Water Intelligence - The Long Story

Thursday, Jun 22 2017 by
40

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,

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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
277p
Change
-4.5%
Mkt Cap (£m)
44.2
P/E (fwd)
26.4
Yield (fwd)
n/a



  Is LON:WATR fundamentally strong or weak? Find out More »


50 Posts on this Thread show/hide all

Effortless Cool 17th Aug 31 of 50

Cheers, sharmvr.

As to what happened today, I blame Pete!

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mmarkkj777 17th Aug 32 of 50
1

Hello Effortless Cool.

A really good initial post if I may say so. Followed up with some interesting posts over the last 12 months (of which I have been oblivious to, unfortunately)!

It certainly seems a good company Water Intelligence (LON:WATR) and a good "keeper" as an investment. Agreed, the price is no longer value at a 40 odd multiple, but I like the model, especially the franchising with the buy-backs to operate as hubs. Additionally, most of the companies I have held that have done well in the longer term, ended up with a very high PEs (for example Fevertree, now over 70).

As a Johnny-come-lately, would it be really selfish of me to say the dip of 8.5% today has presented a bit of a buying window for newcomers :-)

Thanks again for the info. Really well done. I think I will open a position on Monday or Tuesday (when I feel the slight dip is over).

Cheers,

Mark.

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herbie47 23rd Aug 33 of 50

Any idea why the shares are down over 8% today, can't see any news, now around 360p. I tried to buy some some but no market.

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Effortless Cool 23rd Aug 34 of 50

In reply to post #392944

No news that I am aware of. Probably just small cap volatility. I hope Mark (post 32) delayed opening his position.

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sharmvr 23rd Aug 35 of 50

In reply to post #392944

I was able to get a quote for 350 shares at 370. Nothing any larger than that - no price returned.
I'm tempted to add. Now we are at a bargain basement 2xrevenue!
EC - there margins are trending lower (understandably) - do you think this reverses back as the business settles down?
Whilst I don't like adding to stocks in the punt stock part of my portfolio (other than those from capital gains), I think this is deserving of a higher rating than a punt (valuation aside!)

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Effortless Cool 23rd Aug 36 of 50
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 37 of 50

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 38 of 50
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 39 of 50

Thanks EC as always for you updating

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Effortless Cool 9th Oct 40 of 50
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 41 of 50
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 42 of 50

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 43 of 50

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 44 of 50

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 45 of 50
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 46 of 50

In reply to post #410319

Thanks EC. Understood

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Effortless Cool 4th Dec 47 of 50
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 48 of 50
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 49 of 50
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 50 of 50

In reply to post #424613

certainly been called worse!!

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