Emeria - Aggressive - Positioning
All,
Please find our initiation of Emeria here.
Sometimes the equity story is better than the credit story and so it is with Emeria. The roll-up strategy makes sense and from a shareholder’s view should continue, but the business has taken a steeper decline since the rate hikes than the Organic Growth stats suggest. As a result, we see little chance that the fresh cash Emeria will need early next year will come from creditors and with another quarter of deterioration to go, we think the situation will get worse before the shareholders must step up.
Investment Rationale:
- We are now taking a 5% short position in the 3.375% SSNs at 81c/€. We see leverage continuing to rise and failing to fall below the Dec 23 mark by the end of the year - i.e. missing management guidance. But in particular, Q2 should see further deterioration on Q1 with little operational improvements to console investors. The company will have further drawn its RCF and the need for a near-term cash injection will become very apparent. However, we do not at this time foresee the sponsors to have come rushing with fresh cash themselves, which should lead to all notes trading off.
- While we do not believe Emeria deserves a 20x EBITDA multiple like the one its US counterpart FirstService is trading at, we think there is at least a little merit in the roll-up strategy and that the sponsors should feel very good reason to hold on to the business. It looks very unlikely they would lose it over this expansionary drive. So we anticipate rotating out of the SSN short into a SUN long in H2 of this year, although that will depend on how scared we are then because the SUNs have no way of defending themselves in any restructuring - should it ever come to that.
Next Catalyst:
- We see the Q224 reporting at the end of August as the next catalyst and don’t believe the sponsors would be trying to preempt that date with a generous cash injection.
- Leverage is likely to rise further in Q2 on further WC outflows, more M&A integration cost and Restructuring costs.
- Management believe the business to bottom out in H124 - about now - although more time is needed to be sure in hindsight when it has happened.
- We also expect management to draw the RCF significantly in Q2 to fund the outflows.
- We expect therefore the problems to be communicated in the Q224 reporting without the shareholder signalling any generosity yet.
- Emeria looks as though it requires fresh cash by Q125 at the latest.
Valuation:
- FirstService in the US are trading on a 20x EBITDA multiple. Like Emeria the company is an M&A roll-up.
- Emeria however, seems to generate insufficient "organic growth” to justify that same multiple, which is mostly dependent on the amount of M&A vs the size of the company in the first place.
- Emeria buy bolt-on acquisitions for just under 5x EBITDA, but then spend almost the same amount on M&A integration, restructuring and other one-offs to integrate these businesses. So the eventual cost is closer to 10x.
- Looking forward generously the business will make sufficient money to cover interest approx. 1.5x. However, we are concerned that this won’t be apparent in time for the cash need.
- The cash need is primarily a consequence of the aggressive growth strategy Partners Group and TA Associates are driving. For that reason and because we do see positive equity in the business we expect the sponsors to step in and address the situation at least temporarily.
Here to discuss with you,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk