Water Intelligence - The Long Story

Thursday, Jun 22 2017 by
41

Water Intelligence (LON:WATR) came to the Aim market in 2010, through a reverse takeover of Qonnectis plc. Its principle asset is the American Leak Detection (ALD) business, which it operates on both a franchisee and corporate-owned basis.

Background

As described in the 2010 prospectus:

http://www.waterintelligence.c...

“ALD focusses on the accurate, non-destructive detection of all types of leaks including hidden water and sewer leaks, together with repair and other related services. ALD’s service technicians utilise proprietary training and specialist equipment such as infrared cameras and acoustic devices to pinpoint leaks, employing less invasive methods to find the source of the leak compared to breaking or drilling holes in walls and floors. Because leaking water can travel along water lines or leaks may be pinhole size along a water pipe, in many instances, ALD’s service offerings have the potential to reduce the repair costs for the consumer compared with typical plumbing solutions as they do not rely on a “trial-and-error” method of exposing whole sections of pipes to detect leaks”.

Also taken from the prospectus:

“[ALD] believes that its competitive advantages include its full range of service offerings, its brand and over 30 years of experience, the specialised equipment it uses, the training it provides its franchise owners and technicians working from business run directly by ALD, its marketing system and the key relationships it has with channel partners such as insurance and restoration companies. For certain segments of its business, ALD may face competition from others, including independent plumbers, repair services, other leak detection companies and services”.

“[ALD] is aware of certain other companies or businesses that offer leak detection services. However, as far as it is aware, these businesses tend to be small owner-run operations without the franchise or branding presence of ALD”.

The Franchisee Business

The ALD franchisee business is the core business of Water Intelligence.

ALD’s revenue model is principally derived from franchise royalties. Franchisees pay monthly royalties based on a percentage of gross monthly sales, ranging from 6% to 10%. It also derives revenue from the sale of new franchises and supplying its franchisees with revenue and equipment at a modest mark-up.

As of year-end 2016, ALD had 96 franchisees, the vast majority being in the USA. System-wide sales for 2016 were approximately $75m, generating franchise royalty income to the Group of $5.5m.

http://www.waterintelligence.c...

Franchise revenue is on an upwards trend, in spite of a reduction in franchise numbers as some have switched to being corporate-owned (more later). In fact, this trend has accelerated during the first four months of 2017, rising 7.7%, driven mainly by new national agreements with an insurance company and a pool management company.

http://www.investegate.co.uk/w...

However, what the market seems to have overlooked is the remarkable stability of this income stream, which has the characteristics of an index-linked annuity. This reliable, high margin business provides a remarkably strong foundation for the investment for growth going on elsewhere in the business.

594bce9cdffe8chart2.png

Corporate-owned Franchises

Water Intelligence has a strategy of selectively buying back franchisees in order to retain a greater share of the profits and to create regional hubs to support continued franchisee growth at a local level. During 2016, it increased corporate-owned franchises from six to ten and has added two more (one a start-up) so far during 2017.

The corporate-owned franchises are the major engine of revenue growth, rising 61% to $4.2m in 2016 and 60% in the first four months of 2017. Although much of this growth relates to the expansion of the network, it is also driven by organic growth after reacquisition.

International Businesses

Although ALD has operated various international franchisees for many years, during 2016 it took its international strategy a step further by buying businesses in Australia and the UK. The Australian business was a former franchisee but the British one, NRW, is a bigger company specialising in municipal work, most notably with Thames Water. NRW is now supporting corporate and franchise locations elsewhere to bid for and execute municipal jobs.

NRW contributed $0.5m of revenue during the first four months of 2017.

Financials

Only one broker – finnCap – covers Water Intelligence. For 2017 and 2018, finnCap forecasts revenues of $14.8m and $16.3m, respectively. These have not been updated in response to the very bullish message on revenue growth in the June trading statement. My own forecasts, which I do not consider aggressive, give $15.8m for 2017 and $17.2m for 2018.

The June trading statement indicated profits in line with expectations due to the costs associated with increased headcount and infrastructure to enable accelerated revenue growth. finnCap forecast net profits of $0.91m for 2017 and $1.11m for 2018. I am somewhat more conservative, at $0.78m and $0.84m, respectively.

Cash at end-April was $935k, which the company advised was “sufficient to execute its growth plan”. My projections do not suggest any cash flow strain is likely over the next two years.

Downsides

Besides the normal risks arising from any small cap investment, there are specific risks applying to Water Intelligence that should be taken into consideration.

Firstly, it is an overseas business listed on AIM. There are many unfortunate precedents in this regard that have cost UK investors a great deal of money. There are two factors that give me reassurance in this regard, however: (1) It is a US company, rather than Chinese, Malaysian or Greek; and (2) the reverse takeover of a complementary business at least gives a sensible reason for it ending up on AIM.

Secondly, Patrick DeSouza appears to have a potentially over-dominant role. He is Executive Chairman of Water Intelligence, contrary to governance best practice. He is also Chief Executive Officer of Plain Sight, a related party to Water Intelligence bringing clear potential for conflicts of interest. Finally, he is the largest shareholder, with 24.8%. He seems to be playing things straight thus far, however.

Valuation

Water Intelligence appears to be well-positioned to establish a dominant position in a fragmented market. It is showing excellent growth, driven both organically and by acquisition. It is already profitable and its growth ambitions are underpinned by the near guaranteed profitability of the franchisee business, I consider a PE ratio of 25 a perfectly reasonable target.

Taking my projected results and adjusting for debt, options, deferred considerations, amortised intangibles, FX, etc, I arrive at a valuation of 183.2p, which represents a premium of 38% to today’s price of 132.5p.

I consider Water Intelligence to be a STRONG BUY.

Declaration of Interest

I hold 65,000 shares at an average of 118.8p.

[EDIT - Now 103,985 at an average of 146.4p (October 2018)]


Filed Under: Stock Picks,

Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. The author may own shares in any companies discussed, all opinions are his/her own & are general/impersonal. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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Water Intelligence plc, formerly Qonnectis plc, provides leak detection and remediation services. The Company offers a range of solutions (including products) for residential, commercial and municipal customers. The Company's segments include Royalties from franchisees, Corporate-operated Stores and Other activities, including product and equipment sales. Its geographical segments include US and International. The Company mainly operates in the United States, with operations in the United Kingdom and certain other countries. The Company's subsidiaries include Qonnectis Group Limited (holding company of ALD International Limited), ALD International Limited, American Leak Detection Holding Corp. (holding company of ALD Inc.) and American Leak Detection, Inc. (ALD). ALD International Limited and ALD provides leak detection product and services. more »

LSE Price
272p
Change
-4.6%
Mkt Cap (£m)
41.4
P/E (fwd)
23.3
Yield (fwd)
n/a



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55 Posts on this Thread show/hide all

Effortless Cool 23rd Aug '18 36 of 55
3

sharmvr,

The trend on gross margins largely reflects the gradual transition from the franchise model to the corporate store model. As such, I expect it to continue, rather than reverse, but to be more than outweighed by the corresponding top line growth. Also admin expenses relative to turnover are already trending down, and I expect that to continue too, to the benefit of operating margins.

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sharmvr 24th Aug '18 37 of 55

In reply to post #393079

Thanks EC - certainly there should be operating leverage - understood at gross level - thanks for the feedback.
For anyone interested I was able to execute a (very) small buy at the offer price shown.

Get the impression market maker might be trying to flatten his book before month end

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Effortless Cool 7th Oct '18 38 of 55
5

I have now updated my forecasts to reflect the detail in the recent interim results. I have extended the modelling to a full valuation but, given the rapid growth of this company and the lack of history, do not present the results with any great conviction yet.

I do feel I have got a decent handle on revenue, however. I'm projecting $23.6m for 2018, versus the broker forecast of $21.7m. Now that finnCap have opened up their research to retail investors (thanks for the tip-off, Paul Scott), I am able to see the breakdown of the broker forecast by segment. To be honest, I think the finnCap figures are daft, with all segments except Corporate-owned stores projected to show lower revenues in 2018 H2 versus 2017 H2. All-in-all, I am confident of a beat for 2018. My 2019 revenue forecast is $26.0m (finnCap $24.4m).

My normalised EPS projections are 13.4c for 2018 and 18.3c for 2019. finnCap have 11.2c and 13.3c, respectively.

My valuation is 379p, based on an adjusted PE ratio of 25.5, which is the mean for shares classed as Speculative, Small Cap, High Flyer on Stockopedia.

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Housemartin2 8th Oct '18 39 of 55

Thanks EC as always for you updating

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Effortless Cool 9th Oct '18 40 of 55
2

Water Intelligence (LON:WATR) active again, buying up certain northwestern franchises to complete a nationwide network for its corporate-owned franchisees.

https://www.investegate.co.uk/water-intelligence--watr-/rns/reacquisition--of-portland/201810090700043465D/

The bought-back franchises generated $1.05m of revenue in 2017. That equates to a 10-15% increase in corporate-owned revenues. There will be a corresponding small (c. $100k) decrease in franchise royalty income. The $0.35m of profit these franchises produced in 2017 means this transaction will produce a material benefit to the bottom line. The announcement states it is immediately earnings-enhancing.

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Effortless Cool 14th Oct '18 41 of 55
1

Allowing for the Portland reacquisition and, at the same time, incorporating a couple of other small refinements to the model, has not made much difference to my valuation, which is now 378p. Of course, the price has collapsed since I last posted, so Water Intelligence (LON:WATR) has moved from 'Hold' to 'Buy' territory for me. I have put my money where my model is, and added another 4,951 shares on Friday.

The reacquisition definitely raises the probability of 2018 beating forecasts, since finnCap rather absurdly, haven't adjusted their 2018 figures to reflect it. I am now projecting 2018 revenue of $23.9m versus broker consensus of $21.7m (a 10% beat).

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Housemartin2 18th Oct '18 42 of 55

In reply to post #408449

Hi EC. In today's Telegraph under a picture and the 'Inventor with his device' is the caption 'You WU of MIT .... shortlisted for the James Dyson Award for his Lighthouse - a low-cost robot that can travel inside water pipes and find leaks before they grow into costly bursts'

Looking at it, it is only, in its prototype form, useable on large guage pipes but it seems to me to be the sort of tool that Water Intelligence (LON:WATR) would use. Would they not have something similar ? Given its an 'invention' perhaps not but I would have thought it was obvious.It says low cost which sounds exciting but who knows what this actually means in a real world scenario.

Nascent competing technology ?

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Effortless Cool 18th Oct '18 43 of 55

In reply to post #410099

Yes, interesting, but not necessarily competition. Potentially just another weapon in the Water Intelligence (LON:WATR) leak-finders arsenal.

http://uk.businessinsider.com/mit-grad-made-a-robot-to-detect-water-pipe-leaks-2018-9

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Housemartin2 19th Oct '18 44 of 55

In reply to post #410139

Potentially just another weapon in the Water Intelligence (LON:WATR) leak-finders arsenal.


Are you saying that this is something Water Intelligence (LON:WATR) already have ? Is the Australian  company Detection Services (who are trialling this technology) a company related to Water Intelligence ? If so I had missed that.

Detection within the pipe via suction changes seems a v good concept to me ( who is not an engineer)

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Effortless Cool 19th Oct '18 45 of 55
1

In reply to post #410304

No, what I meant is that Water Intelligence (LON:WATR) do not generally own the technology that they use. What they do is supply the skilled workforce that uses it to find leaks.

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Housemartin2 20th Oct '18 46 of 55

In reply to post #410319

Thanks EC. Understood

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Effortless Cool 4th Dec '18 47 of 55
3

A very good q3 trading update this morning, underpinning my forecasts. I have shaded up revenue forecasts to $24.4m for 2018 and $29.0m for 2019, with no change in my valuation (378p). FinnCap still lag with their revenue forecasts for both years.

Extremely happy with progress here.

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sharmvr 4th Dec '18 48 of 55
1

In reply to post #424568

Was waiting for an update to the article from you EC and defer to you on judgement here.
I would have thought they can break 25m if they can deliver same run rate as Q3 ($7m in Q3) with one further franchise acquired recently but I am a fuddy-duddy boring accountant and a huge fan of conservatism!
Also I like that margin is going in right direction. Also, having lived there a few months, I can say Australia take water conservation very seriously so certainly be a market open to their product. Will be watching for development in OZ because I think that will be a good marker for whether there is real value in their service or just another business.
I hold (not in same size as Mr Cool) - have considered topping up a few times and may well do if there is another bout of unexplained volatility, which given US, might be tmrw!

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Effortless Cool 4th Dec '18 49 of 55
1

In reply to post #424578

Hi sharmvr (spellcheck tries to change that to 'charmer', which is certainly snappier),

I'm pretty sure they won't reach $25m. Looking back to last year q4 was lower than q3 for franchise royalty income and I assume that corporate-owned stores will show the same underlying trend. I don't think that the addition of the Portland franchise for q4 will be enough to get them there.

I agree with you about Australia, and this is certainly something that Pat DeSouza seems to have picked up on at their convention, so hopefully we will see some significant progress there next year.

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sharmvr 5th Dec '18 50 of 55

In reply to post #424613

certainly been called worse!!

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Effortless Cool 5th Feb 51 of 55
1

An encouraging update from Water Intelligence (LON:WATR) this morning.
1.Buy-back of the Ontario franchise, adding $400k+ to 2019 revenue and establishing first presence in Canada.
2.Expansion of the franchise network with the sale of franchise territory in Youngstown, Ohio. Step in a strategy of expanding into greenfield locations to make the business more attractive to insurance partners with national coverage.
3.Financial support to the Idaho franchisee to accelerate addition of leak repair and municipal capabilities, beyond simple leak detection. The one-stop-shop solution again being attractive to insurance partners.
4.UK-developed diagnostic sewer technology being rolled out to the US franchise network.

The announcement also hints at a favourable 2018 q4 update, which is expected some time in the next few weeks. I'll wait for this announcement before updating my projections.

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Effortless Cool 17th Mar 52 of 55
2

An excellent q4 update from Water Intelligence (LON:WATR) on Tuesday.

  1. Revenue of $25.3m, ahead of broker (and my) forecast.
  2. PTP of $1.8m, ahead of broker (and my) forecast.
  3. Net cash of $2.6m, ahead of my forecast.
  4. Very bullish on start and outlook for 2019.

I've been slow updating as I have been trying to enhance my valuation model to take more accurate account of deferred payments on acquisitions. I'm not entirely happy with this yet, but it's almost there.

I am forecasting 2019 revenue of $28.7m, versus broker forecast (per Stockopedia) of $27.4m. My adjusted net profit of $2.7m is much higher than the broker's $2.2m. My net cash projection for end-2019 is $3.5m.

Note, however, that Stockopedia is showing the finnCap projections from finnCap who, I believe, have ceased coverage since Water Intelligence (LON:WATR) changed its NOMAD and broker from them to WH Ireland in January this year. WHI are providing coverage, but it is not directly available to PIs and, for some reason, is not being picked up in Stockopedia's consensus figures. I have flagged this with Stockopedia.

My revised valuation has increased from 378p to 406p, which is 35% above the current price of 300p.

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Effortless Cool 17th Mar 53 of 55
2

5c8e9d4cf037cPicture1.png

Here's the updated franchise royalty revenue history and projections. This 'index linked annuity-like' revenue stream is very high margin and offers robust downside protection.

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Graham Ford Mon 5:45pm 54 of 55
1

In reply to post #458783

Nice one EC.

I’m a bit puzzled at how remarkably consistent it is. I would have thought growth would be more variable. I’m also wondering what the influence of the franchise buy backs by corporate are on this. Wouldn’t that tend to make the growth less consistent?

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Effortless Cool Mon 6:55pm 55 of 55

In reply to post #459173


Hi Graham,

You make fair points. I guess Patisserie Holdings (LON:CAKE) has reminded people (for the first time since Madoff, perhaps) that consistency may be an indicator of fake numbers. I hasten to add that I do not believe that to be the case here.

The table below shows the development of half-yearly franchisee royalty income from 2012-2018, and also gives the growth rate against the prior equivalent half-year.

I have a few observations.

  1. Royalties are based on franchisee revenues and, thus, will be a lot more consistent than franchisee profits.
  2. The period covered does not include a recession, so consistency has not been tested in hard times.
  3. The royalties are paid by a multitude (approaching 100, I think) of franchisees. This, absent macro effects such as recession, will tend to produce a consistent flow of cash as individual successes or failures will have only marginal impact.
  4. The nature of these businesses, each involving many relatively small jobs, means revenue at individual franchisee level will generally be consistent and predictable.
  5. There has been a level of variability, with period-on-period growth ranging between 4% and 10%.
  6. The upward trend reflects: (a) growth in opportunities (e.g. more pools); (b) addition of new franchises; and (c) maturation of existing franchises. I suspect they have also grown market share.
  7. Reacquisition of franchisees does affect revenue in this segment, and I believe that is shown in the low growth in 2017 H2 and 2018 H1, when some larger franchisees were bought back in.
2012 H1 1 2,270  
2012 H2 2 2,076  
2013 H1 3 2,389 5%
2013 H2 4 2,221 7%
2014 H1 5 2,547 7%
2014 H2 6 2,370 7%
2015 H1 7 2,715 7%
2015 H2 8 2,506 6%
2016 H1 9 2,893 7%
2016 H2 10 2,650 6%
2017 H1 11 3,174 10%
2017 H2 12 2,751 4%
2018 H1 13 3,312 4%
2018 H2 14 3,001 9%

Monetary figures are in $k

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