and that's even allowing for some cash leakage in terms of costs and taxes and so on, so 600 million for a little over half the business is more than the entire market cap of the whole business today, and the TIC business is the older part of the business.
Which they've been in since 2015 when they made their first acquisition, so it would make sense that maybe they would look to monetize that. Certainly if the public markets aren't really rewarding it in terms of what they've built to date, so they sell that business and you're effectively getting the GRC, or the governance compliance and risk business for free essentially, and that's a much higher margin business. Just to touch on that, the GRC segment, that's growing well, good 8, 9% organic growth, but 25 to 30% EBITDA margins compared to about 13, 14, 15% maybe EBITDA margins on the TIC segment.
It's growing nicely, but as much higher margins, and that's because there's a SaaS software component to it, and about approximately quarter of the revenues at the moment are SaaS related, and that's going to grow over time, so for me it's fundamentally cheap. What it's also a breakup event type situation as well where, this company could be sitting on its own market cap and cash in twelve months time or within the next twelve months, and then that also is the interesting follow on implication that, you leave behind the GRC business that's 200 million in run rate revenues.
That's probably too small to be publicly listed realistically, and so then you again, look at private market comps, at fifteen to thirty times or thirty three times EBITDA multiples, and there's been a lot of consolidation in that space. I could easily see them selling out of that business, as well at a nice multiple in time, so there's a couple of levers here for the value to be realized, so essentially the business is trading at a big discount not just to peers, but to its private market value, so I think in all likelihood, I would expect there to be some event within the next twelve months.
Interestingly, they put out a trading update recently, which was very, very brief and didn't mention the TIC segment at all. It only mentioned the GRC business, so I thought that was interesting. You compare that to the trading update around this time last year, and it was much more detailed, this was literally a couple of paragraphs, so I just thought that was interesting in terms of the relative silence in that update compared to what you would normally maybe expect.
Andrew: First, that was an incredibly... you went through just about every question I had on here, so you've put me to shame as the host, but I think there's some places that I can go there, so let's start with [inaudible], so you mentioned, hey, mid-June, 2023, so this year there's an article in Sky News, which is obviously a very reputable source that says, hey, Marlowe backed by Lord Ashcroft, you mentioned he is got a habit of making money, which my joke is when you said it, there are worse habits to have.
I'm always trying to kick my sugar habit. I think I'd rather have thev making money habit than the sugar habit, but it says Sky News, Lord Ashcroft Marlowe, they're looking to sell their biggest division for about 650 million pounds, as you said, that's more than the market cap, and that would cover just about all the debt, so you would be getting the remaining business, which is clearly valuable for free if they hit 650. The interesting line here is it says, Hey, exploratory talks have gotten underway in recent weeks. They're looking for sixteen times profit, and then there's a line that says insiders caution that a sale would only take place if bidders meet management expectations.
To me, you see that line and that's a warning. Hey, we are price sensitive, we are price disciplined. We know what we think we have here. We're not a desperate seller, but the counter to that would be, hey, you and I are talking in mid-September and there's been no update on the sale process, so look if they sell or not, doesn't change if the value's there, but obviously the catalyst isn't quite there if they're not going to sell, so do you think a sale is still in the cards here, or do you think...
Connor: Hey, Andrew, I don't know if you can hear me. I think the intranet is...
Andrew: Hey, I can hear you now. I think we had just a 2 second blip. Did, did you hear all of my question or should I just go back through it?
Connor: I didn't catch the last part just after the part...
Andrew: Okay, so we'll just go back there and I'll it to my editor, so my question was, look, it's been 3 months. They said we're going to be disciplined on pricing. Doesn't change if the value's there, but there is an interesting question, hey, if we haven't seen a sale now, doesn't mean a sale's not out there, and maybe management thinks this is sixteen times, but if you run a process and everyone says, hey, that's a ten, twelve times business, and you say sixteen, I'm not going to sell, maybe the value was really ten, twelve, so are you at all concerned that the sale process is long in the tooth here?
Not that that breaks the thesis, but it certainly changes the thesis if they're not going to sell, or if nobody was willing to bite on 16X?
Connor: Yeah, no, I thought that's fair in terms certainly, it's a bit like when a company announces a strategic review, the company themselves haven't announced anything here, but the market intelligence indicates that they are, they have an advisor who is engaged to try and sell this business, and they are open to selling it, so it's not like a live merger arb situation, but I think, and I have looked at situations before where a deal was announced, discussions were ongoing, and then the deal was pulled because financing wasn't available, or wasn't available on the right terms and so on.
Yeah, of course that's a risk here, but I think the incentives are there in terms of the duration of their investment, in terms of having built up this business. They have a private equity type mindset. I think the compensation structure in terms of the CEO and the nature of his compensation's way below market, he only really makes money if there's a liquidity event or a sale, and there's change of control provisions around some of his share options and so on, that would crystallize, so I think they're certainly incentivized to sell, so then obviously the thing is, but will the markets allow them to sell at the price, which I think is the point you're making, so I think certainly it's possible that a sale mightn't get done.
They might get bids of 10X or 12X and they're holding out fifteen. If that is the case, this business is valued at 7 and a half times, and its public appears today are trading well north of that, so on absolute terms, on relative terms, sorry, on an absolute terms, it is cheap and so there's still value there and they'll continue on with their roll-up model, and it'll be become a bigger platform company, one would think so I think, yeah, no to your question is is the catalyst at risk of breaking?
Yeah. Possibly, yeah, but I think you've got the secondary, I suppose support of the undervaluation there.
Andrew: Let me just quickly on the TIC, one of the things is, it's one of those quirky businesses where you see it and you look at the unit economics, like this is government regulated, that you have to have this, it's compliance and safety driven for the most part. Those are the type of things that are growing in the modern world. Compliance costs are going up, regulate... not only growing, but they're mandatory. You have to do them, and you see this in their results.
I was reading their Q4 call, and I didn't get quite all the way through it, but most of their 2023 capital markets, and the thing they keep stressing is, look, if you look at us on net revenue retention, we're over a 100%. People don't exit these services. In fact, one of the great reasons for a roll-up is it people actually increase and we can upsell them, and all that sort of stuff. Yeah, so that's a great, I don't know where I was going at that point. I'll put that aside if I can remember it.
Oh, here's where I was going. Is there really active, because they're so quirky, it's not like in the US where I can say, 'Hey, this is a really hot space. The last 4 public companies here have gotten taken out here's what it looks like." It's quirkier than most of the takeouts are like smaller bolt-ons. Is there a really active space? Who do you think the bidders are for this? Is it just a private equity firm leveraging it up? And we'll talk leverage in a second. Is there a strategic bidder that would make sense? How do you think about that?
Conor: Yeah, there is a mix, so on the TIC side, when I look at this business, and as my background is in private equity, and when I look at this business, this seems it's an ideal candidate for a mid-market private equity takeout, and so there's a couple of features to the business that lead me to that conclusion. I suppose you mentioned there the retention rate, so on a headline basis, 85% recurring revenues across the business, it's not over leveraged. They maintain 2 times the target leverage is around 2 times net debt EBITDA.
They've consistently maintained that over a long period of time, so it's not massively over leveraged. On an underlying basis, and we can get into this now, it does generate cash-flow. The perception is that it doesn't, which is one of the main bear arguments, and we get into that after, but when you look at the profile of the business, it's resilient. It's recession resilience, certainly in terms of it provides business critical or essential services, and that's shown in the recurring revenue nature.
The contracted revenue profile in terms of there's multi-year contracts with a lot of its customers, governments, large corporates, small companies, across the whole landscape of customer types, and I suppose the real interesting thing about this as well is that regulation and compliance, as you indicated, is getting more and more onerous, and so it's not like a lot of these companies can opt out. If you run a property business or a development business, or you're a landlord of any description, your fire exits, all that stuff has to be certified.
There's no way out of that, and that's true. That's just one example, but that's true across, air ventilation, water filtration, all that stuff. That all that stuff has to be tested by law. It's legally or mandated by regulations, so those revenue lines are revenue streams are not going to dry up, and so in that sense, it's a very bankable or credit worthy type of business for a private equity acquirer, and also then I suppose the runway to growth it's a buy and build or a serial acquisition, so it is plenty of room to bolt on further acquisitions.
Then the other thing I suppose as well is that overall, and so across the overall business, not just the TIC segment, but management estimate they occupy about 5% of the total addressable UK market across the 6 particular sub-sectors that they're focused on, so the average ticket size on their acquisitions over the last 8 years is about 8 million pounds sterling, some of these they bought some businesses for 130 million and they bought others for less than 10 million, but the average ticket size is about 8 million.
There's a lot of very easy Bolton opportunities for this, and then it's just a multiple arbitrage play where you're buying small, small Boltons for 4 or 5, 6X and then you look at in the public markets, businesses like this, and Marlowe itself, historically has been valued at north of 15X, so...
Andrew: That is always a tough one for me because I do hear it, but it's just tough. There is value. We'll probably talk about this more in the risk section. There is no doubt there's value created like hat they said, I'm doing this roughly for math, that they said, hey, in 2022, the average acquisition we did was 7 times EBITDA pres synergies, and then after synergies and integration and stuff it was 5 and a half times EBITDA or something.
There's no doubt you're creating value by taking out, if you do the math there, you take out 20% ish of the cost base and just synergies. There's no doubt you're creating value there, but I always hate it. Maybe I'm just being too much of a stickler, but I always hate it when you say, "Oh, this company trades twelve times on the public markets and they're buying private market peers at 6 times, and the moment they do that, the thing they just bought for six is worth 12, so it's just tough because part of the reason it trades at sixteen times is they think you can go out and create like that synergy value.
I don't know, it's tough. I always get confused by the [inaudible]
Connor: It's not so much, I think it's not so much that what they just bought, the small boolton on goes from being worth 5 to 15X. It's the overall platform that, that is Marlow itself is what is worth more than a low single digit multiple, and it's the scale. As you said that the opportunity for synergies further growth, and what they can do with a small bolton relative to that small bolt on acquisition continuing on a standalone basis is, that's the value, that's what drives, that's what should warrant over time a higher multiple.
Andrew:This does come back to they talk about, hey, we buy things and not only do we take the costs out, but their organic growth accelerates once they come on us, because either we cross sell their regulatory compliance products to our customer base, or we go into their customer base and start cross-selling them onto our stuff, so, yeah, I hear you. One more thing, and then I want to turn into the bear thesis. 'cause there is a loud and passionate, I would say bear thesis, as you saw when I tweeted this out, or I've seen it in other places, but one last thing we mentioned management incentives.
I love businesses. I've dealt with so many businesses where management teams don't own any stock. The board doesn't own any stock, and I don't even know. I used to think incompetence or that they were shady, and sometimes that happens, but a lot of times what happens is, hey, I'm making $200,000 per year as a board member at this company. I own $4,000 worth of stock. If there's option A, which sells the company and get shareholders a nice premium or option B.
Which maybe doesn't create tons of value, but I keep collecting that $200,000. I can always convince myself that option A will be there in a year, right? And option B is better for me, so, but management incentives, nice thing here is Lord Ashcroft owns a nice chunk. There's this really interesting management incentive plan in place based on TSR, which I think is actually controversial. People would laugh it up in the US but in the UK I think it might be a little controversial, so do you want to speak to management ownership, the incentive plan and all of that?
Connor: Yeah, well, I think, again, coming back to the management, so the incentive relative to the catalyst here and selling the business. That to me, it's rare that you see a CEO happy to have a salary that's 50% roughly below his peers salary, and when you look at the value that they've created, that's even more striking. I think I wrote this up in my newsletter and I put a chart in where I showed the performance of Marlowe since, Alex Daker became the CEO and plotted that share price performance against a lot of some well-known serial acquires, Alma, PLC, DCC and a few other well-known names.
Marlowe has outperformed all of them, I think a Accumilative return is something like 300%, which is more than Halma[?] for example, has returned, over that same time period, so, he has created value. He has an argent to say, I should be paid, , top rate or top market rate salary, and he's not, so there's a reason he is not, and it's because he sees his return not through very generous incentive plans, or paying himself massive salary, but through creating value and then creating an event or liquidity event, and that's why he has a number of different share options incentives, which crystallize on a change of control, some of them, not all of them, but a good chunk of them do, so I think...
Andrew: He's got those, and then he's also part of him in the whole senior management team, if I'm remembering this correctly, they get 10% of total shareholder return over a 10% hurdle by April, 2026, so that means the stock price, as we speak, you and I are speaking, the stock is at like six six pence. Is it six pence? 606
Connor: Six pence, yeah.
Andrew: Six pence. Okay. It has to hit, 11.1 in order for him to get that return, and if he does, it is a massive, massive return, but, again, that's a CEO betting on himself. If shareholders win, I'm going to win huge. If shareholders break even or lose, I was way underpaid, and maybe deservedly so because shareholders broke even off, but I just love that setup because he can only get paid if shareholders get paid, and it creates a mini hard catalyst. Look, if we're in a great depression in 2025, 2026, he's not going to be able to sell this for 11 pounds or whatever, but if we're not, he's going to do everything he can to get the share price there.
If the stock's undervalued, that's buyback shares. If there's a creative sale to be done there, it's a creative sign, so I'm sure he's got that, April, 2026 date circled in his calendar of, hey, if we don't get the sale done now, let's circle back up in 2025 and get that sale done, so, yeah, I don't know anything else you want to say on management center?
Connor: Yeah, and I think just the price, the about 11 pounds of share benchmark there, or price that you mentioned. That's in and around where maybe what I'd call or considered the fundamental value of this business to be. I think my own numbers, the breakup value of the business, if you just look at private market comps and apply that to this business, it's north of 12 pounds a share, and then similarly, if could take a slightly more conservative, view and assume they sell TIC, and then the remaining GRC business stays public and re-rate to 10X on run rate earnings from where it is today.
It's just short of about 10 pounds of share on that basis on my my numbers, so I think, 10 to 12 pounds of share is where I think the fundamental value of this business is based on looking at a number of ways, so I think management have that same view as well in terms of where the value is.
Andrew: I'll just to hop on there, and I'll include a link to the write-up in the show notes, so people can go click subscribe if they want to see the whole thing, but again, the stock is at 6 pounds.
You come at it a lot of different ways, but basically every way you come at it centers around the 10 to 12 pound fair value. That's also11 pounds by April, 2026 is where this management team gets paid, so if you think about that, A, they're showing you where they think fair value can get to, and B April, 2026 is 2 and a half years from now, so there's another 2 and a half years of compounding to get the stock in the fair value over and above that if you don't sell today or something.
Very interested. Let's go to the Bear case again I saw your write-up, I had one other friend who's a very sharp friend who I asked some questions about on the pod who's involved. Actually, you receive it off. I told him you were coming on, and he was like, "Oh, I'm actually flying to London tomorrow, tomorrow to talk to Marlowe." He was going there, but there's a very active and vocal bear case here, and there's actually like probably 7 different parts or 7 different theories to the bear case, but the main one would be look at this company, you have a roll-up with huge adjusted earnings.
Huge adjustments on the earnings because their adjustments are for, we're buying something, we're integrating it, obviously we're firing people, doing changes and everything, those are one-time costs allegedly, but the Bear case says, look at the huge adjustments, huge adjustments, and they just always keep coming. That's part one, and part 2 is, but in part because of those huge adjustments, but also because of working capital and stuff, this roll-up has never really generated any cash flow.
When you take huge adjusted earnings plus no cash flow in a roll-up story, that is how every roll-up that I've ever seen blow up blows up, and when roll-ups are good, you get the Danaher long-term compounders just in incredible returns. Everybody worships at their feet when roll-ups are bad, you get the valiant. Which blows us back to accurately, and everybody says, hey, look how aggressive the accounting was. How could anyone have been invested that thing? So I believe some of the directors here were involved in roll-ups in some way, shape, or form, that had a similar issue.
Where working capital was always getting adjusted, it never generated cash flow and the business blew up, so how did you address or get comfortable with those bare thesises?
Connor: Yeah, so yeah, pretty much the whole bear case on this stock is that you either you have to believe management's adjusted numbers to get comfortable, or to believe in the story, because otherwise, when you look at EBITDA down to free cash flow, it doesn't really generate any cash, and I suppose the way I'd look at it, you have to look at where the business is currently, so looking at, take the FY23 numbers where it's hitting a 1000 million or 95 to a 100 million in run rate EBITDA, and that's translated to I think it's about... sorry, 83 million.
Not on a run rate, but on the reported adjusted EBITDA number, and that flows through to about 6 million of free cash flow to equity, so people look at that and say, "This business isn't generating any cash." And so what's happening there? This is actually a very working capital life business, so there's no quirky accounting around working capital, really, the CapEx pretty light about 16 million on 84 million of EBITDA. You've got lease payments, taxes interest, and then you've got about 25 million of acquisition and restructuring costs.
Really a lot of the leakage is coming through the costs of operating a roll-up business model, and so I suppose that's what people should remember as well. You'd go back and look at Halma[?] and look at their accounts over the years, and the EBITDA to free cash flow to equity conversion is pretty low at times as well. When you look at how they've built, so Halma[?] is a great track record. It's a great business, Marlowe is much smaller, it's much earlier in its only about 8 years old, and so it's still in that earlier stage, but how I got comfortable with is if you're looking at this business, if they stopped the roll-up model today.
Say they've hit 500 million in revenues, that's a very strong level in 8 years to hit that revenue a 100 million run rate EBITDA, if they just stopped and ran the business for cash, the cash flow underlying cash flow profile starts to look very different. When you look over the way they in incur restructuring costs, what are they for? That's really for integration, software integration migration of software, and IT systems onto their platform and they buy a business and they're buying lots of small little businesses and boating them on.
There is some cost involved in doing that until they get everything transferred over. There's a lot of duplication of roles and staff, and obviously there's redundancy programs then to rationalize workforce numbers, so when you look at the numbers those restructuring costs typically last twelve to eighteen months maybe. They fall away after 2 years at most, really, so you think about if they ran this business for cash that 84 million in EBITDA, actually are that that 84 million EBITDA that break initially looks like 6 million free cash, so you add back those restructuring costs to look at it on a stabilized basis.
Assume no growth, and you've got 30 million of free cash-flow, now that's a 6% free cash-flow equity yield, but then now then you look at on a run rate basis today, where it's at a 100 million when you factor in the Boltons that they completed over the course of last year, so you've got a 100 million EBITDA CapEx is still the same. It's not like they invest a massive amount in maintenance CapEx, simply working capital life, so you've just got interest and lease payments, which are not huge. Lease payments are 11 million a year, so on my numbers, the a 100 million converts to, on a stabilized basis to about 43 million of free cash flow to equity.
That's more like an 8%, free cash flow to equity yield, and then you look at the businesses growing organically at 8 to 10%, , and on a run rate basis, iit's hitting, 19 20% EBITDA margins, , and so on a 43 million of free cash flow on a 100 million EBITDA, that's 43% conversion, so then I looked, compare that to someone like Halma, Halma last year, their free cash conversion, you factor in that they capitalize development costs, they have pension costs that they have to pay, they've similarly lease payments and so on.
Halma's conversion was about 41%, I think, or 42%, so they're not way off, other more established, platform companies, so when you look at it on that basis, I think it's not as bearish or as negative as people think, or as it's perceived to be.
Andrew: If I can just, yes, Andrew, so I don't have a position here though. I might in the near future, but if I can suggest one thing you can go look is look depths of COVID, they pretty much stop acquisitions for a while. They shut the machine down because COVID, and if you go look at their EBITDA, then yes, there are still add-backs, but the cash-flow is much stronger and the add-backs are much lower, because that's what you would expect.
We stopped the acquisition machines, so we don't have these integration expenses. If they're truly 1 time it should come down and guess what? They come down, so I would just say yes Andrew there, and you were alluding to it, but the back half of the fiscal year, 2023, which they just reported, their fiscal year ends in March, so it's already done, but the back half, they generated huge amounts of cash-flow, and again, that's because they did some big acquisitions in calendar year late 2021, early 2022.
Had the integration expenses, but then by the back half of the calendar year 2022, early 2023, those had rolled off. They didn't do similar sizes, so you start to see the cash-flow really starts pouring, so again, I don't think it's my personal opinion, I don't think it's a 100% settled, but when you combine the 2020 numbers was the back half of fiscal year 2023, I think you've got really good signs that they're not lying to you.
This will be a great cash-flow generative business. The other thing, and I'll just let you comment on this....
Connor: Yeah, sorry, just to finish off on that point, on the cash. I think a lot of people will look at this that see to mention of adjusted number is they look at the cash-flow, on a headline basis and say, okay, I can't see where, how this is translating earnings to cash-flow, and it goes into the 2 hard pile and they don't want to do too much digging...
Andrew: A funny thing my friend said is he said, "Look, this is a UK listed company and if you look, their leverage like sits right around 2 and every time it ticks up a little bit above 2 for any reason, shareholders freak out and there's these big adjusted numbers and UK investors just like won't give them any credit." And my friend was laughing because he's like, look, if this was a US listed business, their shareholders would be ready to set the company on buyer because they'd be like, you have a steady cash flow generative bolt on roll-up business like this needs to be 4X levered tomorrow.
What are you doing? Start paying the dividend or start buying back yours or get way more aggressive rolling up because you are not levered enough, and he thinks the add backs would be looked on much more favorably in the US, which honestly I think he's probably right on both counts, but it's just funny. I know geography is destiny, UK investors more conservative, don't like the add-backs, don't like the leverage, and because of that Marlowe's running around those targets, which again might be an argent, hey maybe this should be private.
I personally think this should probably be 3 and a half times levered, and they should definitely keep doing the acquisitions and maybe be a better target as a private equity owned company.
Connor: Yeah, when you look at the emergence of private credit now as well, I think this again, I mentioned earlier, I think this falls into that I think sweet spot for a middle market private equity with a private credit lender providing the debt, and I think it works. I think it would work well in that type of... again, especially given the resilience of recurring nature of the revenues and cash flows.
Andrew: Let me lob up a softball to you. You know, I would just encourage anybody who's interested in the thing to go look at the 2023 investor debt. I think it's like if you were interested in compounders roll up stories, it's a little bit like value investor porn, where they've got the great slide, one of those famous capital allocation slide. Like here's our free cash flow. Is leverage too high? Yes, cash flow goes to paying down leverage is leverage too low, is leverage too high, no cash-flow goes to organic gross above our ROIC or M&A.
If we can't find any of those, any excess goes to share buybacks or dividends, and then it's got all other stuff on how good the acquisitions are. It really is like if you publish it here, there would be like twenty five Twitter accounts dedicated to just talking about how great it is, so it's softball, but I do want to ask like capital allocation. All right, the merger story's great, it provided you believe it, which I think you do. I do. We haven't seen the share repurchases yet. We haven't really seen the dividends yet.
How are you thinking about free cash flow and the story going forward? Because leverage is it at that magical 2X number especially with growth, they don't need to pay down debt anymore.
Connor: No, they don't, the debt is very manageable, and so they could, and yeah I think you're right. If this was a US business, it probably would lever up more and there would be more scope for it to do that. Management I think are reasonably conservative in that sense, so in terms of capital returns, again, earlier in its life than maybe other better known larger roll-ups, it's still in that growth phase. I think they're on a mission to build it to a scale and then monetize it through an exit presumably, and I think that that 500 million in run rate revenues, a 100 million in run rate EBITDA, which they're at now, which was their target for next year, that seems to be now... my sense is they're at that level now where there's an event of some kind.
If they sell TIC rather than the whole business, they're going to be sitting on a pile of cash and that provides them with the scope to do a big buyback special distribution, or something like that because they're not going to sit on a huge cash pilot. It's either that or they buy another similar sized business in GRC, but I think when you look at the GRC space, they're more likely to be acquired rather than be an acquirer because of just because of the relative size, and...
Andrew: It's the beautiful thing about having a major shareholder who as you said has a habit of making funny money, and a CEO who gets paid if the stock price goes up, right? They get a lot of cash flow in. The worst thing in the world for them to do would be to just sit on the balance sheet. It needs to go back to shareholders because if it sits on the balance sheet, guess what? That harms your TSR it's a drag on your returns.
You're not going to get paid it off on that big TSR thing, so go buy something at GRC and again, you get paid on the stock price, so any deal you do at least management's going to strongly believe that it's very, very accretive to value, or get it all back to shareholder. Let's get a question just on business quality. We've talked about business quality retention here, especially on the TIC side, which is the fire safety and security and water and hygiene side.
My understanding is the roll-up, it works not just because you're buying another smaller player and putting on the platform like that is why it works, but these are very route density local Modi businesses, where, hey, if you're doing the fire and compliance for 1 warehouse here, yeah, okay, cool, that's great, but if there are twenty warehouses there and you can get all twenty, you can really leverage the fixed cost and, 1 inspector or 1 service technician can do all twenty on one stop.
Which really leverages the fixed cost. I'm I thinking about that, right or is that just completely off?
Connor: Yeah, so no, you're right, so that's essentially like cross-selling service, and that's something they highlight or flag as part of the organic growth opportunity, so there's 2 aspects to the growth prospects of this business. One is just the market growth because of regulation and compliance standards that's just growing, and it's just mandated, so that's 4, 5% growth rate, and then additionally there's probably a similar level of growth again from the root density approach.
Or the cross selling whereby we're doing your fire and your security compliance work, we should probably do your error as well across your entire state, not just a particular premises, and I think that that is a big component of how they grow organically a similar Rentokil[?] and other businesses, service business like that have a similar approach in terms of that route density approach, so it's the same principle here in terms of you get the account and then you go out across the estate, in terms of across all the warehouses or all the factories, or office blocks or whatever.
Andrew: I just wanted to make sure we hit on that, it's easy to say, "Oh, this business is worth fifteen times good returns." But it there a lot of times all the time, the business worth fifteen times, not just because on an Excel sheet, it's got financial characteristics, but there's an underlying business reason why those financial characteristics look so good, and local route density.
Anyone who's familiar with waste hauling, anyone who's familiar with.. it's one of the best moats because once you get that local route density here, it's not going to be a 100% incremental margins like it would for some of those businesses, but it's very high margin, and if you've got twenty warehouses and the 21st gets built, or just a random guys looking to take one on, you're going to have a much better pricing.
It's a really nice moat that's very difficult to end. I've mentioned the capital, I've mentioned the investor deck. Again, I'd encourage anyone who's interested to go look at it. I'm looking at slide seventeen, it is just such value investor I call it porn because slide seventeen, consistent and resilient history of organic growth, it starts at 5% and by FY23 it's up to 10%. Anytime you've got something growing organically in the high single digits, you love that.
Consistent EBITDA margin enhancement, all this sort of stuff. It's just what you want to see as investor. Let me ask another question. I've talked partially, we talked about the bear case, which is the roll up and accounting, cash flow, add-back, red flags. If we just put a aside the, hey, I don't trust the numbers. I think this blows up spectacularly. I never used the f word on here, but it's fraud like is what some people might say. If we put that piece aside, what worries you the most about this business? Because you've got great revenue retention, you've got secular trends.
What worries you the most? Is it most of the revenue is London based, so you're just worried if London is just a general mess forever or sorry, I said London. English based, or is there other worries that you have with this business?
Connor: No, I don't think that's an issue. They've got I think about fifty thousand customers across the whole business, so it's pretty well diversified across the whole UK market, so I think, think that's a positive. I think the main risks in terms of my particular thesis on this, the main risk is the catalyst as in the breakup or the sale event doesn't occur, but I think as I said earlier, fundamentally it's a good business. It's resilient, it is positive investment attributes and it's cheap.
I think there's some support and downside protection in that. I think the big risk really is around I suppose capital allocation, a bad acquisition is one poorly executed M&A, but they've been at this eight years and it's hard to see how they would make a really bad acquisition or bot it, especially, they're not trying to buy, and their model it's a roll up, so they're not trying to buy companies larger than themselves, and it's not buyer buying Monsanto or that stuff where it's just totally a totally different combination.
I think capital allocations is an obvious risk, but then when you look at the track record and their approach, and they have a very, very clear defined framework in terms of what types of businesses they buy, how they fish, how they manage them and how they integrate them, so I actually think the probability of that blowing up the business is pretty low, so then the other one then obviously in terms of the capital stack and how it finance itself.
Leverage, I don't really see as an issue because they've shown that they're pretty conserved on that, so that just leaves the equity side, and so how they funded acquisitions to date is if they're small boons for 10 or 20 million, that's comes out of cash-flow and existing internal resources, but for bigger acquisitions time to time they do equity placings, and that's I think about 80% of the capital deployed and acquisitions over the last 5 years, have been through new equity placin.
Dilution risk then is obviously what you would think would be a risk there, that's 1, but then you look at how, again, it goes back to the track records. They've raised money in the past. The largest placing they did was a couple of years ago for an occupational health business about 130 million share placing, which funded pretty much nearly all the whole consideration, and that was what they refer to as a platform acquisition rather than a bolt-on acquisition, just larger, but that acquisition's working out really well. That's in a really good growth area or good growth sector, so...
Andrew: It comes back to hey, you've got a management team who made your shareholder history of making money, owns a lot of the stock, his exit is clearly going to be a sale. He clearly wants to sell at some point and realize money. My opinion, but I think that's what Distracter. Got a CEO who's very share price incentivized. Look, if they're going to issue stock, I don't think they issue stock today at the current price, but you just hope, like, if it's one of the companies I talked about earlier where the each board member's getting $200,000 per year, and they own $4,000 worth of stock.
They'd probably issue stock just to grow the business because they don't really care, but if you've got a CEO and major shareholders who are very incentivized to get the share price higher if they're issuing stock, look, people can be wrong. People can make sense, but people can make mistakes, but you have to think they're doing it because they see a path to a higher stock, or they see a lot of value in the deal. Yeah, go ahead. Go ahead.
Connor: Sorry, I was just going to just touch on that point now. They're not going to offer stock at this price level, the last time they offer issued stock was at 9, 10 pounds a share or something like that, so that's the level where they have issued stock in the past, and that's to complete strategic commercially sensible acquisitions, so I suspect what we'll see now is that if the share price is languishing where it's at and the market doesn't care about a potential sale or liquidity event, and they've hit that 500 million revenue, a 100 million EBITDA threshold.
You're probably going to see them run it more for cash-flow purposes, because if that's what the market wants to see, well then maybe that's what's going to drive a re-rating and time absent, a sale event or some other transformative acquisition or something, so yeah I think at the current share price, you're not going to see any dilution, it just wouldn't make sense.
Andrew: Last question I'm going to ask you, and then we're running long and I'll let you go, so look, again, people know I had you on the first time I had you on, again, I'm an active subscriber. I really enjoy your subscription service. Also because of that, I've read all your ideas and I know like you are a big believer in inflation being sticky or higher than normal, and a lot of your ideas have centered around. I don't want to pitch them all, but they've centered around that idea. You and I share a AMLP royalty play that gets, a natural gas prices as they go higher.
I won't share it, but we've looked at that pond. You've shared a lot of ideas that benefit or take the idea of stickier higher inflation. Now this is a good business with great recurring revenue characteristics. If you believe the numbers cash-flow comes in, these types of businesses tend to do well in any environment, but a lot of your investments have centered on that core thesis, so I just want to ask this is a little bit different. It does speak to your history as a value investor. It's very private equity ish, but it's different than a lot of your other things.
What attracted you, obviously there's a catalyst here, but how does this fit into your overall framework? That's a little bit of a different question I did, but when your service recommends like 8 plays that have higher inflation, higher commodities, that type of stuff invested, and then this 1 play that is great business private equity characteristics, catalyst driven, just struck me as interesting. How did it fit into your worldview?
Conor: Yeah, well, I suppose I didn't deliberately go out of my way to just focus on energy or commodity, because the way I view the world now, and I'm not a macro analysts, but I think you have to think about the backdrop, and my view of the world is that I think it's not going to be 10% inflation, but it's not going to be 1 point a half percent inflation like it was in the last cycle. I think realistically it's probably more 3 or 4% probably inflation, so that's still a multiple of the old world inflation levels.
In this cycle, I think what I would call real assets and that, and within that I'd include not just energy or commodities, or I even think certain real estate selected real estate companies and types of assets will do well, but I think real companies are a type of real asset, and that's companies that like the likes of Marlowe, that service real businesses in the real economy and provide essential mandated services that pricing will probably track inflation, and I think the last cycle, it was all things tech facilitated by low interest rates and the promise of growth over everything else.
I think this cycle is more about what really less so about apps, and more so about real assets and essential, materials and assets for the economy and society, so I think that fits in.
Andrew: I hear you on all that. I have a lot of energy exposure on, and for me, it's not that I have any type of macro views on oil going to fifty or oil going to two hundred or something. A lot of it is, I just look at it and I say like, okay, let's pick a break[?]. Oil is at 95 as you and I speak right now, I can find a lot of commodity companies where I look at the stock price, I'm like, hey, the stock price implies that oil is at 70 currently, and obviously there's a curve in everything.
I think the stock price implies oil prices and energy prices 30% below the curve, and I feel like I'm getting a margin of safety where if energy prices stay here, they're going to make so much money almost nothing else matters, and if any energy prices go down, then they turned out to be fairly valued, so the curve was wrong, but the stock prices was right, but I'm not going to lose money, and it feels like investors are either they've just been burnt by energy so much they don't want to invest in it, or they're applying massive, massive corporate governance management incentive, capital allocation discounts.
I hear all that, but it's really big. It's really big. Oil, as you and I speak over the past couple months, it's gone from Brent high seventies to mid nineties, and if you look at any energy prices, it is implying absolutely none of that. Or look at Tidewater, which I did, one of my favorite podcasts was at Tidewater CEO on, and that stock's done incredibly, but if you look at where day rates are and where energy prices are, it's like, hey, the stock, it's done really well, but it is somewhat levered and the day rates have gone up more than stock.
It just feels like you're getting a really big margin of safety there, and as you said, like so much investment, it's really easy to go underwrite the next Facebook killer. Not a lot of people have been thrown into, hey, Tidewater offshore vessels, let's go build some new ones. No one has, so if prices stay here, you could imagine a lot of services or energy could go a little bit parabolic. I don't know, it just feels interesting risk reward to me.
Conor: Yeah, no, and I think on that as well, it also happens that a lot of these, what I again would call real asset companies are, are cheap, and the multiples are low and, twelve months ago people were saying, "Oh, the multiples are low 'cause they're over earning and commodities are going to roll over and everything's going to collapse." And that was the thinking for a couple of months despite what we knew about the energy and commodity landscape particularly post Ukraine, and what's going on there in terms of how that's disrupted the supply of everything really.
I think when you think about things like onshoring and disrupted supply, resource nationalism, demand is still growing, urbanization is increasing, and we were supposed to be at the age of peak oil, and yet oil demand has gone up this year exceeded 2019 peak, so I think it's reasonable to assume that oil and other commodities and materials demand is not really going to collapse for the many times, so I don't think oil... and who knows really. Oil could do and oil could go negative again, who knows, but I think over a medium term reasonable time-frame.
It's unlikely that demand is going to create, or prices for these materials or commodities are going to collapse. Something like in the fertilizer space is really interesting as well at the moment in terms of what's happening there, that related to energy and I just think the world has changed, and I think that has implications and this year has actually been a good example of this. People assume that, "Oh, it's just going to go back now to the previous cycle before COVID and tech is where it is." And you look at what the winning trade this year as you plot the XLE and ours just reversed.
Andrew: Well, I think the winning trade this year was YOLO long Tesla options maybe, but I don't know. No, I definitely hear all that. The one thing I do get into debates because I hear a lot of people saying energy policy's crazy, and I get it. I'd love to have more nuclear. I think we should have started nuclear 30 years ago. I'd love to see some more drilling, I understand environmental concerns, but oils at 90, I think a lot of people in the world really benefit from cheaper oil today, all that stuff, but the one thing with inflation and the higher [inaudible]
That has generally been a bad bet. I remember in 2014 when oil was a hundred, I had friends, very smart friends who managed tons of money who were like, "We've underwritten the entire world. Oil supply oil can never go below 70 again, and we've underwritten all of our investments to be in the money as long as oil's over 60, these are the best investment we ever make." Eighteen months later, oil's in the 40s. It's just, I never want to bet against human general. Anyway, let me give you last thoughts.
You can comment there, you comment Marlowe, anything you want to talk about before I need to wrap this up, and get some other stuff done as well.
Conor: Yeah, no, I think, just thanks for having me on the podcast. Really enjoy the discussion as I have the previous ones and yeah, I think Marlowe's a a really interesting situation. I think there's going to be more news ahead, on it and I think it's just one of a number of really interesting, names in the UK market at the moment. UK equities are really neglected.
Andrew: I think UK is one of the most interesting markets right now because it's just so shelled out in the multiples, and some of these. Again, I think if Marlowe, if it was all US revenue trading in the US I it would trade 50% higher. It would trade for a 50% higher multiple, which would actually be higher stock price. I think the UK is so interesting right now. It's so shelled out. People are so desperate over there, but that will be a conversation for another time. Conor, I am distraught that it took so long to have you on for the second time, but UK is super interesting.
You're doing great work. We'll have to have you on for the third time in the very near future. I'll include a link to the Marlowe right up in the show notes, and looking forward to the third time.
Conor: That's great. Yeah, look forward to that and we'll speak again soon. Thanks Andrew.
Andrew: Thanks man.