Insane in DE.membrane (ASX:DEM)

30/07/2019

Trav Mays

Follow @MaysTrav 

Today we will be looking at De.mem, a wastewater treatment company that looks set to hit an inflection point. They have a proven and patented technological advantage, which gives them the ability to not only extract more clean water from wastewater, but they can do it whilst operating at a lower cost. Technologies such as these are vital, according to an article on National Geographic titled “Freshwater Crisis”, “Freshwater makes up a very small fraction of all water on the planet. While nearly 70 percent of the world is covered by water, only 2.5 percent of it is fresh. The rest is saline and ocean-based. Even then, just 1 percent of our freshwater is easily accessible, with much of it trapped in glaciers and snowfields. In essence, only 0.007 percent of the planet's water is available to fuel and feed its 6.8 billion people”.

Company

De.mem (ASX:DEM) is a water treatment company that generates their revenue predominately through Build Own Operate (BOO) agreements, but also through the sale of water treatment products (some of which they design and build in-house) and general services. Whilst this has formed the backbone of their revenue to date, the real growth potential comes from their worldwide exclusive licence agreement with NTUitive (Nanyang Technological University), which gives them access to cutting edge membrane technologies, Nanofiltraion, Ultrafiltraion and Forward Osmosis. These membrane technologies are relatively new (especially on the industrial level) and offer several advantages to traditional technologies. These advantages essentially boil down to the system producing very similar results, whilst requiring a lot less hydraulic pressure.

DEM was established in Singapore in 2013 and listed on the ASX on the 7^th April 2017, for $0.20 per share, giving them a market cap of ~$19 million. Having just IPO’d, DEM moved quickly, setting up trials for their membrane technology and the construction of a membrane manufacturing facility. This facility was completed and operational by July 2017, producing membrane modules in both 4 and 8 inch diameters. The perfect size for small scale commercial projects, the size of projects they and the yet to be acquired Akwa-Worx were undertaking.

In an effort to transform DEM into a profitable company, whilst they wait for the development of their Licensed Proprietary Technology, they acquired Akwa-Worx in September 2017 for $1.96m (2.4x Akwa-Worx’s 2017 EBITDA). Akwa-Worx is a leading Australian (based out of Caboolture, Brisbane) water and wastewater treatment systems and solutions provider. Akwa-Worx gave DEM a massive boost in revenue and changed their revenue structure up substantially. They went from generating $0.28m of revenue in 2016 to $10.52m in 2018, that’s a 3657% increase in 2 years. Along with this, their contracting segment went from non-existent to 46.7% of revenue, 0 to $4.9m, in that same 2-year period.

Along with the massive boost to revenue, Akwa-Worx’s founder Mr. Shane Ayre came on board, bringing with him over 17 years of wastewater experience. Mr. Ayre founded Akwa-Worx in May 2002 and whilst it is quite common for the Director of an acquired company to stay on for a year or two as part of the sale agreement, I hope Mr. Ayre will be staying on a for a while longer. Mr. Ayre, along with the CEO, Mr. Andreas Kroell own a combined 4.5% of DEM, not huge but not small either. Positively Mr. Ayre has been adding to his holdings, having purchased 620,120 new shares in 2018.

Along with Mr. Ayre, DEM is being led by the talented Mr. Andreas Kroell, who having working as a Director and Partner of one of DEM’s largest shareholders, New Asia Investments for over 7 years, switched from being an investor to a leader, taking on the role of CEO, in 2016. New Asia Investments as described on Mr. Kroell’s LinkedIn page “is a Singapore-based venture capital fund” “that co-invests with the National Research Foundation (Singapore government) into companies from the water, clean-tech, industrial and med tech sectors”. This experience would have clearly given him the necessary skills to lead DEM into the future. Prior to this, he worked as a Senior Portfolio Manager at Nanostart NG for just over 2.5 years and as a Senior Auditor at Deloitte for just over a year.

Since Mr. Kroell and his team purchased Akwa-Worx, it would appear that they have taken their eye off Singapore somewhat. This can be seen (I might be reading too much in to this) when we look at where geographically DEM generates their revenue from. Whilst both the Singaporean Services and Sales of Goods segments were decreasing between 2017 and 2018 (95% and 60% respectively), all of the Australian segments were improving, increasing from $7m in 2017 to $10m in 2018, a ~43% increase (2017 figure of $7m is the unaudited figure presented in the acquisition announcement). The majority of this increase was in the contracting segment, DEM obtained a total of $2.96m of new contracts in CY2018. Please note that this graph is a bit misleading, the Australian 2017 figures are only for the 3 months after DE.mem purchased Akwa-Worx.

The focus on the Australian Leg has not stopped either, they recently opened 2 new offices, one in Melbourne and another in Adelaide and are still looking to recruit more people. DEM are currently advertising on their website for two new positions, a BDM in Melbourne and a Process Engineer in Caboolture. Whilst still only early days, it appears that the new offices and the continued focus on Australia is having a material effect on CY2019, having to date received $4.17m in new orders. That’s an increase of 40.9% when compare to the whole of 2018 and we are only in July, very impressive.

The increased focus on Akwa-Worx is understandable, not only is there a large market to expand into, estimated by IBIS to be worth $5b p.a., they are currently the only profitable segment of the business, generating $0.37m profit before tax in CY2018, off $10.2m in revenue (PBT margin of 3.1%). Not only that, but they keep getting better, having increased revenue per month by 44% ($0.26m) and increased their return on assets to 15% in CY2018.

 

“That’s all great Trav, but I need more up to date info, how have they gone this year?” That’s a great question, unfortunately, we have only had one quarterly statement released so far and they are yet to publish their half year statement. But as you can see below, receipts from customers in the first quarter are still quite high, not as high as in the past, but not looking too bad.  

A different story plays out once we look a little bit further down the cash flow statement, it would appear that whilst DEM was close to breaking even in Q2 and Q3 last year, they have fallen away this quarter, both from a decrease in receipts and an increase in expenses. Staff costs have increased, but that is expected, especially when you open two more offices. One encouraging thing about the Q1 result was that despite them decreasing the op costs as a percentage of receipts, they stated “that the higher than average burn has been offset by receipt of a customer payment of $715,000 on 8 April 2019, and as a result, “operating performance in Q2 2019 is expected to be substantially improved”.

In other CY2019 encouraging news, DEM just raised $1.9m by offering 13.6m shares at $0.14 each. A portion of this is to continue the Akwa-Worx expansion, another portion is to keep the company afloat and the rest is to fund acquisitions, which I originally thought was going to be a German waste water treatment company (they have been speaking about this for about a year) but a very recent announcement stated that they are looking at a Tasmanian one instead, PumpTech. PumpTech specialises in the design, supply, installation and maintenance of pump sets, pump stations and sewage and water treatment plants; essentially, they do the exact the same things as Akwa-Worx, just that they are situated in Tasmania. This acquisition, if successful, (as of writing, they have only stated that negotiations are currently being undertaken) would allow DEM to essentially bypass the cost and time needed to set up a wing of Akwa-Worx in Tasmania, allowing them to simply walk in, lean it out somewhat, implement their Australian wide systems, use their economies of scale and increase profits (sounds simple, but as we all know, is quite difficult).

Whilst they may have shifted a large portion of their focus onto the Akwa-Worx business, this doesn’t mean that they aren’t still concentrating on their licensed technology. Since the Akwa-Worx acquisition, DEM has been busy validating and expanding the technologies product range, below is a list of some of their achievements

• October 2017: Completed a number of pilot water treatment systems, giving them access to critical data
• November 2017: DEM signed a Memorandum of Understanding with Virtual Curtain China Limited to jointly pursue a number of Chinese opportunities, nothing has come of this as yet
• March 2018: Exclusively licenses hollow fiber forward osmosis membrane technology
• April 2018: The first order of the low pressure hollow fiber nanofiltration membrane modules, 20 8-inch modules in total, giving DEM a total revenue of A$30,000
• May 2018: Took a strategic stake (32%) in Aromatec, a Singaporean company targeting the food and beverage industry, at a cost of $100,000. Aromatec is focused on the commercialisation of an innovative hollow fiber forward osmosis technology
• May 2018: Introduced a Ultrafiltration membrane, expanding their product range considerably
• July 2018: Introduced a “point of use” filtration system using their nano and ultrafiltration technologies, targeting a worldwide market estimated to be worth US$24.5b by 2020
• October 2018: Recorded successes at the deployed pilot programs stated earlier. These sites were to treat wastewater at a car wash, an electronics factory and another to treat river water from the Mekong Delta.
• October 2018: Received AUD$90,000 from three small scale commercial projects using DEM’s filtration technologies, one at a car wash facility, another at an oil and gas factory and the last at a research institution, all in Singapore.
• November 2018: Released a ready for commercial sale Ultrafiltration membrane that was developed in-house.
• February 2019: Recorded their first sale (50 units) of domestic “point of use” water filters.
• June 2019: Recorded first revenues from commercialisation of new hollow fibre Forward Osmosis Technology, ~$150,000.

On the surface this last one doesn’t sound like much and you are right, it is a small drop in 2018’s ~$10m bucket. But it is however, as DEM stated, “validation for the commercial readiness of the technology”, which has led to them “currently preparing an industrial solution for this FO technology in response to strong customer interest”. Which is great to hear, but as we have yet to see this technology generate any real money, a better understanding of it and the other technologies potential is needed before we even think about evaluating DEM.

Competitive Advantage

DEM’s competitive advantage comes from their worldwide Exclusive Licence with NTUitive that gives them access to several cutting-edge filtration technologies, each used at a different stage of the wastewater filtration system. Their original licence gave them “details on the fabrication, characteristics and performance related to the low pressure hollow fibre nanofiltration membrane technology”. This license cost them $35,000 over 2 instalments, with DEM continuing to pay 3% of net sales of licensed products and 25% of all sub licenses. So what does a low pressure hollow fibre nanofiltration membrane do?

Traditionally the filtration of wastewater has been completed through a process called reverse osmosis. Basically, reverse osmosis, when used to treat wastewater, is the process of pushing unclean water through a membrane, which filters out any particles that are of a certain size, producing relatively clean water. The problem with this system is that it not only removes the unwanted particles but all particles, which means needed elements such as magnesium, calcium, potassium etc are often added back into the water after it passes through this system. A relatively new process, called nanofiltration is able to overcome this by operating at lower pressures, which allows the use of more sophisticated membranes that are able to reject solutes not only on size but on charge as well. By doing this, they have created membranes that can reject just the unwanted elements whilst operating at a lower cost.

Nanofiltration up until recently, was mainly used to treat portable drinking water, its usefulness was however expanded when DEM in conjunction with Nanyang Technological University produced the first industrial sized low-pressure hollow fibre nanofiltration membrane module. Their nanofiltration membrane can produce almost as good results (when compared to reverse osmosis), whilst requiring only 20% of the hydraulic pressure, 2 bars of pressure as opposed to the 10-15 bars typically needed in the reverse osmosis process. To put that into context, 2 bars of pressure is equal to 29 PSI, just shy of what you put in your car tyre (32psi) whilst 10 bars of pressure converts to 145 PSI, 4.5 x your tyre pressure. As you can imagine, the large reduction in the pressure required, results in a decrease in the initial CAPEX, (Capital Expenditure; the pump size and in some cases, pump type required are smaller/cheaper), but not only that, these types of systems also have a large impact on OPEX (Operating Expenditure), in some cases reducing the energy required by as much as 80%. This cost saving is extremely important, as the US Department of Energy’s Office of Industrial Technology highlight in their document titled “PumpLife Cycle Costs”, “Energy consumption is often one of the larger cost elements and may dominate the LCC (Life Cycle Cost analysis), especially if pumps run more than 2000 hours per year”. Whilst obviously helping to save newly created plants a large sum of money, due to the standard size of the modules, DEM’s nanofiltration modules can, at times, simply replace existing reverse osmosis modules without the need to change the system in anyway, other than reducing the pressure at the pump. The estimated market size for this technology is ~$570 million p.a.

Along with their nanofiltration modules, DEM has added a number of other technologies to its product list, most notably an Ultrafiltration membrane, which was developed in house and therefore “comes without any royalty obligations” and a domestic water “point of use” filter system. The Ultrafiltration membrane is used in the pre-filtration step for both reverse osmosis and nanofiltration systems, where it removes bacteria and viruses. It has an estimated market size of ~$570 million p.a., whilst the point of use filters market size is estimated to be ~$19.9 billion worldwide, be it an industry with far more competition.

The other exciting technology that DEM has at their disposal is the hollow fibre forward osmosis membrane. As opposed to reverse osmosis that uses hydraulic pressure to push the fluid through the membrane, forward osmosis uses an osmotic pressure differential to draw the fluid through the membrane. For those of you who may not be familiar with this phenomenon, this video gives a great explanation, but essentially it works by two fluids with differing solute levels equalising. For example, if you have a u – tube that has a membrane with pore sizes large enough for just water (Solvent) to flow through, if you were to dissolve salt (Solute) in one side, this would decrease the water concentration on that side whilst simultaneously increasing the solute concentration. As the universe likes to always be in equilibrium, the water molecules will be drawn to the side with a relatively high concentration of solute, this will result in the water level on that side being higher than the lower solute concentration side.

Sourced from: http://regularbio.blogspot.com/2018/11/diffusion-and-osmosis.html

Forward osmosis takes advantage of this phenomenon by using a draw fluid (relatively high solute fluid) to draw the unclean water through a membrane. To do this, unclean water is pumped passed a membrane with a draw fluid being pumped passed the other side. The high solute concentration therefore draws the unclean fluid through the membrane and into the draw fluid, cleaning it in the process. This clean water is than separated from the draw fluid, with the draw fluid again being pumped past the membrane, which in turn pulls clean water through the membrane and on and on it goes. 

Sourced from: Jiao, Yanmei & Kang, Yuejun & Yang, Chun. (2015). Osmosis and Its Applications.

The advantage of forward osmosis technology is that it can reduce the amount of concentrated liquid that is needed to be treated at a dedicated water treatment plant. Onsite water treatment technology is currently only able to economically extract a percentage of the potential clean water, the rest is trucked to a dedicated water treatment plant at a cost of ~$400/tonne, where they treat it before putting it back into the environment. DEM’s forward osmosis system is able to reduce the volume of the rejected concentrated liquid by as much as two thirds, giving consumers a considerable cost saving. Even more impressive, is the fact that this “technology can be utilised in place of current ‘Zero Liquid Discharge’ processes and evaporators, which are expensive to purchase and operate, leaving De.mem well positioned to capitalise on the market, which is cited to be worth approximately A$400 million per annum (Source: ForwardOsmosis Tech)”.

DEM is also working with Aromatec (DEM owns 32%), a company that is targeting these technologies, more specifically forward osmosis, on the food and beverage industry. This gives DEM an essential foot in the door to sell not only its forward osmosis technologies, but all of the technologies stated above, which is extremely exciting, as the worldwide food and beverage market for membrane technologies is predicted to be worth US$5.5 billion by 2020 (Sourced from ASX release dated 18 June 2019, DEM cites BCC research).

Evaluation

To Evaluate DEM, due to them not currently generating a profit and the insane level of difficulty in predict anything (earnings in this case), I will simply compare DEM’s Price/Receipts from Customers to a number of companies in a similar albeit different industries.

If we use CY2018’s price to cash receipts, we can see that DEM is trading at a multiple less than half of the next closest.

From this we can calculate what the share price and potential gains we will receive if the market was to assign a more aligned price/cash ratio, the results from which are quite encouraging. If the market assigns just a price/cash ratio of 3, we will see a gain of roughly 30%, keep in mind that that is still only just over half of the next lowest.

‘That’s all well and great Trav, but Q1 saw some massive changes to cash received, especially from PET who received more cash in Q1 2019 than in all of CY2018 and DEM’s decreased by half a mill’. That’s a good point, so to double check our analysis we will run it again using 2019 Q1 figures. As you can see, the results are reassuringly similar.

Risks

This is again my attempt at evaluating a growth company. I therefore would like to take a minute to explain the huge amount of risks associated with this company. I outlined a number of generic risks in my recent article on Tubi (ASX:2BE) so I won’t repeat them here, but that doesn’t mean DEM doesn’t come with its own set of specific risks, some of which I will outline below.

The large potential gain that could come from their licensed technology, whilst it is patented, it isn’t patent around the whole world. Not only that, but the patent only describes a certain type of manufacturing process, this means that other people could potentially produce the membranes using other means, or simply use the same technology in a country where they don’t have patent protection.

This means that they are essentially reliant on the first movers’ advantage, which while it may be extremely powerful, it only gives you a short window in which to prove your product and build brand loyalty. Amazon used this wonderfully to their advantage, everyone knows the brand and they have made their product extremely sticky. Netflix on the other hand is an example of a company that hasn’t used it as well. Their product isn’t especially sticky, I got rid of my subscription ages ago and with a large portion of their good content going to Disney Plus, I think they might be in a bit of trouble in the not too distant future, especially if their recent subscription numbers are anything to go by. Management will need to act quickly and execute well over the coming years for us to receive the payoff that I believe can be generated.

My above analysis is extremely flimsy.

It is currently trading at a 35.7% premium to the price offered to institutional investors just last month.

I learnt a little about process engineering when I completed Mechanical Engineering and a bit more when I did Petroleum Engineering, but I am definitely not a subject matter expert, so my thoughts on the usefulness of this technology could be incorrect.

Whilst not being an ethical investor by any stretch of the meaning, I do however, find myself drawn to companies that are having a positive effect on the environment (who really wants to be part owner of a cigarette company?), which has lead me to purchasing companies when I don’t fully understand them or overlook certain aspects. Windlab is a good example of that, whilst I understand the technology and thinks it’s amazing, I don’t really understand their business model, but I purchased anyway (I have since realised this and sold). Another example is Carnegie Clean Energy, despite some questionable management decisions I purchased a small bundle because again I really liked their technology, I did sell before the price got anywhere near where it is now, but my judgement was clouded due to the ethical bias that I have. This could be the same story playing out again, as Mark Twain is rumoured to have said “History doesn’t repeat itself, but it often rhymes”.

Discussion

This filtration system has not only been proven in the laboratory, but in real world applications as well. This is very important milestone for DEM and one that they have only completed relatively recently (October 2018). Along with these pilot projects, DEM has secured a number of orders for both their Nanofilters, Ultrafilters and point of use filters, which is excellent to see. The momentum is something that DEM will need to continue to build on, which leads me to their Australian Acquisitions.

The Australian Acquisitions (one is still currently pending) not only gives DEM an opportunity to generate revenue in the short term, but also gives them the chance to get more of their product out working in the market and therefore more projects to promote and continue the momentum. I see these acquisitions as DEM converting themselves into a company similar to LaserBond, whereby they both have intellectual property that will form the backbone of their growth, but in the mean time operate businesses that are sort of a supporting act, generating a profit, but have limited growth potential. LaserBond’s revenue was stagnant for a number of years following the GFC, it wasn’t until 2 years after they had started to invest in their R&D again, that their revenue started to build, resulting in the large increase in its market cap that we saw in 2018 (If you would like to learn more about LaserBond, please check out my article here). DEM has already spent the money on purchasing and developing their range, they have shown its usefulness both in the lab and out in the real world, so I believe that DEM is similar to LaserBond around the 2017 mark, before the inflection point, but by how much, who knows.

Within the LaserBond article I used the 6 common ingredients of 100 Baggers from Mr. Christopher Mayer’s book “100 Baggers: Stocks that return 100 to 1 and how to find them” in an effort to learn more about inflection point investing. LaserBond around the 2017 mark had five of the six ingredients needed, with the final one just being time for a company to compound its good work. DEM only has 4 of the ingredients, not quite as good as LaserBond, but still quite reassuring. They are as follows:

1. They are small
2. Have a low multiple
3. Owner operators
4. They have been investing in themselves

The additional ingredient that LaserBond had was high returns on capital, which is quite an important one, but something I believe DEM will be able to generate in the future. I’m not trying to say that DEM will be the next LaserBond, I am just highlighting that they both share characteristics with companies that have gone on to become 100 Baggers. LaserBond had several things going for it that DEM doesn’t have, such as the fact that they developed their technology inhouse and were profitable at the time. I view DEM similar to the way I view XRF Scientific, both are currently valued at a 30 – 40% discount from what I believe they are worth and both have a large potential upside, assuming they get some lucky breaks and management executes well.

Conclusion

If you have been reading some of my posts over the past couple of months, you would have noticed that I am currently trying to better predict companies at or just before they reach an inflection point, DEM is in my opinion, just such a company. The market is assigning a market cap of just $25m, which is only 6 million higher than when they IPO’d back in 2017. Since then they have proven and increased their product offering, increased their revenue by 3657%, purchased a 32% stake in Aromatec, expanded into Australia through an acquisition (potentially again) and then further expanded within Australia by opening offices in Adelaide and Melbourne. The Australian revenue since DEM has taken over have increased by $3m (42.8%) and their new contracts to date (July) are 40.2% higher than the whole of CY2018. Whilst they have not yet produced a profit in any quarter, they got extremely close in Q2 and Q3 last year and I believe they are currently sitting just a stone’s throw away from hitting this massive milestone. However, due to this, I would recommend that only those with a considerable risk tolerance begin their own analysis, a lot of things need to come together for this thesis to work out.

As always, thanks a lot for reading, I really appreciate all the feedback I have received so far. I have also just recently found twitter Follow @MaysTrav, give me a follow if you like and/or send me a msg, it’s always great to meet other ASX investors. If you don't have twitter we can connect on Linkedin .

Thanks for reading

Just Culture Investor

Trav Mays

Subscribe to Just Culture Investor by Email 

Sources:

1. https://www1.eere.energy.gov/manufacturing/tech_assistance/pdfs/pumplcc_1001.pdf
2. https://www.nationalgeographic.com/environment/freshwater/freshwater-crisis/
3. Jiao, Yanmei & Kang, Yuejun & Yang, Chun. (2015). Osmosis and Its Applications.
4. http://regularbio.blogspot.com/2018/11/diffusion-and-osmosis.html
5. https://www.youtube.com/watch?v=L-osEc07vMs
6. https://www1.eere.energy.gov/manufacturing/tech_assistance/pdfs/pumplcc_1001.pdf

The author is a current owner of a portion of DE.mem, given this, they may be subject to one or a number of biases, more specifically anchoring and/or confirmation bias. This article is neither general nor personal advice and in no way constitutes specific or individual advice. The website and author do not guarantee, and accept no legal liability whatsoever arising from or connected to, the accuracy, reliability, currency or completeness of any material contained on this website or on any linked site. This website is not a substitute for independent professional advice and users should obtain any appropriate professional advice relevant to their particular circumstances. The material on this website may include the views or recommendations of third parties, which do not necessarily reflect the views of the website or author, or indicate its commitment to a particular course of action. Please refer to Disclaimer page for a full list of disclaimers.  

Tubi or not to be (ASX:2BE)

12/07/2019

Trav Mays

Follow @MaysTrav 

Today we will be looking at Tubi Limited (ASX:2BE) a recently IPO’d growth company with a bright future ahead of it. Whilst reading this, please keep in mind that this is my attempt at evaluating agrowth company, which is not a style of investing that I have a lot of experience with. It was however suggested to me by a very smart investor (Mr. Joshua Baker) and I also saw that “The Gentleman”, an ASX growth investor who blogs for Ethical Equities has it in his portfolio, so I thought it was worth a good look.

Before we get started, I would like to expand a little on my thoughts about the difference between value and growth investing.Without growth there isn’t value (other than a pure asset play), the two go hand in hand, as Warren Buffett said in his 1992 annual letter “The two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive”. By calling this company a growth company, I am referring to the fact that there is little to no history for Tubi and with the company changing so dramatically in the near future, the metrics that I normally use are completely useless. So I have instead put a lot more emphasis on trying to predict future growth.

Company

Tubi group (2BE:ASX) is a HDPE pipe manufacturer with a twist, they have created a patented modular manufacturing facility, allowing them to produce their pipe onsite. This has a number of advantages over a conventional fixed factory, the main two are that they can produce longer lengths of pipe, due to them not being limited to available space on truck beds and there is no need for transportation, cutting expenses down immensely. Along with their modular factory, they have the ability to put large diameter (up to 315mm OD) HDPE pipe on a reel for transportation. Whilst not currently patented, this technology is quite unique and gives Tubi access to additional revenue streams.

Tubi was founded in 2009 by Marcello Russo, who up to this point had worked for 15 years as the General Manager of Cromford, a plastic pipe manufacturer. Just 5 years later, they had completed their first plant and successfully manufactured pipe for the British Gas Coal Seam project in Queensland. From here they have gone from strength to strength, below is an excerpt from Tubi’s prospectus.

As you can see, after supplying to ISCO Industries, they were awarded the contract to supply the Central Plains New Zealand Irrigation Project, a 10-month long project that supplied irrigation water to farmlands. The success of this project paved the way for the 2 year take or pay contract with MPS Enterprises in the Permian Basin. 7 months later, MPS signed another agreement with Tubi, requesting a second modular facility and another 2-year supply contract. December 2018 was a busy time for Tubi, not only did they secure the second MPS contract, but they sold a modular factory to Iplex to be used exclusively in NZ, commissioned the building of these two plants and Jeff Shorter came on board as CEO.

The sale of the modular plant to Iplex was an Equipment Purchase Agreement, under which, Iplex is prohibited from selling or transferring the plant to any other entity or person or transporting it to another country without consent from Tubi. Along with the Equipment Purchase Agreement, they have signed a 3-year Service Agreement, which pays Tubi a monthly service fee for support of their modular factory. Under the Equipment Purchase Agreement, Iplex has agreed to pay for the modular factory in instalments, with 40% being paid on signing of the agreement (21/12/19), with the rest paid once the plant is delivered to site and successfully passed its SAT (site acceptance test). The modular plants take 9 – 12 months to construct, so the final 60% should be paid sometime in the first half of FY2020.

The contracts with MPS are far simpler, they are your typical 2 year Manufacturing and Supply Agreements (MSA). Within which, Tubi has a protection clause that stipulates that MPS must purchase a minimum quantity of pipe per year. On completion of the contract, the agreement automatically renews for an additional year unless either MPS or Tubi supply advanced notice that the plants are not required. They also give MPS first right of refusal to enter another MSA on any additional mobile plants that are constructed.

Along with securing the two contracts outlined above, in December 2018, they also employed Mr. Jeff Shorter as CEO. Mr. Shorter, a Texas based veteran of over 25 years in the oil and gas, piping and steel industries, holds a Bachelor of Mechanical Engineering from Michigan Technological University and a MBA from Youngstown State University. Mr. Shorter begun working at the top level of management in 2002 as VP and GM of Maverick Tube corp. He has since worked at the top level for several companies, most notably Flex Steel pipeline technologies, Tenaris and Sturrock and Robson. There isn’t much info online about Mr. Shorter, but it is clear that he has worked at large organisations in senior positions and compliments the other members of the board’s skills excellently.

Following on from this, Tubi completed a pre-IPO capital raising, issuing 50 million shares at a price of $0.20 per share, raising $10 million. This money was then used to help fund two additional mobile plants (four in total), costing a total of $22 million ($5.5m each).

They then went on to list on the ASX on the 14^th June, issuing 28.8 million shares at a price of $0.20 raising $5.76 million, valuing the company at ~$50 million. As opposed to issuing to raise funds for growth or acquisitions, Tubi has listed, primarily, to allow the founder, Mr. Marcello Russo, the opportunity to receive a return on his investment. There are no new shares being issued for the IPO, all 28.8 million shares are coming from Mr. Russo’s slice of the pie, see below, encouragingly, he still owns quite a large percentage. Please note that the no. of shares is a little misleading, Mr. Willsallen and Mr. Tilley both have a stake in the 104,014,980 shares, they don’t both own that amount.

Competitive Advantage

Tubi’s mobile plant gives them a number of competitive advantages over the conventional factory, but essentially it comes down to their ability to produce HDPE pipe sections in lengths that exceed 50 feet. Whilst the $/lm (Linear meter) will be higher than a conventional factory, their ability to reduce both transport costs and the number of welds brings them out ahead, by a considerable margin. MWH Global in their document titled “An introduction to the Central Plains Irrigation Scheme” commented that “A major advantage of making pipes on site is the resulting speed of installation, since the number of welding operations (which can take many hours at larger diameters) is reduced by a factor of around 7”.

CS&D Services did a thorough analysis (find it here) of the Central Plaines New Zealand Irrigation Project and found that the number of welds needed was reduced by 80%! When you add this to the transportation savings, Tubi was able to reduce the total projects cost by $3.217m (~16%), a saving of $0.32m per month. CS&D’s breakdown of the costs can be seen below.

Along with the cost savings, Tubi has that advantage of being able to set up their self sustained plant in just 2 days anywhere on the planet. They also have both an Australian and an International patent, helping to reduce competition. There is another company called Poly Piping Systems, who also have a mobile HDPE plant, but from what I can tell, despite them holding the patent for mobile plants, they have yet to start any projects. I’m basing this off their website as the only images of the plant are CGI and every other photo is just a stock image. Other companies offer mobile plants, which are essentially mini HDPE factories, requiring concrete foundations and large sheds to be built on site.

Evaluation

As this company doesn’t have a long track record, we will be making a lot of assumptions, but if we are conservative, it should give us a somewhat solid foundation to build our house of cards on 😊.

We will begin the evaluation by approximating the revenue a plant has the capacity to generate in a given year, obviously this will vary depending on the size of the pipe but is a good starting point to begin with. In FY2017, Tubi generated $4.66m in revenue, this was from the initial 3 months of work on the NZ Central Plains Irrigation Project. In FY2018 they had the mobile plant operational for 10 months, 8 months in NZ and the final 2 in Texas working for MPS, generating a total revenue of $17.38 million. As you can see below, they generated a higher amount of revenue per month in FY18, $0.19m more. Unfortunately we can only speculate on the cause of which, it could be from a final push at the NZ site, or the Texas site is producing more costly pipe, fingers crossed for the latter.

Now that we have established the average amount of revenue one plant can produce in a given year (I’m sure you are all rolling your eyes at the moment, saying “Come on Trav, you can’t extrapolate from 2 data points and then create your whole thesis around that” and you’re right, more data is always better, but as this is all we have, so as long as we don’t let the assumptions get out of hand we should be ok), we can estimate the sale price of the Iplex unit as well as the FY EPS for any combination of plants we can think of.

In HY2019, Tubi generated $17.172m in revenue, which included 40% of the total Iplex unit cost and 6 months of continuous work in Texas. Using the average Rev/month of $1.65m, we can estimate that Iplex paid $18.24m for the unit (That’s a gross profit of $12.74m and a gross margin of 70%).

Now that we have approximated the cost of the Iplex plant and the potential revenue from a single plant, we can estimate the FY19, FY20 & FY21 EPS and from this it’s FP/E and PEG, with the hope of trying to equate if they are currently under or overpriced. As we have no information regarding the Iplex Service Agreement, I have just left this out, which is most likely making this approximation too conservative, but given the results, I think we can look at it as cream. Other assumptions made are as follows:

1. First plants are constructed and shipped to site before the end of HY20 and the second lot of plants are constructed and producing for the whole of FY21 
2. EBIT margin of 8.8%; taken from their prospectus 
3. Tax rate of 30% 
4. FY19 revenue is HY19 + 6 months of continuous production of one plant at the average monthly revenue calculated above 
5. FY20 revenue includes 18 months (1.5 plants) of production + the remaining 60% of the Iplex plant 
6. FY21 revenue is from 4 plants producing for 12 months 
7. No new shares are issued

Peter Lynch famously said that a company’s P/E ratio should roughly equal the growth rate of the company. Essentially, he is stating that a company’s PEG (Price/Earnings/Growth) rate should be equal to 100 (or 1, depending on your denominator), anything below shows a company that is undervalued whilst over 100 is a company overvalued. The tricky part is choosing the right growth rate, above I have simply used the approximated growth rate in EPS in the next year, with FY21’s growth rate of 25% being the added benefit of one extra plant. As you can see below, I have changed the growth rate’s around a little, I have looked a little further out for FY19, bringing it up to 60% and assumed a little worse FY21, reducing FY20’s growth rate to just 50%. 

As you can see, we have approximated values that are indicating that Tubi is currently under-priced. Very encouraging, especially given my conservative assumptions and the fact that this doesn’t include the service agreement revenue.

Risks

This type of stock has several major risks associated with it and I wouldn’t recommend people even begin to start their own research, if they are not more risk tolerant than the usual. There is a plethora of articles, anecdotes and statistical evidence that show how extreme the odds are against an investor who purchases a company at its IPO.If it wasn’t for the skill of Mr. Baker, who recommended it, and the fact that this is not a capital raise, it is just an opportunity for the founder to cash in on some of the hard work he has been doing over the past 10 years, I would never have looked at it.

I have used several assumptions in my evaluation, all of which would be subject to any number of cognitive biases, confirmation, framing effect, in group etc (Feel free to pick any number from Barry's great list) all having either a negative or positive effect on the evaluation.

Whilst they do have the first movers advantage, they are reliant on the modular factory patent. If there is a way for them to either lose it or a competitor can find a way around it, they could be in a lot of trouble from the big pipe producers. They are currently working with pipe producers as opposed to competing against them, so this risk is somewhat mitigated, but if there is a big enough margin, competitors will always follow suit.

Another risk is that after they sell the unit to Iplex, the vast majority of their ongoing revenue will come from MPS Enterprises. If there was an issue either within the Oil and Gas industry or MPS, they have little to no protection.

The mobile plants take between 9 – 12 months to produce, this means that future growth, after the 4 ordered plants will come about somewhat slowly.

Marcello Russo sold his shares for just $0.20 cents each, they are currently trading at a 80% premium to this ($0.36).

This stock was suggested to me, Matt Brazier again with extremely timely advice wrote this a day or 2 later on his blog “It is ok to get investment ideas from other investors if you also thoroughly investigate these stocks independently by scrutinising primary sources. It is tempting to skimp on this process after you have been spoon fed a seemingly compelling thesis. You may earnestly attempt to do the research without realising that you are merely going through the motions. If you don't do the work properly then you don't know what you own and if you don't know that then you are asking to have your money taken off you.” This could definitely be what has happened during this analysis.

Whilst I have tried to overcome these risks with conservatism, it is almost impossible. I do however think that I have taken adequate precautions and the level of potential growth is high enough to warrant purchasing at today’s prices.

Discussion

Whilst Tubi may not yet have contracts for 2 of their ordered plants, they are starting to ramp up their operation, more specifically the number of employees. In June 2019 they filled the following positions, a Senior Operations Manager in Texas, a Technical Sales Manager in Texas and a Project Engineer based in either Sydney or Texas who will be required to spend 5 months in Texas, 5 months in Sydney and 2 months in Europe. I don’t think we should read too much in the 2 months in Europe, but clearly they are looking to expand there in the future. Right now though, they are rightfully focusing on the Permian Basin, having hired a Texas based CEO and recently moved their headquarters to Texas. Which is a smart move, as the Permian Basin is now the world’s most productive oil field.

Initially when I saw that Tubi had sold a plant to Iplex I thought that they were going down the wrong path, selling instead of renting out their modular plants. However, I now believe that they have sold this unit to Iplex because they are focusing on the Permian Basin and didn’t want to spread themselves too thin, which is great to see. I have witnessed a number of start ups (I’m not sure if this still constitutes a start-up) expand to fast, it’s as if they believe that all they need to do is expand, expand, expand and eventually they will tip over a point and everything will be fine. But during this rapid expansion, if you don’t keep a tight ship, you allow bad processes and cultures to develop (Uber for example, although if Tubi expands rapidly and gets to the same evaluation as Uber, I wouldn’t be complaining 😊). A good balance between the rapidity of growth and the time it takes to ensure that once you get big everything is set up for further growth is a tricky balancing act.

Conclusion

Tubi is an excellent company with very large insider ownership, forward orders in the bag, easily scalable, limited industry and geological specific risks (they can move anywhere and work for more industries than just oil and gas), a proven concept and a very simple business to understand. The success of these modular factories is clear, as the only two companies to have used them so far have either purchased a factory for themselves or started another contract. It doesn’t come without risks though, I do believe that the potential rewards from this company outweigh the risk, but, an investor would need to be quite risk tolerant to even consider doing their own analysis on this one, a lot of things need to come together for this thesis to pan out.

As always, thanks a lot for reading, I really appreciate all the feedback I have received so far. I have also just recently found twitter Follow @MaysTrav, give me a follow if you like and/or send me a msg, it’s always great to meet other ASX investors. If you don't have twitter we can connect on Linkedin .

Thanks for reading

Just Culture Investor

Trav Mays

Subscribe to Just Culture Investor by Email 

Sources:

1. https://www.mattbrazierinvestmentdiary.com/2019/07/two-reasons-not-to-be-sheep.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+MattBraziersInvestmentDiary+%28Matt+Brazier%27s+Investment+Diary%29

2.  http://www.milfordonline.com/milford-strategic-partnership-distribution-with-tubi/

3.  https://www.waternz.org.nz/Attachment?Action=Download&Attachment_id=426
4.https://csdservices.com.au/wp-content/uploads/2018/05/CSD-TUBI-High-Level-General-study-SFIS-Pipe-Schedule-V1-Project.pdf
5. https://ritholtz.com/2018/12/24-cognitive-biases-warping-your-reality/
6.https://www.forbes.com/sites/rrapier/2019/04/05/the-permian-basin-is-now-the-worlds-top-oil-producer/#10b057ca3eff

The author is a current owner of a portion of Tubi Group, given this, they may be subject to one or a number of biases, more specifically anchoring and/or confirmation bias. This article is neither general nor personal advice and in no way constitutes specific or individual advice. The website and author do not guarantee, and accept no legal liability whatsoever arising from or connected to, the accuracy, reliability, currency or completeness of any material contained on this website or on any linked site. This website is not a substitute for independent professional advice and users should obtain any appropriate professional advice relevant to their particular circumstances. The material on this website may include the views or recommendations of third parties, which do not necessarily reflect the views of the website or author, or indicate its commitment to a particular course of action  

Learning from Laserbond (ASX:LBL)

02/07/2019

Trav Mays

Follow @MaysTrav 

LaserBond (ASX:LBL) recently hit an inflection point, after some excellent management decisions and some tailwinds, shareholders have been rewarded with a 244% gain over the past year. Today we will be investigating if there are gains still to be made and to see if there is anything we can learn.

LaserBond first come to my attention whilst researching XRF Scientific (click here for that post). A number of excellent articles, such as Mr. Joshua Baker’s on Livewire titled “A platinum crucible in the rough”, compared XRF to Laserbond. So ever keen to learn more, especially about inflection point investing, I decided to dive deeper to see what nuggets of knowledge I could uncover.

Company

LaserBond, originally called HVOF Australia P/L, was founded by Mr. Gregory Hooper (Currently Executive Director) in 1992, working out of a small workshop in Ingleburn NSW. (HVOF stands for High Velocity Oxygen Fuel, which is a type of thermal spray system that uses combustion to heat and propel particles near supersonic speeds. These high flying particles collide with a material, forming an extremely high density low oxide coating.) Gregory’s brother, Mr. Wayne Hooper (Currently Executive Director) joined HVOF in 1994 and together they were at the forefront of laser cladding innovation, building one of the first high-powered cladding systems using a 6kW CO² laser. In 2007 they listed on the ASX and changed their name to LaserBond Limited, listing for $0.2 per share and a market cap of just over $13 million.

The capital raised from their listing was quickly put to use, they invested in R&D and purchased Peacheys Engineering in Gladstone Queensland for $3m in 2008, as an attempt to capitalise on the growing gas industry. Unfortunately for LaserBond, the Queensland division wasn’t able to get any traction, the global financial crisis hit and then the large increase in activity within the Gladstone region pushed both rents and employee expenses up immensely. After a number of bad results, in 2013 they sold off 5 large pieces of equipment and their order book for $750,000, ceased all machining and fabrication work within the area, moved a number of other pieces of equipment to NSW and continued to do surface engineering work for the region from their NSW premises.

 

Whilst the Queensland division wasn’t doing very well, the rest of the business was, in fact they were doing so well, they had to move their NSW facility from the original workshop to a larger facility in Smearton Grange, just to keep up with orders. Not only that, but after 12 months of trials, LaserBond had signed a Memorandum of Understanding (MoU) with Gearhart United, within which, Gearhart committed to exclusively commissioning LaserBond for all their laser cladding work. To accommodate this large influx of work (estimated at the time to increase revenue by $1.2m, a 12.75% increase to FY2013’s revenue), LaserBond established a South Australian branch and to ensure the success of this branch, Mr. Gregory Hooper was later relocated to head it up (October 2014). Whilst the business was doing well, it wasn’t enough to compensate for the Queensland divisions loss; in 2013 LaserBond wrote off the remaining $3.6m in goodwill and posted an adjusted Net Profit after Tax loss of $0.72m. 

It was shortly after all this (February 2014) that the chairman, Mr. Timothy McCauley decided to step down. Having started back before LaserBond had IPO’d, he had done an excellent job during some extremely difficult times. Mr. Allan Morton was appointed his successor in March 2014, which in my opinion, is when the seeds for the 2018 inflection point were planted.

Mr. Allan Morton an Engineer by Trade, obtained his Bachelor of Mechanical Engineering from the University of Technology in Sydney, later going on to obtain an MBA from Harvard Business School. Prior to starting at LaserBond, Mr. Morton had worked as an engineer at CSR and successfully moved up the ranks to the operations manager role. After this he worked at a number of companies in high executive roles and/or founded a number of his own companies. Not of any real importance but interesting nonetheless, he worked for 3 years as a general manager for a company called Quickflix limited, which had the very same idea as Netflix. Having started out as a company that shipped the latest DVD’s and Blu-ray’s through the mail (they still do this), they have evolved into a streaming website, offering all the latest blockbusters, on a subscription basis, either online or via the mail! I had never heard of these guys and I am not sure if they are still operating, as they delisted from the ASX at the start of 2017, but their website is still up and running and it looks like they have some new movies on there, so it looks promising. Might be worth checking out if you are looking for another subscription or have had enough of Netflix. Anyway, one very interesting and relevant role he had, was as a founding partner of Waypoint Strategies (Founded in 2010), a consulting group that specialises in turnarounds. Which is just the type of manager LaserBond needed at this time in its history.

LaserBond started off as an innovator at the cutting edge of the surface engineering industry, they had however become complacent, drunk on the profits from the mining expansion, they had taken their focus off the company’s vision, “To be a global leader in the research, design and implementation of advanced surface engineering technologies”. This is clearly seen in their R&D spend below, after spending $0.57m (16% of revenue in 2007), the R&D spend for the 5 years between 2009 and 2013 was reduced to almost nothing, with 2013 actually being $0.

Mr. Morton came on board and changed all that, with the following couple of years reading straight out of a turnaround play book. Having divested the unsuccessful QLD branch, they reduced expenses (they implemented Lean Manufacturing in 2014), they focused on organic growth and started to reinvest in themselves, more specifically, the core of the business, its research and development department.

LaserBond kicked a lot of goals over the next couple of years, so to keep this post short, I have condense them to dot points:

• Feb 2015: They created a new class of Down-the-Hole (DTH) hammers and associated drilling components that last 2.44 times longer than the average DTH hammer, which equates to a 7% saving on the total drilling cost.
• The lean manufacturing techniques they implemented in December 2014 improved the 2HY 2015 gross margin of the NSW division from 49.3% to 53.2% pcp.
• April 2015: DTH hammers begin testing in European geothermal wells
• July 2015: Laser bond splits into three divisions, Services, Products and Technology. The Services division continues their core surface engineering work, the Products division to continue to manufacture specialised products and the Technology division to oversee the licensing of its technology to non-competitive international markets.
• October 2015: Lodged two international patents on a ground breaking laser cladding process, using the laser deposition method
• FY2016 Increased investment in themselves, more specifically employment, Advertising and research and development
• May 2016: Entered an agreement of collaboration with the University of SA
• August 2016: Awarded $3.22m over three years from the Commonwealth Government to fund the design, building, installation and commission of a dual robotic multi-axis handling system, which included a 16kW laser.
• September 2016: Enters first technology licensing contract with a crushing equipment manufacturing company in China. LaserBond is to deliver a turnkey package with all work done in-house from design to commissioning for $1.45m. The contract also includes 5 years of training and support, in return for a revenue based fee.
• February 2017: Awarded $2.616m as part of a three year collaboration with the University of South Australia and Boart Longyear (total govt fund $8.266m) to extend wear life of critical pieces of mining equipment.
• February 2017: Signed a non-binding strategic partnership to pursue mutually beneficial commercial products and services with Boart Longyear
• FY2017 report: Products division became profitable

Other includes R&D and Technology divisions

• September 2017: Mr Allan Morton steps down as Director
• August 2018: Signed a Technology licensing agreement with a UK multinational engineering company
• December 2018: LaserBond breaks into the US Steel Industry market with their Composite Carbide Steel Mill Rolls, which typically deliver 5 to 15 times the life of a standard roll.

All of this laid the groundwork for the huge increase in earnings per share for the first half of 2019, see above. Before I go into my evaluation of LaserBond, I would like to take a moment and see if there was anything that should have stood out, in the hopes of spotting the next company about to hit an inflection point.

The Pursuit for Baggers

LaserBond’s share price ,after hovering around the mid-teens for the past couple of years, exploded around the mid of 2018, gaining 244% between the 24/06/18 and 17/02/19.

I for one didn’t see this coming, but that doesn’t mean others didn’t, take the person who goes by the handle Wini on Strawman.com (If you aren’t familiar with Strawman.com, I highly recommend you check it out, excellent source of investment ideas and you get to see what some beasts of the investment world, such as Wini are currently interested in. Think of Hotcopper without the trolls), this person literally posted about LaserBond three days before it started its climb, Talk about timing!

So what should we be looking for? Mr. Christopher Mayer in his book “100 Baggers: Stocks That Return 100-to-1 and How To Find Them”, studied all of the stocks that where at least a 100 bagger (when you see bagger after a number, in this case 100, it is referring to a return of 100 – 1, I think it was coined by Peter Lynch, feel free to correct me if I’m wrong in the comments) between 1962 – 2014, of which he found a total of 365 that weren’t tiny to begin with. He then investigated these 365 companies further, in the hopes of finding commonalities and found that they all had some if not all of the following 6 ingredients.

1.       Start small (but not too small, median sales figure was ~$170m)

2.       Low multiples preferred

3.       High returns on capital

4.       Owner operators

5.       They invested in themselves and

6.       Long time horizon; compounding

So I thought it would be fun to explore each of these six to see which, if any LaserBond had leading up to the huge increase in share price.

1.       Start Small

LaserBond in 2018 generated $15.6m in revenue, a profit of 1.25m (excluding the inventory write-off) and had a market cap of $12m, so they had the first characteristic covered. Revenue and profit both had been increasing since 2015 (2016 profit decreased due to their large investment in themselves) with HY2019 alone producing $10.5m in revenue and $1.2m in profit. They have a goal to increase revenue to $40m within 3 years, still a long way to go, but there have been some quite encouraging developments recently. After taking a large dip in 2016, their profit margin has returned to their historical average of the high 7s and in HY2019 had actually increased it to 10.8%.

2.       Low Multiples preferred

Starting from a low multiple gives any earnings growth an extra boost to the share price. As opposed to starting from high multiples, where a slight decrease in the earnings growth rate, can place 2 downward pressures on the share price. Starting from a low base helps to slingshot the share price higher. It’s like an alley-oop in basketball, the increase in the growth rate puts up the shot and the increase in the multiple slams it in the net.

In 2017-2018, LaserBond had a P/E of around 10, a price to sales of less than 1 and an EV/EBITDA of around  5, all values that a typical value investor would purchase the share. This is especially true if you are a fan of Tobias Carlisle as he says an EV/EBITDA score of 5 or below is cheap, not quite as cheap as the deep value stocks he typically looks for, which have a score of 3 or less, but a cheap stock nonetheless. If we look back to 2014’s values, we can see that they are very similar to those seen in 2017 – 2018, which makes we wonder if I had of bought at this time, would I have continued to hold for those 4 – 5 years, especially with the 2016 drop in earnings?

3.       High Returns on Capital

High returns on capital is about the quality of the business and management’s ability to find and execute projects that generate high returns. Clearly to get a return of 100 – 1 the company will need to be able to generate good returns on capital over a long period of time. There are a number of ways to calculate returns on capital, I prefer Returns on Invested Capital (ROIC) and as you can see above, LaserBond has been able to generate quite high values in recent years. The same can be said about their Returns on Assets (ROA) and their Returns on Equity (ROE). So again, they have this one covered.

4.       Owner Operators

A leadership team that conducts its self as an owner operator is far better at creating shareholder value than a team that is purely motivated by money. This is because by motivating the executives with purely monetary gain, you are essentially shifted the focus from the longer term projects that produce real and lasting shareholder value to the short term goals that bring about no shareholder value but ensure the executives are hitting their KPI’s and receiving their bonuses. If you have ever had a side gig or run your own business, you know the difference you feel about the work when you are doing it for yourself, as opposed to doing it because you are paid.

One way to look for an owner operator leadership team is to look for companies that are still being run by the founder. LaserBond was no longer being run by the founder, he had been put into a position that better suited his skills, as the head of R&D, but his brother, one of the original company employees was still running it.

Another way to see if the executives are shareholder focused is to see if they own a large percentage of the company, this way, both shareholders and executives gain when they generate shareholder value. LaserBond’s executive team at the time owned 23 – 24% of all outstanding shares, with the Hooper brothers making up the bulk of the owner ship. This is very encouraging.

5.       They invested in themselves

LaserBond, after a couple of years of neglect have been continuously investing in themselves since 2014, with another big investment in 2016. The fruits of which can clearly be seen.

6.       Long Time Horizon

This one has to do with it taking a long time to reach a return of 100 – 1 as it takes time for the company to capitalise on its previous good work and then build on it and capitalise and then build on it and over and over. Clearly LaserBond have done well to continue to build on the momentum they started back in 2014, with the share price now showing a more realistic valuation of the company than in the past.

Mr. Mayer’s research emphasises the power of small cap value investing, look for well run small companies, that are currently mis-priced (low multiple), with a management team that is aligned with the same goals as the shareholders and hang-on through all the ups and downs, simple J (Disclaimer: I don’t believe you should buy a company and just hang on, if you see changes to the fundamentals and/or the story has changed, a re-evaluation is needed). LaserBond was this type of company in 2017 and 2018. I think this is one that a typical value investor would have purchased if they had turned over the right rocks, it’s just a manner of overturning enough rocks until you find one as good as LaserBond. Easy to say in hindsight, I know, but it doesn’t help to beat yourself up over missing a stock.

Evaluation

LaserBond is a great company, well run, good returns on capital and have had some large wins in recent times, most notably their expansion into the American Steel industry, but that doesn’t mean that they are currently miss-priced enough to warrant purchasing.

LaserBond has stated on a number of occasions that they are aiming to generate $40m in revenue within the next 3 years, using this, their NPAT margin and the trailing 5 year EV/EBITDA multiple we can try and approximate a figure the market would place on this result. LaserBond in 2018 had a EBITDA margin of just 14.3%, they have however said that they are working on increasing this margin (it was 17.9% in 2017), so I have instead used 16%. I have also increased the number of shares using the past 5 year growth rate and also used the trailing 5 year EV/EBITDA multiple of 7.5. As you can see below, if they are able to achieve their revenue goal of $40m and the market assigns a historical margin, we are looking at a 9% gain on today’s prices, 5% if they miss it by 10% and 14% if they exceed it by 10%. If they instead assign a multiple of 10, we are looking at gains of 20%, 26% and 33%, respectively.

Whilst I have calculated that the share price is currently between priced about right and a number that I believe doesn’t offer enough of a safety margin for me to purchase, I am reminded of Matt Joass article on inflection point investing, where he explains the human brains inability to extrapolate anything other than linear forecasting very well, see below. I am wondering if I am falling into this trap now, maybe I am working off estimate 2 or 3, when I should be working off estimate 4.

Image source: https://mattjoass.com/2018/11/10/inflection-point-investing/

Conclusion

Mr. Morton did a great job helping to refocus LaserBond on their core business, the results of which are clearly beginning to bear fruit. They have divested the non-profitable parts of the business and grown organically whilst reducing expenses and have achieved a HY2019 EPS just shy of the EPS produced for FY2018. I do however believe the market has repriced the company about where it should be, given the recent developments and their growth. They did generate $10.5m of revenue (45% increase pcp) in the first half, but given that their revenue is close to 50% first half 50% second half, they will still need to double that in both halves before they reach $40m revenue, not an easy task, but definitely achievable.

I set out to do this post to try and learn from other people’s successes. Instead it has reignited my belief in value investing, but at the same time, emphasised the need to look for companies going through inflection points. Missing a small percentage of the upside is better than purchasing and holding out for years in the hopes the market might see the mistake it has made. It has also shown me that I need to spend more time on Strawman watching what other great investors such as Wini are doing, reading their reviews on companies and learning what I can from them.

Whilst I missed the ship with LaserBond, it’s great to see that there are potentially still mispriced companies out there, especially given how long this expansion has been going on for.

If you liked this and would like to read more, I have started working on a series about inflection point investing, read my first post about XRF Scientific here, the second post about Korvest here, the third about Paragon Care here and don't forget to subscribe, so you don't miss out on my upcoming posts. I am on Twitter Follow @MaysTrav and Linkedin  if you’d like to connect, feel free to send me a msg, it’s always great to meet other ASX investors, especially those who have a different view point 

Thanks for reading

 

Just Culture Investor

Trav Mays

Subscribe to Just Culture Investor by Email 

Sources:

1.       https://www.livewiremarkets.com/wires/a-platinum-crucible-in-the-rough

2.       https://www.amazon.com/100-Baggers-Stocks-100-1/dp/1621291650

3.       https://www.waypointstrategies.com.au/

4.       https://www.quickflix.com.au/

5.       www.Strawman.com

6.       https://mattjoass.com/2018/11/10/inflection-point-investing/

The author is not a current owner of a portion of LaserBond, they may however still be subject to one or a number of biases, more specifically anchoring and/or confirmation bias. This article is neither general nor personal advice and in no way constitutes specific or individual advice. The website and author do not guarantee, and accept no legal liability whatsoever arising from or connected to, the accuracy, reliability, currency or completeness of any material contained on this website or on any linked site. This website is not a substitute for independent professional advice and users should obtain any appropriate professional advice relevant to their particular circumstances. The material on this website may include the views or recommendations of third parties, which do not necessarily reflect the views of the website or author, or indicate its commitment to a particular course of action. The author could change their opinion on any of the holdings at anytime and are not under any obligation to update the website if/when this occurs.