Description

Description/Elevator Pitch

J2 Acquisition Ltd is a blank-check company run by Martin Franklin of Jarden fame, who recently completed their business acquisition of APi Group, a large conglomerate of regional fire safety, specialty contracting, and industrial businesses. J2 (which is now effectively the APi Group) trades at an extremely attractive discount (124% upside to our base case PT of $22.19) on conservative forward estimates with expectations for generating massive amounts of cash, caused by liquidity structure in SPACs and technical selling. This allows an unbelievable opportunity for investors.

Exhibit 59: Risk/Reward Framework

The key high-level points are

• FCF Monster: An operating model that generates significant cash flow under almost any market condition (never gone cash flow negative including in the Financial Crises). This is at the center of this idea.
• This company generates enough cash that they could buyback almost 50% of the float at prices 50% ABOVE LAST under conservative assumptions [we expect them to do deals though]
• They generate so much cash they have been able to more than double their organic revenue growth rate over the last 8 years via accretive M&A completely internally funded without ever needing to tap external sources
• In the next 5 years (including 2019), they will generate almost much cash as the current market cap...after interest, after capex, after working capital…
• Huge Valuation Discount: They trade at discounts to even the most conservative comp valuations, resulting in superior risk/rewards with a clear explanation and defined catalyst to remove that discount. We see a 8.0x reward-to-risk in the equity from current levels to our base case valuation, which we believe very conservatively values them at discounts to peers with inferior businesses, margins, growth, and cash generation.
• Catalyst: As mentioned above, this stock trades at a discount due to the fact that there is no real market post-merger. Martin Franklin got a great deal, and the stock is in no-man’s land as it is illiquid, OTC, doesn’t clear DTC (for 2-5 weeks), has no coverage (recent $14 PT from CJS notwithstanding), and minimal shareholder engagement so far. They will clear DTC within 5 weeks. They will list on the NYSE in March 2019 and be eligible for index inclusion and can finally see some vanilla demand. They will get coverage (multi-billion dollar company led by the team behind Jarden and Nomad [each well covered on the street]). They will market this story and people will understand the model here. 
• Supply/Demand: Similar to the above, once those catalysts hit, there should be a massive supply/demand imbalance. The holders list is guys who are loyal to Martin Franklin and understand this deal. There has been no panic selling into it. 50% of shareholders exercised their warrants to INCREASE their positions post-deal. This is a closely held stock and at these levels, there will not be a ton of supply. What happens when the buyers can come in?
• Market Position: Strong market positions in core markets, with 7% historic organic growth (15% total CAGR with M&A), an easy expectation for  GDP+ growth going forward, and an ability to take share in regional markets. This is a company with #1 share in their core business (Safety Solutions), 85% customer retention rate, low customer concentration (no customer or project >5% of revs), and a top 5 specialty contractor. The business is acyclical, with multiple diverse business lines, and strong service revenues. There are plenty of tailwinds, even if not much growth is needed to drive value.
• M&A: APi Group proven roll-up strategy that has created enormous value over the years, along with a synergistic fit with new management who has executed a similar strategy. There is a large pipeline of fragmented opportunity. This has been extremely successful for APi Group [and J2’s sponsors with Jarden/Nomad] over the years, and could drive significant upside to our target valuation.
• Sponsor who creates value: A sponsor with a track record of creating value in a similar model that sees the opportunity here and knows how to execute. Franklin and team operated a similar model at Jarden (in the consumer space), and know how to operate a centralized management office overseeing multiple brands run by empowered leadership teams. They see this as an even bigger opportunity than Jarden, and are completely aligned with you (own ~10% of the company pro forma).
  • They will also quickly use this experience to boost margins, with a target to increase Adj EBITDA margins from ~10% in 2019e to ~12%+ in 2023e. Management has identified low hanging fruit and does not see this as an aggressive target. Their experience implementing technology, purchasing power, ERP systems, payroll, and more at Jarden will create opportunity for growth here. 

As discussed in more detail below, there is a supply/demand imbalance in the stock due to technical reasons surrounding the UK SPAC structure (listing, liquidity, management engagement with the investment community, sell-side coverage, and position trimming/profit-taking) that is creating the valuation discount, all of which should clear up by the end of 1Q20. Starting a position now give investors the opportunity to get ahead of this re-rating when supply dries up and demand increases, investing alongside (and indeed at a discount to) management and prominent investors Viking Global in an extremely cheap and cash generative security.

We use multiple valuation methodologies [DCF, P/E, EV/EBITDA, and FCF Yield] under multiple cash deployment scenarios [cash building on the balance sheet, debt paydown + accretive M&A, debt paydown + share buybacks], and our base case scenario is a PT of $22.19, +124% from last. The cash flow protection on the downside, ability to generate cash in recessionary environments, and discounted valuation provide downside support at ~$8.40 [-15.2% off last]. This creates a base-case reward/risk of 8.0x, one of the most attractive situations we have ever seen.

Transaction Background

On 9/3/19, J2 announced they were acquiring APi Group. APi Group is a market-leading provider of commercial life safety solutions and industrial specialty services. By acquiring JJAQF, you are initiating a position in pro-forma APi Group. APi Group is organizing itself into 3 separate business units for it’s life as a public company, which we will discuss in more detail below

1. Safety Solutions – 44% of revenues
2. Specialty Services – 31% of revenues
3. Industrial Solutions – 25% of revenues

These businesses represent an amalgamation of multiple regional fire safety, specialty contractor, and industrial construction products and services. Their largest segment, Safety Solutions, is mostly fire detection and protection, where APi Group is the leading independent integrator of safety systems and the #1 fire protection and sprinkler provider. In Specialty Services they are a top-5 specialty contractor in the United States. 95% of their revenues are in the US and they operate under the regional brand names while providing the expertise, resources, backing, and technology of a multi-billion dollar company.

A quick note on the tickers. J2, which currently trades only in the US under JJAQF, is the ticker of the blank check SPAC business. They have already completed their acquisition of APi Group, and thus are one and the same now. When the full listing process in the US is complete, the ticker will change to APG, representing the completion of the process into a NYSE-listed, multi-billion dollar company.

Safety Solutions [~44% of LTM revenues as of 6/30/19; Implied $1.76bn in ‘19e revs based on same contribution]

Business Description: Safety Solutions is APi Group’s largest segment, containing market leading positions and is the most homogenous business segment. Almost all of the companies in this segment consist of fire protection companies. They offer both products and services including life safety, emergency communication systems, mechanical services, and a full suite of alarm and detection systems from engineering and design to fabrication and installation to back-end work such as inspection, repair, monitoring, retrofitting, and upgrading. While the majority of the companies in this segment are commercial fire protection companies, it is worth noting that they do have other businesses in this group, including Grunau (offers HVAC, temperature control, electrical, refrigeration and more), Twin City Garage Door Co (garage doors), Metropolitan Mechanical Contractors (large-scale design and construction contractor who worked on Target Field and Mall of America among others), Tessier’s (HVAC), and more. 

Exhibit 1: Safety Solutions Businesses from Investor Presentation

Market Position:  As mentioned above, APi Group is a leading independent integrator of safety systems and the #1 fire protection and sprinkler provider.

There are 65 separate regional companies in this segment, and APi mention that the large installed base drives significant recurring revenue through service and monitoring agreements. And that is a significant theme for much of APi’s strategy. They focus on getting the contract work, which drives success in multiple ways. (1) This is a recurring revenue stream that is typically much higher margin, which can be seen in APi groups strong margins compared to comps and (2) It creates a client relationship allowing for higher margin business on new project work. Typically a client will be looking for sub-contractors for work, and puts out an RFP that receives multiple proposals mainly competing on price. This drives margins lower as it’s a race to the bottom. However, by establishing that relationship, APi Group can often get exclusive work which drives less price competition and increases margins.

Life Safety’s revenue mix is ~40% recurring service work, up from just 21% in 2008. Management has called this recurring revenue “high margin business”. This helps insulate from downturns, gives visibility into revenue/earnings, and drives the benefits mentioned above. The deal presentation also mentions Fire & Security end markets as acyclical. In fact, management said on the deal call that Life Safety is a strong backbone to the business and enjoys a strong margin profile. In meetings, they have said this is a ~12% EBITDA margin business.

As the #1 fire protection company in the US, APi Group companies in this segment benefit from national scale and sophistication that regional providers can’t match. Due to local ordinance and building codes, as well as the smaller scale nature of the work, much of fire safety is still a regional business. However, with the strength and sophistication of a multi-billion dollar organization behind them, APi Group companies have access to technologies and offerings local firms can’t compete with, such as specialty foams, hazmet, different fire suppression options, and more. And being number 1 in market share, as well as strong relationships, also means they are typically first call on many projects.

Market Characteristics/Growth: Management also expects growth here to be driven by non-discretionary regulatory spend, providing a stable annuity stream of revenues. Management cites the National Fire Prevention Association as showing the US Fire Safety Market growing at a CAGR of 7.8% from 2018-2025. 

Exhibit 2: US Fire Safety End Market Growth from Investor Presentation

Management’s presentation notes the significant damage from inadequate fire protection (citing statistics from the NFPA), which is leading to increasing public awareness and related regulation, which they say creates growing tailwinds for APi.

Other third party research firms generally agree with the view laid out by management

• Allied Market Research: Allied Market Research sees the North America Fire Protection Systems market as growing from $13.79bn in 2017 to $25.58bn in 2023, representing an 8.5% CAGR. Allied thinks tailwinds include a “growing requirement for fire protection systems across various industry domains and increasing need for automation in residential and commercial buildings drive the growth of the North America fire protection system market. Moreover, stringent government regulations and infrastructural developments in the sector supplement the market growth. However, higher costs of installation and maintenance hinder the growth of the market. On the other hand, technological advancements and innovations in equipment and networking would create new opportunities in the industry in future.” Allied’s report discusses various product and service segments and notes installation & maintenance will grow at a CAGR of 10.8%, due to a need to ensure rapid ROI and facilitate faster delivery, which has been noted as a focus area for APi Group management. 
• Grand View Research: Grand View Research sees the global fire safety equipment at $58.43bn in 2018 [of which they pegged North America at $22.18bn] and expect an increase at a CAGR of 8.8% from 2019-2025. They list tailwinds as “Growing demand for advanced fire safety systems for industries, such as manufacturing, utilities, petrochemical, mining, oil & gas exploration, energy & power, automotive, and construction” and mention developed regions, including North America, as having implemented stringent regulations which mandate the installation of fire safety systems at industrial, residential, and commercial places. They mention reconstruction activities and implementation of building safety codes against fire protection as helping growth here. 
• Zion Market Research: Zion Market Research saw the global fire protection system market at $57.31bn in 2018, which they expect to increase at a CAGR of 8.1% from 2019-2025, reaching $98.85bn in that final year. Regarding services, Zion specifically said “The maintenance service segment is anticipated to lead the market in the future, owing to its increased demand across different verticals.” As mentioned above, this is a key focus for APi Group. And the report also mentions that North America, while not growing as fast as APAC, will contribute the largest share to global fire protection system market in the future, a key statistic for APi Group who generates 95% of their revenues North America. The report says North America will be driven by major infrastructure developments and favorable government regulation/increasing concerns on fire safety
• Market Research Future: Market research future also looked at the global fire protection systems market, which they said would grow at a CAGR of 8% from 2017-2023 in order to hit a total valuation of $95bn in that last year. They mention North America leads the global fire protection systems market and is expected to witness “a fabulous market growth during the review period.
• Research and Markets: Research and Markets had a note pegging the global fire sprinkler market at $9.1bn in 2018, which they see growing to $14.7bn by 2023, with an 8% CAGR over the period. Said owing to frequent loss of life and possessions in fire incidences, installation rate for sprinkler systems has escalated the past few years. They also mention governments across the globe imposing strict regulations for installation of fire sprinklers. 
• Market Research Consulting: MRC sees the Global Fire Sprinkler Market at $7.66bn in 2017, which they expect to grow to $19.95bn by 2026, a CAGR of 11.2%. Regarding tailwinds/headwinds, MRC said “Factors such as rising trend of automation in commercial buildings and different norms of government agencies and growing fire protection expenses in different enterprises are fueling the market growth. However, high cost of retrofitting and lack of integrity in system interfaces are some of the factors hindering the market growth.” 

While it’s difficult to put too much emphasis on any single research report, here we have multiple sources corroborating similar market growth expectations, as laid out below. This includes industry trade groups (NFPA), management, and multiple third party research organizations. We can see these growth rates coalesce around a high-single digit CAGR over the coming years, and while the different periods and geographic markets /product markets make it impossible to do an average, it is telling that all the different periods and methods seem to confirm the solid growth rate in this end market.

Exhibit 3: Third Party CAGR’s in Fire Safety

Specialty Services [~31% of LTM revenues as of 6/30/19; Implied $1.24bn in ‘19e revs based on same contribution]

Business Description: Specialty Services is the APi Group’s other core focus market, together a leading provider of infrastructure services and specialized industrial plant solutions. Service offerings include installation, maintenance and repair of critical infrastructure such as underground electric, gas, water, sewer, telecom infrastructure, specialty construction projects, and diversified civil construction. They mention customers as public and private utilities, communications, industrial plants, and government agencies.

 Exhibit 4: Specialty Services Businesses from Investor Presentation

As seen above, there are ~14 companies in this segment:

• APi Contruction Co: Specialty industrial contractor. Preform high-quality, reliable installation services at many of the industry’s largest power plants. Contractor for scaffolding, insulation, lagging, industrial siding and refractory services. Experienced with midstream and downstream projects, coal-fired boilers, air quality control systems (AQCS), natural gas power plants, and specialized nuclear power plant maintenance. In addition, APi has completed many projects across the pulp and paper, waste-to-energy, mining, and petrochem markets
• APi Distribution: APi Distribution is a leading supplier of insulation, high-performance coatings, and specialty building products for commercial, industrial, residential, and oil & gas industries. Their inventory includes a wide range of insulation products and accessories that control temperature conserve energy and attenuate sound. They provide fiberglass, ceramic blankets, mineral wool, polystyrene, polyisocyanurate, calcium silicate, spray polyurethane foam and jacketing (metal and PVC) and other insulation accessory products.
• Arrowhead Refrigeration: Air Conditioning Contractor [now a Jamar company]
• ASDCO: Construction supply company to contractors across multiple markets in the Midwest.
• Classic Industrial Services: Construction service organization specializing in insulation, scaffolding, siding, refractory, electric heat trace, and fire proofing.
• ICS: Provides structural, mechanical, security, and civil solutions to clients. ICS provides a wide variety of expertise to our customers including: safety, quality control, carpentry, earthmoving, excavation, heating and ventilation, steel fabrication and erection, plumbing, high-pressure steam piping, pipefitting, pipelines, security equipment installation and maintenance, concrete placement, precast installation, masonry, millwright work, welding, industrial process equipment installation, hoisting and rigging, and surveying.
• ICI: ICI deliver professional mechanical and electrical construction services. ICI have extensive experience specializing in boilers, piping, electrical, structural steel, equipment and all facets of the industrial construction market.
• J Fletcher Creamer & Son: J Fletcher is a construction contractor with services across all range of construction including guide rail, heavy construction, pipeline rehabilitation, utility construction, and more.
• Jamar: Specialty Contractor solving difficult challenges for industrial and commercial customers. Services include industrial construction, plant maintenance services, specialty fabrication, HVAC & plumbing, architectural metal & roofing, commercial & industrial service, roofing service, and thermal insulation.
• Mid-Ohio: Industry leader in pipeline construction, specializing in natural gas distribution, transmission, and related facilities. 
• Modulus MEP: Construction integrator
• M Lukus Company: Leader in refractory services in the upper Midwest.
• NYCO: Mechanical insulation contractor specializing in insulating piping, ductwork, tanks, vessels, boilers, and other equipment for the commercial and industrial markets. Applications include hot, cold, and cryogenic piping and equipment for office buildings, schools, hospitals, power plants, petrochemical facilities, food processing plants, and others.

Management has described this business as more “institutional” with MSAs.

Market Position: The PR and investor presentation bill Specialty Services as a “leading” provider of infrastructure services and industrial plant solutions. As noted, APi Group is a top 5 specialty contractor.

They also mention that their competitive moat is that they have regional leading businesses, suggesting attractive positioning in end markets here. APi Group overall has only a 1.5% project loss rate, with recurring customers of 85% as noted above. Between the above facts, and organic growth greater than their end markets and competitors, it is clear this is a successful business for APi.

 They view this as an attractive business, and mention this business line also has ~12% EBITDA margins.

Market Characteristics/Growth: The presentation discusses tailwinds in general for the company, and some applicable to this segment include evolving regulation (water quality/pipeline upkeep), a $2.0bn US infrastructure plan, 5G broadband capex, aging infrastructure base in the US, a shortage of skilled craft labor, and market consolidation. Management mentions that this business is “positioned to capitalize on secular industry tailwinds”.

J2 and APi Group mention in their presentations that they have “favorable market dynamics” and show end markets of US Infrastructure Spending and US Non-Residential Industry Growth by End Market:

Exhibit 5: US Infrastructure Spending CAGR by end market from Investor Presentation

Exhibit 6: US Non-Residential Industry CAGR by Industry from Investor Presentation

As would be expected, given the business is described as more “institutional” and clearly involves large amounts of specialty contracting and construction services, these end markets seem extremely relevant to the growth of this business line. They also appear to line-up well with the 7% organic growth seen at APi Group from 2010-2018 as a whole. Total Construction dollars in the US grew at a 6.2% CAGR over this period, while Non-Residential construction grew at a more tepid 4.0%. However, APi’s key end markets of Lodging (13.3%), Office (8.8%), Commercial (11.4%), Manufacturing (7.0%), Communication (4.2%), Education (1.3%), and Health Care (1.0%) grew at a faster rate on average. In fact a simple average of those end markets resulted in a non-residential CAGR of 6.7% from 2010-2018, very similar to APi Group’s overall organic revenue growth rate (noting that their other large segment also has similar growth).

Exhibit 7: US Non-Residential Industry CAGR by Industry from 2010-2018 (data from US Census Bureau)

As seen above, using a similar method implies a similar expected forward growth rate. The presentation shows Lodging with growth at an 11% CAGR from 2013-2022 (implying a slight downtick from the above), Office at 10% CAGR over the same period (implying a slight increase from the above), Commercial at 8% (implying a slightly higher 340bps deceleration from the above), Manufacturing at 6% CAGR (a slight downtick), Communication at 5% (slight uptick), Education at 4% (implying a large uptick of 300bps), and Health Care at 2% (mostly inline).

Given the high correlation between these end markets, the business strategy, and the past results, it makes sense to expect a similar performance going forward, especially with roughly similar growth expected through at least 2022.  

Industrial Solutions [~25% of LTM as of 6/30/19; Implied $1.00bn in ‘19e revs based on same contribution]

Business Description: Industrial Solutions is APi Groups smallest market, and they specifically have pointed to the other two business lines as their focus going forward, with plans to de-emphasize this business.  They describe this business as being a niche specialty contracting service to diverse end markets, a leading transmission and distribution specialty services contractor, providing a full suite of solutions to midstream oil and gas to build new pipelines and perform integrity management + maintenance. They also provide other specialized services such as steel fabrication.

Exhibit 8: Industrial Solutions Businesses from Investor Presentation

As seen above, there are ~12 companies in this segment

• LeJeune Steel Company: Steel fabricator with an output capacity of >40,000 tons of structural steel per year
• Wisconsin Structural Steel Co (WSSCO): Associate company of LeJeune, which has shared management, inventory, and ownership. WSSCO boasts steel fabrication production rate of >10,000 tons per year
• Industrial Fabricators Inc: Industrial Fabricators, Inc specializes in industrial silencers (noise control for industrial processes like engines, blowers, turbines, etc) used for both safety and environment. Silencers are used primarily in industrial and heavy equipment applications. They ship silencers to plant locations and equipment sites worldwide, including engine exhaust mufflers to South Korea, and steam blow down silencers to Ireland.
• Northland: Northland is a construction company whose work includes Earthwork/Utilities, asphalt paving/production, crushing/screening (literally crushing rocks down and screening out raw material from quarry cites/mines/construction sites),
• M&N Energy Services: M&N Energy Services is a leader in non-union pipeline and facility construction industry serving the oil & gas industry in western Canada. M&N projects consist of small-to-medium pipeline diameter construction (above ground and below ground lines), compressor, battery and pumping station construction. Most of the larger projects have been in the oil sands of southern Saskatchewan. The company works with a variety of pipeline materials such as steel pipe, HDPE pipe, flex pipe and fiberglass pipe.
• Quality Integrated Services (QIS): QIS was initially focused on inspection of pipeline construction, compressor stations, metering stations, pumping stations, and tank farm facilities, but have expanded to include project management, construction management, fiber optic construction inspectors, rights-of-way acquisition, as well as, safety and Operator Qualification training for pipeline construction personnel.
• Summit Pipeline Services: Summit Pipeline Services is a construction services based company providing maintenance, rehabilitation and installation of piping and facilities services to the oil and gas transmission industry in Canada. Summit Pipeline Services offers customers corrosion remediation, leak repair, valve replacement, pipeline replacement, pipeline installation, hydrostatic testing and pipeline coating.
• Jomax Construction: Jomax is one of the leading cross-company pipeline contractors west of the Mississippi. Jomax specializes in laying cross-country oil and gas transmission pipelines of 50 to 100 miles in length, and up to 24 inches in diameter. The client base includes numerous mid-stream oil and gas transmission companies. Jomax has three complete mainline “spreads” (crews) that perform the cross-country pipeline installation. Jomax owns Okemah Construction Inc., a complimentary mainline construction business in Okemah, Okla.
• Kanyon Specialty Contractors: Their website re-directs to Jomax, so it appears they are the North Dakota subsidiary of Jomax, providing similar pieplein contracting services
• United Piping Inc (UPI): General contractor specializing in the construction of new, and modifications of existing facilities for the oil and gas industry. Offer a variety of construction and maintenance services including Pipeline Facility Construction, Pipeline and Facility Maintenance, Shop Fabrication, Horizontal Directional Drilling, Hydrostatic Testing, Access Services, Cathodic Protection, Blasting/Coating/Paiting.
• J Koski Company (JKC): JKC on APi Group’s website re-directs to the UPI website, so they are probably  a subsidiary of them, and UPI does indeed show it’s HQ in Duluth, MN, where J Koski was based. However, certain press releases also mention them as partnering with Jamar. An article in EMI Magazine mentions them as an oil and gas pipeline and well construction company, which would fit well within UPI
• Push HDD: Push does not show up as a separate company, but APi Groups financial statements mention certain assets of Push HDD, a directional drilling contractor HQ’s in Duluth, MN were acquired in April 2017.

Management has stated this business line has ~50% exposure to oil and gas (which is expected to decrease over time), with the remainder appearing to come from steel fabrication, silencers, and large construction support from Northland.

Market Position: There isn’t a ton of discussion around APi Group’s position in the industrial market, but guidance is that margins in this segment are much lower, and the oil and gas business is notoriously difficult for construction/supply firms. Management has pegged this business at closer to ~8% EBITDA margins, and as noticed it is not one of their key “focus” divisions going forward.

Market Characteristics/Growth: Given this market is mainly levered to construction equipment, construction support, and pipeline construction, it is easiest to focus on those end markets. While US Census data shows the “Power” market grew at a 2.3% CAGR from 2010-2018, it peaked in 2015 and actually grew at a -8.8% CAGR from that 2015 peak to 2018. This lines-up roughly with a study done by Deloitte which reflected midstream capex at a CAGR of -7 to -11% from the period of 2014-2018. 

Exhibit 9: Midstream CapEx 2014-2018 per Deloitte

 

Despite this, APi Groups presentation shows US Oil & Gas Pipelines growing at a 1.9% CAGR through 2024. This is the only end-market they showed through 2024e though, which raises the question if it was chosen to reflect a better growth rate then what is expected through 2022e.

This may be due to the mixed outlook on the space, with many reporting “caution”, with very mixed drivers. While some have credited Donald Trump’s election with increasing activity, it also may have resulted in certain projects being pulled forward ahead of a 2020 election. Per North American Oil & Gas Pipelines, “Long-term, the prospects for both the pipeline and distribution markets are solid and will continue to exhibit growth. Both the Interstate Natural Gas Association of America (INGAA) and American Petroleum Institute (API) are equally bullish.” They also mention how the pipeline construction segment is (naturally) tied to the prices of crude and natural gas. This was responsible for the downturn in 2015/2016, when “the typical U.S. pipeline contractor saw revenues fall between 40 percent and 60 percent since the 2013/2014 peak.” They show growth of ~4-5% going forward for this segment.

Offsetting some of the negatives above is the large backlog and current construction activity of pipelines, whether the Dakota Access, Rover, Mountain Valley, Permian, and more.

With oil & gas comprising roughly 50% of the segment, and 2% growth going forward, as well as overall US infrastructure spending at 3%, it’s hard to expect much more than low-single digit growth out of this segment, with large amounts of volatility. Thankfully as the smallest revenue and lowest margin segment, the impact on the larger APi group from lower growth here should not cause material impacts to the company.

Exhibit 10: US Transmission & Distribution CapEx from 2007-2022 per NAOGP

 

M&A History + Sponsor Track Record + Expectations

APi Group has a strong history of successful bolt-on M&A, and is the result of multiple, accretive roll-ups. This is apparent in their strong top-line growth, over and above an already impressive organic level:

 

 

 

 

Exhibit 11: APi Group’s M&A History per Investor Presentation

 

As seen in the graphic above, APi Group reports having completed >50 acquisitions since 2005, around when current CEO Russ Becker took the helm. This impressive, targeted acquisition strategy has allowed APi Group to grow it’s topline at more than double the rate of its organic growth rate, giving APi Group an additional $1.6bn in revenues, which equates to ~$160mm in additional EBITDA at average 2019e Adj EBITDA margins.

Most impressively, is that they have done this at multiples of 4.0x-5.0x on average. This should equate to roughly $410mm in value creation conservatively assuming they are still trading at 7.6x ‘19e EBITDA (far below our price target), with no margin pick-up from these businesses. That corresponds to a 51% ROIC in the deals completed between 2010-2018, an incredibly impressive use of capital.

And what is the most incredible part of all of this? They funded this all out of internal capital! This is a company that has generated enough cash to more than double their top-line growth rate and create hundreds of millions in value, all without tapping the debt or equity markets. That is an unbelievable story.

And what is so exciting about this opportunity is that Martin Franklin and team are just as excited about the opportunity going forward. See the APi framework below for why this disciplined strategy works, and fits so well with J2’s pedigree. Franklin described the M&A pipeline as just as exciting as the organic growth prospects, with large markets that remain extremely fragmented. APi Group gets a look at every Fire Safety deal due to their market positioning, and the regional managers being empowered means that APi Group managers can also source deals.

Exhibit 12: APi Group’s M&A Criteria per Investor Presentation

J2 believes that APi Group has a strong pipeline of deals, and sees large avenues to create value via roll-ups. Given Jarden’s track rolling-up various companies, this should be a perfect fit and opportunity to create a ton of value. The below presentation should make obvious to anyone the enormous fit between J2 and APi Group, and truly demonstrates the opportunity here. This is a management team that has executed on a similar strategy (albeit in a separate market), in a very similar business model, who executed and delivered value to shareholders at incredible rates.

Exhibit 13: Jarden’s M&A History  per Investor Presentation

Martin even said he sees this as a similar opportunity to Jarden, but on a LARGER scale.

Model Drivers

Revenue

Bringing the above all together, it appears that Safety Solutions can be expected to grow at a 7-8% CAGR organically, while Specialty Solutions appears likely to grow slightly faster than GDP due to end-market exposure. Industrial Solutions is bound to be relatively volatile, but it looks like assuming ~2% growth for that end-market makes sense given the various offsetting positive and negative tailwinds/headwinds smoothed over the next few years. Below is forecasted GDP growth over the next two years. Management has reiterated that they see this business as growing faster than GDP.

Exhibit 14: US GDP (and forecast) 2012-2021 per Bloomberg ECO

The below is a chart of revenue CAGR inputs to be used in the model, with the high-end estimates being illustrative [we will not use these, although our “high-end” estimates matching the organic growth from 2010-2018 should show these are not at all aggressive]. 

• The high-end estimates are based on:
• Safety Solutions: Based on the higher-end of the revenue CAGR based on the various market reports at ~8.0% [of the 7.0%-8.0% range]
• Specialty Services: Based on the historical organic CAGR of the end-markets that APi Group focused on, with the forward estimates for those core markets not differing materially per the presentation. 
• Industrial Solutions: High-end estimates per pipeline capex estimates from North American Oil & Gas Pipelines and US infrastructure spending estimates

Exhibit 15: High-End Estimated CAGR

 

• Midpoints estimates: For all sections, a simple average of the high-end CAGR and low-end (non-recession) CAGR

Exhibit 16: Midpoint Estimated CAGR

 

• Low-End Estimates
• Safety Solutions:  Based on the lower-end of the revenue CAGR based on the various market reports at ~7.0% [of the 7.0%-8.0% range]

• Specialty Services: Growing at projected GDP going forward, slower than the average US Total Infrastructure forecasts out of caution, despite superior performance in the past.

  Industrial Solutions: No growth, representing lower-end estimates from various market projections on the segment.

Exhibit 17: Low-end Estimated CAGR

• Recession Estimates
• Safety Solutions: Recession assumes that the lag on the 40% of Safety Solutions that is services continues to grow at 7% due to regulatory requirements. New construction declines by the -9% peak-to-trough CAGR of Non-Residential Construction from 2008-2010 per US Census Data on the remaining 60% of the business. Recession lasts 2 years and rebounds to the low-end of estimates and then the midpoint of estimates.
• Specialty Services: Decline of 9% represents the peak-to-trough CAGR of Non-Residential Construction from 2008-2010 per US Census Data. Recession lasts 2 years and rebounds to the low-end of estimates and then the high-end of estimates.
• Industrial Solutions: Blend of a 2yr decline of 50% in the half of the business exposed to oil & gas pipeline construction (matching the decline in 2015/2016 in pipeline capex). Other half of the business levered to construction declines by the -9% peak-to-trough CAGR of Non-Residential Construction from 2008-2010 per US Census Data.  Recession lasts 2 years and rebounds to the low-end of estimates and then the midpoint of estimates. In reality, this could likely bounce back much faster given actual results observed post 2015/2016 where the oil and gas segment had large losses followed by equally large rebounds.

Exhibit 18: Recession Estimated CAGR

 

Overall, this gives the following table of potential revenue CAGRs over the next 4 years. 

Exhibit 19: Modeled Scenario CAGRs from 2019-2023e

Our “base case” valuation reflects the “low-end” CAGR assumption above, both out of caution and in order to reflect the potential for a near-term demand softening recession, although not quite to the extent of a prolonged downturn reflected in the “recession” numbers above. APi Group has shown an astounding ability to navigate downturns, and their strong core service offerings in regulated environments will hold up well even if private investment slows.

Our “bull case” reflects the midpoint of estimates, which as we pointed out we believe to be conservative given the actual high-end estimates expected and correlate well with past performance, including through the industrial recession of 2015/2016.

Our “bear case” estimates will reflect the full prolonged recession estimates that drive a 4 year -1.5% CAGR, which per the below revenue growth chart from the APi Group Presentation is a greater drawdown then even the 4 year period following the great recession [2012 revenues of $1.731bn were actually above 2008 levels of $1.605bn, whereas this model assumes 2023e revenues of $3.769bn, ~6% BELOW the 2019e revenues of $4.0bn]

Exhibit 20: APi Group Revenue Chart from 2007-2018 per Investor Presentation

We believe that the above is extremely conservative, and management has pointed to numerous tailwinds that should support these business lines, including much needed infrastructure investment, supporting new non-residential construction activity, providing retrofit and upgrade services to existing buildings, delivering the services required for new technologies such as 5G, or supporting the growth of life safety service contracts for existing customers. Management has consistently pointed to the fact that their Life Safety recurring service revenues were only 21% in 2008 and have now grown to 40%, enabling them to be much more able to withstand recessionary environments. There are currently high amounts of fire damage due to inadequate protection and increasing regulatory requirements, which will continue to drive growth in Safety Solutions, while 5G expansion and outdated US infrastructure, combined with a shortage of skilled labor, should provide numerous tailwinds throughout market cycles.

Management has also mentioned that they believe they have a robust pipeline and are not completely levered to new builds, so some of the growth rates similar to non-residential construction may be conservative in light of their higher service revenues. 

EBITDA Margins

Another key input is managements goal to expand their adjusted EBITDA margins from ~10% to 12%+ by 2023e. Adjusting for acquisitions, adjusted EBITDA margins have been consistently in the 9-10% range for 2016-2018, with a 10% target for 2019. 

Exhibit 21: APi Group Adj EBITDA margins per Investor Presentation

They can pick-up margin in a few ways. First, as the mix shifts towards the higher margin end-markets of Safety Solutions and Specialty Services, the model shows them picking up ~15bps in margins just based on mix-shift organically. This doesn’t include the fact that M&A will be focused on higher margin Safety Solutions and Specialty Services, as well as potential non-core divestitures in low-margin Industrial Services.

Both APi Group management and the J2 sponsors believe there is low-hanging fruit for margin expansion, and both see the 12% target as conservative. APi Group had actually targeted margins at that level before the involvement of J2. And with J2’s sponsorship, they should be able to see cost savings in the conglomerate model, as this is very similar to how Jarden operated with disparate brands coming to a centralized management company. The J2 team is extremely experienced in collecting data from regional/heterogeneous businesses and improving central functions such as purchasing power, payroll, etc. ERP investment should drive increased ROIs as the technology upgrades allow APi Group to improve their operations and cut down on expenses.

In numerous discussions, it appears the bottom-line is this is a very achievable target from both an operations perspective given APi’s own detection of cost savings and an execution perspective given J2’s fantastic track record in driving business improvements in a centralized manner. 

Exhibit 22: Jarden Adjusted EBITDA margins 2008-2015 (data per Bloomberg)

Our “base case” model assumes Adj EBITDA margins expand linearly from 10% in 2019 to 12% in 2023. Our “bull case” model assumes margins expand at an increased rate, to 12.5% in 2023, while our “bear case” model assumes margins revert to 9%, before rebounding to 10% post-recession. As seen, even in the industrial recession, Adjusted EBITDA margins held up at these levels. A strong service mix, a propensity to not take low-margin business [much of compensation is tied to margins, not revenue growth], and strong levers to pull [variable cost structure with labor being one of the largest costs makes it easy to scale accordingly]. As we will discuss in the next section, cash flow also does astoundingly well in recessionary environments.

Cash Flow Bridge

The most incredible part about APi’s business is it’s large cash flow generation, an attribute which holds up in all environments. In fact, APi Group has been able to fund not only all of their CapEx, but also their M&A activity through organic cash flows without tapping the debt or equity markets. The long-term operating model calls for “continued” free cash flow conversion of 80%+, a level that management has said is very consistent over time and cycles. However, we need some adjustments to get from that number, which includes only CapEx, to levered FCF.

• CapEx: We keep the CapEx at 20% of Adjusted EBITDA in our model, given the aforementioned consistency in this calculation [2.0%-2.5% of sales, although speaking with the company this seems a bit on the high-end, any decrease increases cash flow and target price]
• Working Capital: Simplistic working capital defined as current assets – current liabilities was 3.0% in 2017 and 3.4% in 2018. However, management has guided to a higher number here of ~10%. Given the change in working capital is taken out of Adjusted EBITDA, we use Revenue Chg x 0.10 to get to the change in working capital to be stripped out for FCF.
• Cash Taxes: We use the 23% tax rate as complete cash taxes. We value the NOL separately at its NPV.
  • Note: Management has made a 338(h)10 tax election, allowing them to step-up their tax basis and receive tax benefits the company has valued at a $180mm NPV.
• Interest: Interest is the ~4.8% interest rate x the principle amount, with principle being paid down to 2.25x [versus guidance of 2.0x-2.5x].  APi Group saw strong demand for the $1.2bn cov-lite TL their priced at L+250bps in late September.

EPS Bridge

• Taxes and interest expense calculated per the above

   

• D&A is ~2.0% of sales, per guidance (while higher than the historic ~3.5% from 2016-2018, the difference is related to public GAAP accounting, with the GAAP number closer to 2.0%)

• Share count is modeled per the below, with buybacks included when noted

•  

  Note: We run 3 capital usage scenarios across 3 market environments for our sensitivity table. The market environments are the “bull case”, “base case”, and “bear case” revenue and margins above, while the capital usage includes letting cash build on the balance sheet, using it for buybacks, and using it for accretive M&A, all after paying down debt to the target level.

   

Starting Capital Structure

Below shows the sources and uses of cash in the J2 acquisition of APi Group. J2 issued 125mm shares at $10.00 per share, raising $1.25bn in its initial IPO. It has since invested the cash in short-term securities, increasing its available cash. J2 also solicited early tenders for its outstanding warrants, with about half being exercised in return for a lowered strike price [taken from $11.50 to $10.25], raising another $210.23mm in cash. The seller is rolling over $291mm in stock at $10.25, and J2 is plugging the rest of the purchase price with new debt financing, which they tapped the markets for in late September.

Exhibit 23: Sources and Uses of Cash in the APi Group/J2 Transaction

Thus, per the above, pro forma JJAQF will have ~$1.25bn in net debt and ~174mm shares outstanding, with a further ~21mm warrants [actually ~63mm, but you need to exercise 3 for one share] with a strike of $11.50 and a 3yr term outstanding. Debt is equal to the “New Debt Financing” + $20mm in other debt per the presentation. 

Exhibit 24: Pro Forma Capital Structure

Base Case Model

Per the above, our base case model had the following assumptions/methodologies:

• Revenue CAGR: Assumes a 4 year growth CAGR through 2023e of 3.8% top-line
• Adj EBITDA Margins: Scale linearly from 10% in 2019 to 12% in 2023e
• D&A: 2.0% of sales
• Interest: 4.8% on principle [see below for debt treatment]
• Tax/Cash Tax: 23.0% tax rate for both
• CapEx: 20% of adjusted EBITDA; per the above, this is likely conservative as actual CapEx is most likely to be somewhat lower
• Working Capital: 10% of revenues. FCF is Adj EBITDA – CapEx – Cash Tax – CHANGE Working Capital – Interest
• Net Debt: Starting capital structure per above. We then look at 3 potential uses of cash given managements stated 2.0x-2.5x Net Debt target: 
• Buybacks: Cash used to pay debt down to a target of 2.25x, with additional cash used to fund buybacks at $15.00 per share [>50% above last]
• Cash Build Up: Cash used to pay debt down to 0 with no target to show cash flow accumulation of the business, then accumulates in cash account
• M&A: Cash used to pay debt down to a target of 2.5x [given this is trailing, it pushes the actual EV/TTM EBITDA to ~2.2x], with remainder used to acquire businesses at ~5.0x EBITDA and Adj EBITDA margins equal to that of APi Group at the time. Acquired revenue is then added to the next year, and picks-up EBITDA gains with the rest of the business due to efficiencies. See M&A history and expectations above.
• Share Count: Starting count is the simple outstanding shares per the above. We reduce common shares by excess cash (above debt paydown) in the buyback model. We then use the treasury method to dilute the warrants at $15.00 per share buyback price in our final valuations.
• Discount Rate: See appendix for calculation of discount rate

Exhibit 25: Base Case Income Statement with Buybacks

Exhibit 26: Base Case Income Statement with Cash Build

Exhibit 27: Base Case Income Statement with Accretive M&A

Bull Case Model

Per the above, our Bull case model had the following assumptions/methodologies:

• Revenue CAGR: Assumes a 4 year growth CAGR through 2023e of 5.3% top-line
• Adj EBITDA Margins: Scale linearly from 10% in 2019 to 12.5% in 2023e
• ALL OTHER INPUTS and METHODOLOGIES THE SAME AS BASE CASE

Exhibit 28: Bull Case Income Statement with Buybacks

Exhibit 29: Bull Case Income Statement with Cash Build

Exhibit 30: Bull Case Income Statement with Accretive M&A

Bear Case Model

Per the above, our base case model had the following assumptions/methodologies

• Revenue CAGR: Assumes a 4 year growth CAGR through 2023e of -1.5% top-line
• Adj EBITDA Margins: Drop from 10% in 2019 to 9% in 2020 due to a small recessionary environment [similar to the industrial recession of 2015/2016], before rebounding back to 2019 levels by 2023 linearly
• ALL OTHER INPUTS and METHOLOGIES THE SAME AS BASE CASE

Exhibit 31: Bear Case Income Statement with Buybacks

Exhibit 32: Bear Case Income Statement with Cash Build

Exhibit 33: Bear Case Income Statement with Cash Build with Accretive M&A

Comps/Valuation

When looking at valuation, it’s difficult to peg an exact public comp for APi Group, as no peers match exactly the type of business they have. Their exposure to end markets varies compared to comps (Fire Safety, Industrial, Energy, Construction), their exposure to revenue mix is different than many comps (service vs new build), their geographic exposure is much more narrow than many comps (almost solely US), and their business projects are much different than most potential comps (smaller projects with low customer concentration, short duration, and low loss rates).

In general, EME is one of the better comps given their exposure to Fire Safety and some of their service business, as well as having smaller projects, although their margins are lower due to the type of business they undertake.

JCI has a business line (Tyco) that is similar to APi Group, but many of their projects are much larger and their business is much more varied than APi Groups.

MTZ, PWR, TEAM, FIX could be infrastructure/industrial services type comps, although those are each imperfect for various reasons not matching with some of the above characteristics.

In the end, we decided it was best to cast a wide net and look at various metrics to see how J2 staked up with all of the puts and takes of the above business differences.

Exhibit 34: Comp Table

As seen below, APi Group has a 2018 to 2019 YoY growth rate above the average, and in fact in the top-quartile of the wide range of selected comps.

Exhibit 35: Comp Comparison of 2018-2019 Revenue Growth Rate

From a margin standpoint, excluding outlier ADT (almost 50% EBITDA margins), JJAQF is a bit below the average. However, it is only one company away from the median and in the 46th percentile by Adjusted EBITDA margins. Their plan to increase margins will put them above the median.

Exhibit 36: Comp Comparison of 2019 Adj EBITDA Margins

Moreover, these margins appear to correlate relatively highly with various valuation metrics. It has a 0.46 correlation when a regression is run between ‘19e Adj EBITDA margins and ‘19e P/E valuation with P/E’s in our “normalized” range of 7.0x-25.0x (Exhibit 33 below) and a 0.27 correlation when a regression is run between ‘19e Adj EBITDA margins and ‘19e EV/EBITDA with EBITDA margins in the “normalized” 5-20% range (Chart 34 below). There is no real correlation when looked at against FCF Yield. This could imply target multiples of ~15.5x ‘19e P/E and ~9.7x EV/EBITDA.

Exhibit 37: Regression of Comp ‘19e P/E multiple against ‘19e Adj EBITDA Margins

Exhibit 38: Regression of Comp ‘19e EV/EBITDA multiple against ‘19e Adj EBITDA Margins

The Net Debt/’19e EBITDA shows JJAQF in the top 88th percentile of the comp group. However, we are not really worried about this, because as shown above, APi Group throws of tremendous amounts of cash throughout almost any market environment. In fact their current Net Debt level is only ~0.6x higher than the top-end of their long-term target, a low differential for a post-merger company. 

Exhibit 39: Comp Net Debt/’19e EBITDA Comparison

And yet despite relatively in-line Adjusted EBITDA margins (almost the median number and only -0.4 standard deviations below the mean) and above-average revenue growth, JJAQF trades at rock-bottom valuations.

Per the below, JJAQF trades at just the 22nd percentile on an EV/’19e EBITDA basis. Comps on average trade 13.8x ‘19e EBITDA.

Exhibit 40: Comp ‘19e EV/EBITDA Comparison

On a P/E basis, the stock is even cheaper, trading at just 8.7x vs an average of our “normalized” P/E’s mentioned above [7.0x-25.0x] of 16.x. This puts it in just the 9th percentile of that sub-group

Exhibit 41: Comp ‘19e P/E Comparison

And yet, JJAQF is far cheapest when viewed through the lens of its massive cash flow generation. Comps trade at an average of ~5.0% FCF Yield (excluding those at negative FCF yields, SCSC which has only 1 estimate and was a negative cash flow company in 2018, and REZI which was has been negative cash flow all year and will likely be flat cash flow in 2019 despite Bloomberg showing a >10% FCF Yield). JJAQF trades almost DOUBLE the average FCF Yield and at just the 9th percentile

Exhibit 42: Comp ‘19e FCF Yield Comparison

The closest comp, EME, trades at 9.6x ‘19e EBITDA, 15.2x ‘19e EPS, and a 3.8% FCF yield. The other main comps listed above (MTZ, JCI, PWR, TEAM, FIX + EME) trade at an average of 9.3x ‘19e EBITDA (excluding TEAM which trades >70.0x), 15.7x ’19e EPS (again excluding TEAM which trades >125.0x), and 4.1% FCF Yield. The max FCF yield is MTZ at 7.6%.

What is clear is that JJAQF is extremely undervalued. This is a company operating in a regional market, with a #1 share in fire safety, with a strong percentage of their business from service offerings with defensive characteristics in a recession (especially ability to generate cash), with 7% organic growth CAGR from 2010-2018 AND 15% total topline growth CAGR over that period, with a continued runway for roll-ups, and with a proven new management team known for creating value in similar business models. They have no major customer concentration, varied end markets, a US-concentration (no trade war exposure, no Europe recession exposure, no Brexit exposure, etc), a <1.5% project loss ratio, and 85% repeat customer revenues.

Price Target

Bringing all the above together, we value JJAQF across 3 valuation metrics (plus DCF) with 3 different potential uses of capital and 3 potential market/financial conditions (“Bear Case”, “Base Case”, and “Bull Case”) and provide a sensitivity of the average of the metrics to the different cases and capital uses.

A quick note on the uses of capital. APi Group/J2’s first priority with cash flow is to pay debt down to their target level (which is reflected in our model). Following that, really only the “Accretive M&A” option is a realistic reflection of how they will likely use that capital. We believe it is highly unlikely that they would allow cash to just build on the balance sheet, but this is illustrative. Similarly, it is somewhat unlikely that they would look to do buybacks quickly given the large pipeline of M&A that both APi Group and the J2 team see in the market. Both groups also have a strong history of accretive M&A roll-up transactions, and that is a key pillar of the investment thesis here. However, we wanted to show how much of their stock they could buyback, even 50% above last, to demonstrate options available and to show just how large the FCF generation really is here.

Regarding the terminal value in the DCF calculation, as noted above, we show the WACC calculation in the appendix. For the long-term growth rate, we assume in ALL scenarios above that APi Group’s terminal growth rate reverts to the GDP level. Bloomberg has GDP projection of 2% for the next two years (Exhibit 14 above) and PWC projects US average GDP growth at ~2% through 2050 (Exhibit 43 below). 

Exhibit 43: PWC Projected GDP Growth by Country

Base Case Price Target: In our Base Case, we see 124.2% upside in JJAQF, based on 2023e financial metrics discounted back to 2019 at JJAQF’s WACC. We use 4 valuation methods, all with conservative multiples. 

• The target EPS multiple is 11.6x, a discount of 25% to not only JJAQF’s average and margin regression implied number, but also to it’s closest comp EME
• The target EV/EBITDA multiple is an average of the overall peer average multiple (13.8x) and its regression implied EV/EBITDA multiple (9.7x), which also coalesces around both its closes comp (EME) and closer comp group’s average multiples. After applying the 25% discount, this is still a discount to almost all of JJAQF’s comps.
• The FCF yield is pegged to the lowest of JJAQF’s closer comps, MTZ, which trades at a 7.6% FCF Yield, rounded to 8.0%. 

As mentioned above, we find all of these metrics to be extremely conservative compared to the superior cash flow profile, revenue growth rate, and margin strength, as well as attractive business mix, M&A opportunities, and management quality.

 Why do we use 2023e, discounted back? To: (1) allow time for the J2 sponsor management team to come in and create the value that they historically have, (2) reflect the superior cash flow profile of the business and the strong long-term operating model, and (3) highlight the strategic and operational value this cash generation has on the business. There is a reason APi Group went from ~$600mm in revenues in 2004 to ~$4.0bn in 2019, COMPLETELY self-funded off internal cash flows. This is a 13.5% top-line CAGR, at scale, with no need to tap external funding. The importance of cash flow generation on this scale cannot be underestimated. 

Exhibit 44: Base Buyback Model PT

 

Exhibit 45: Base Cash Build Model PT

 

Exhibit 46: Base M&A Model PT

 

Exhibit 47: Base DCF Model PT

 

Exhibit 48: Simple Average PT for Base Case

Bull Case Price Target: The Bull Case price target of $27.45 we apply, despite what an almost unrealistic discount (177.3% upside) it points to, is not really predicated on wild assumptions. As mentioned above, we have a 5.3% top-line growth CAGR. This compares to a historic 7% ORGANIC growth CAGR and a 15% overall CAGR from 2010-2019. Under CEO Russ Becker, as mentioned above, we have seen a 13.5% top-line CAGR overall. So it doesn’t really seem wildly out of the question that a company with this background, with a 44% segment growing at 8%, with a runway for roll-ups would be growing only 300bps above GDP. Margins also barely increase above the 12%+ target by 2023e that a proven management team has laid out. Hardly a stretch given the areas for cost savings they have identified and the familiarity with a multi-brand model rolling into a central business function. And despite this superior growth and incredible cash flow generation, we award them only multiples in-line with peer averages.

One quick note is that we exclude the buyback model in our bull case from our average overall price target. It is included below for demonstrative purposes (just how much cash this company throws off and how much of it you could truly buyback with internally generated cash), but given the large amount of cash, the price target is unrealistically high compared to a DCF and multiple based approach under the other capital methodologies. 

Exhibit 49: Bull Case Buyback Model PT

 

Exhibit 50: Bull Case Cash Build Model PT

 

Exhibit 51: Bull Case M&A Model PT

 

Exhibit 52: Bull Case DCF Model

 

Exhibit 53: Simple Average Bull Case PT (excluding Buyback Method)

 

Bear Case PT: The Bear Case price target of $8.39 is also quite conservative, and despite that shows there is not much downside in this stock, especially considered relative to the upside. A -1.5% 4 year topline growth CAGR results in a decline that goes further than that in the 4 years following the Financial Crises. While they also executed M&A during that period (again demonstrating just how impressive their cash flow conversion is), it shows that even under a topline scenario worse than the financial crises this is a company that can hold up well.

While the model also assumes EBITDA margins only bottom at 9% and FCF conversion continues to be strong, we do not believe this is an overly aggressive assumption. The business mix was much less attractive in the Financial Crises, and during the Industrial Recession of 2015/2016, Adjusted EBITDA margins held up better than this level. While it is unclear how FCF conversion held up, APi Group executed a large amount of self-funded M&A during this process, never went negative cash flow, and management has said that the cash flow generation remained strong in recessionary periods. Part of this is the dynamic of their large variable cost structure (union labor), that they can offload as new projects do or don’t come online. A big piece is also their high margin, regulatory service work, which does not stop during recessionary periods. And further, they have the ability to release working capital as projects slow down, pushing more cash flow back into the business. In fact, one could argue recessionary environments are opportunities for a company like APi Group, who has in the past done acquisitions throughout such periods, likely finding bargains in less well positioned regional competitors.

In our average price target, we do not include the DCF price target, because it is actually above last and even drags the average above last. While this yet again shows the power of APi Group’s cash flows, it likely doesn’t reflect the valuation they would get after going through a period of 4 years that would likely be described as worse than anything the company has actually experienced. 

Exhibit 50: Bear Buyback Model PT

 

Exhibit 55: Bear Cash Build Model PT

 

Exhibit 56: Bear M&A Model PT

 

Exhibit 57: Bear DCF Model PT

 

Exhibit 58: Simple Average Bear Case PT (excluding DCF Method)

Finally, while we see the below as our “bear case” price target fundamentally, we do recognize that this stock can trade lower for a few main reasons: (1) Lack of understanding of the business model, (2) Inability to find good comps easily [leading to messy valuations], (3) lack of liquidity, and (4) short-term investing mandates. If we were to go into a serious recessionary squeeze, especially before APi Group formally lists on the NYSE and picks up liquidity, there is a good chance prospective investors would look only at one year forward estimates, and value the business of f bearish multiples surrounding that. In our “trading” downside valuation, we see a -7.6% revenue growth rate in 2020 (assuming a recession hits next year relatively strongly), a 9% Adjusted EBITDA margin, and a 70% FCF conversion rate. A blended valuation at the bear case multiples [7.2x ‘20e EPS, 6.5x ‘20e EBITDA, 11.5% FCF Yield] on just these 2020 forward numbers would suggest ~$7.25 temporary trading downside. We would view this as an opportunity, even if our bear case scenario was ultimately the long-term outcome.

Risk/Reward Framework and Sensitivity

• Risk/reward presents superior opportunity to capitalize on valuation discount with a clear catalyst and explanation for mispricing

Exhibit 59: Risk/Reward Framework

 

 

•  Sensitivity reflects attractive investment across valuation methodologies, capital deployment options, and market cycles

 

Exhibit 60: Sensitivity Table

 

Reason for Price Dislocation

There are five main reasons for the valuation discount, which are all related to the UK SPAC structure of J2: (1) Lack of buyers due to current liquidity and listing, (2) lack of management engagement with the investment community, (3) lack of following, (4) technical selling from warrant exercise, and (5) profit taking from pre-deal shareholders.

1. Lack of Current Buyers due to Liquidity & Listing: J2’s initial main listing was in the UK under JTWO LN. It had a secondary listing in the US OTC market under JJAQF. Since JJAQF is still considered a SPAC and trades only OTC (while currently clearing CREST not DTC), there is a limited investor base looking at this security. 
1. This also creates a lack of liquidity (trades mainly by appointment; it is easy enough to accumulate a large position, but daily volumes and market depth are not there), which further exacerbates the potential investment community.
2. Many large vanilla and long-only funds can’t or won’t touch a SPAC security that trades OTC, doesn’t clear DTC, and has a low ADV. This will all change in 1Q20, when management will complete the transition from SPAC to listed company. Management needs to have a proxy listed and approved with the SEC prior to listing, and plans to do so using YE19 numbers, which is the reason for the delay. But, in late 1Q20, J2 will officially list on the NYSE under the ticker APG.
3. This will eliminate the venue issue (no longer OTC), clearing issue (will clear DTC, although management is also attempting to get JJAQF DTC-cleared in the next 2-5 weeks), and liquidity issue (volumes should pick-up significantly once APG is trading as a normal post-SPAC company).
2. Lack of Management Engagement: On the second point, since UK SPACs differ from their US brethren in that they do not need to hold a shareholder vote or offer a redemption period, the deals close extremely quickly and the pitch process to the investment community begins post-close. 
1. In J2’s instance, they announced their business combination with APi Group on 9/3/19 and closed the deal less than a month later on 10/1/19. A typical US SPAC merger needs a full proxy and vote process, and will take 3-4 months, during which management is on the road selling the deal to investors ahead of the vote.
2. For J2, this process is just starting now after the close of the deal. As such, potential investors are just now learning about and getting up to speed on APi’s business, setting the stage for increasing interest and demand that has previously not existed.

    

3. Lack of Following: The third point is mainly related to the first two. With the deal just announced a month ago and the UK SPAC structure impacting trading venue and liquidity, there is almost no one following this situation. 
   1. There is no coverage from major bank’s equity research analysts (outside of SPAC/event driven desks at brokerage firms,) as there is likely no interest in covering a security no one knows about that doesn’t trade.
   2. However, as volumes pick-up (even prior to listing as APG, if management does indeed get JJAQF DTC cleared and as they continue to pitch the story to investors we should see upticks in interest) this will change.
   3. When APi officially lists under APG in 1Q20, it will be a multi-billion dollar company led by a seasoned and followed management team that will need to be added to various indices. This will almost certainly result in increased following and coverage, which in turn will highlight the valuation arbitrage available and help close the gap
4. Technical Selling From Warrant Exercise: The fourth point on warrant exercises causing technical selling is related specifically to how this deal was funded. 
   1. The SPAC had ~$1,250mm in cash (plus $45mm of excess cash likely from interest generated over the pre-deal SPAC life) which it could use to find a deal. As they needed ~$3.1bn for the deal, management needed to make this up in various ways. $291mm came from seller rollover of equity (taking stock instead of cash). As another source of funding, it was planned that holders of the ~42mm warrant securities could elect to early exercise their warrants, and in return the strike price on the warrants would be amended from $11.50 to $10.25. The balance would be made up from new debt financing.
   2. About half of the warrant holders (including Mariposa, Martin Franklin’s investment vehicle, and Viking Capital) elected to exercise their warrants at the lower strike, giving them $210mm in cash. However, this also meant that those shareholders who exercised increased their at-risk position in the investment by ~33% [since the initial deal called for 1/3rd of a warrant per share to be issued]
   3. This created potential supply of ~21mm shares in theory if those holders were already at their maximum position risk. While it is unlikely Mariposa or even Viking are selling, other warrant holders may need to trim risk in the situation for technical reasons only.
5. Profit Taking from Pre-Deal Shareholders: The fifth point is related to the profit that some shareholders have realized on this security this year. 
   1. As a blank check company with no vote, the security traded at a discount to the initial “trust” value as it had been almost two years without a deal and no one knew what the potential deal would look like.
   2. The stock traded between $8.40 and $9.40 for most of 2019, with a VWAP price of $8.11. That means most investors had realized a profit of 9%-26% to the initial post-deal trading value YtD on the trade.
   3. It is only natural that given JJAQF isn’t fully listing until 2020 that managers would be looking to lock-in some profits on such a jump for 2019.

 

 

 

Appendix 1: WACC Calculation

Exhibit 61: Narrow Set of Comps WACC Calculation

Exhibit 62: Broad Set of Comps WACC Calculation

 

Exhibit 64: Narrow Comp Set WACC Benchmark (Peer Values per Bloomberg)

Exhibit 65: BroadComp Set WACC Benchmark (Peer Values per Bloomberg)

Out of conservatism, we use the broader peer WACC benchmark as opposed to our bottom-up calculation. While we believe the bottom-up number better reflects JJAQF’s low cost of debt and higher relative debt levels (which as noted by their attractive WACC are actually beneficial, especially with their sufficient cash generation), we think that adding in yet another layer of caution gives cushion and reinforces the thesis.

Appendix 2: Quick Note on UK SPACs and Listing Status

J2 Acquisition Corp was a SPAC (Special Purpose Acquisiton Vehicle) launched by Martin Franklin in London. SPACs are essentially alternative methods of IPOs, where the funds for a private-market acquisition are securitized pre-deal, and a sponsor team goes and sources an acquisition that will then become a publicly traded company. It allows companies outside the unicorn hype sphere to market to investors and establish price discovery prior to listing in ways that a traditional IPO can’t. And it often has benefits over other options for sellers (traditional IPOs, sale to private equity, etc).

 In the US, a typical SPAC structure involved shareholders paying in $10 cash to receive one share + some portion of a warrant (1/4 warrant to a full warrant typically). The Sponsor puts up capital and then goes and finds a business combination. They receive large earn-out incentives for free in the US, and once an acquisition is announced, shareholders make a decision to redeem for cash in trust (the initial $10 + interest between the SPAC IPO and redemption date], getting to keep their warrant (or sell it to the market). While US SPACs can often create tremendous trading opportunities as well for technical reasons, management and shareholders are not always completely aligned as management gets free earn-out shares for completing a deal, often receiving a return of >5.0x their capital even if the stock doesn’t appreciate from $10.

UK SPACs are different. There are no free earn-out shares for investors, and there is also no redemption date that creates liquidity for investors at trust. Thus, you are in the same boat as Martin Franklin and J2 in this case, as they buy in at the same price you do with no extra incentives (in fact you are getting a discount at these latest levels). And with no redemption opportunity, it creates an incentive for certain investors to sell in the market, creating a liquidity event.

Sources

http://www.j2acquisitionlimited.com/~/media/Files/J/J2-Acquisitions/documents/press-releases/pr-announcing-acquisition-of-target.pdf

http://www.j2acquisitionlimited.com/~/media/Files/J/J2-Acquisitions/documents/irt/investor-presentation-aug-2019.pdf

http://www.j2acquisitionlimited.com/~/media/Files/J/J2-Acquisitions/documents/irt/financial-statements.pdf

APi Group/J2 Acquisition Call

Management Meetings

Bloomberg

https://www.prnewswire.com/news-releases/north-america-fire-protection-system-market-to-reach-25-58-bn-by-2023-at-8-5-cagr-says-allied-market-research-889146334.html

https://www.grandviewresearch.com/industry-analysis/fire-safety-equipment-market

https://www.globenewswire.com/news-release/2019/03/13/1752273/0/en/Global-Fire-Protection-System-Market-Will-Reach-USD-98-85-Billion-By-2025-Zion-Market-Research.html

https://www.marketwatch.com/press-release/fire-protection-systems-market-2018-global-industry-analysis-by-share-key-company-trends-size-emerging-technologies-growth-factors-and-regional-forecast-to-2023-2018-11-26

https://www.researchandmarkets.com/reports/4763032/fire-sprinklers-market-global-industry-trends?utm_source=BW&utm_medium=PressRelease&utm_code=xqt258&utm_campaign=1236309+-+Global+Fire+Sprinklers+Market+Trends%2c+Share%2c+Size+%26+Growth+(2019-2024)&utm_e

 

https://www.researchandmarkets.com/reports/4763032/fire-sprinklers-market-global-industry-trends?utm_source=BW&utm_medium=PressRelease&utm_code=xqt258&utm_campaign=1236309+-+Global+Fire+Sprinklers+Market+Trends%2c+Share%2c+Size+%26+Growth+(2019-2024)&utm_e

https://www2.deloitte.com/us/en/insights/industry/oil-and-gas/decoding-oil-gas-downturn/midstream-pipeline-infrastructure-transportation.html

https://napipelines.com/art-of-war-north-american-pipeline-construction-overview-2019-2022/

https://napipelines.com/2019-oil-pipeline-report-permian-basin-production-infrastructure-projects/

https://www.pwc.com/gx/en/world-2050/assets/pwc-the-world-in-2050-full-report-feb-2017.pdf

https://www.enr.com/toplists/2019-Top-400-Contractors1

https://www.census.gov/econ/currentdata/

Risks

• Recession – Despite the stock not being extremely cyclical and having large diverse end markets, as well as strong cash flows in recessionary environments, it could trade poorly if the US enters a recession. This is an industrial stock that is not yet well understood. As a hardly followed “show me” story, the stock could end up orphaned in a recessionary environment

• Conglomerate discount – Disparate businesses can often get a discount to their SOTP due to complication and investor confusion, as well as questions around dis-synergies

• Lack of comps causes fundamental discount to persist – There are really no clean comps to APi Group, which may make it difficult for investors to look through to the true value of the business

• Poor M&A execution – Whether due to lack of targets for roll-up or doing bad deals at the wrong time, poor M&A execution is a risk. This is offset somewhat by the strong track records of both J2 and APi Group, as well as the smaller size of the deals traditionally (~$200mm max).

• Near-term Liquidity – Near-term, JJAQF will continue to be OTC listed and may not pick-up liquidity until it lists as APG. This can cause volatile price moves as liquidity and market depth is not there.

• Poor Organic Execution – Despite the strong track records of APi Group and J2 respectively, and the powerful operating model and businesses going forward, it is always possible that the teams could fail to execute. They could seed market share and fail to secure coveted service contracts. They could mis-manage the historically strong margins and cash flow generation, resulting in lower margins and lower quality business and a more difficult time repaying debt. We see this as highly unlikely.

Catalysts

• DTC Clearing

• NYSE Listing

• Equity Research Coverage

• Management Engagement with Investment Community

• Accretive M&A and other cash flow deployment

• Index Inclusion

• Liquidity

Disclosure

I do not hold a position with the issuer such as employment, directorship, or consultancy.

 

I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 

• DTC Clearing

• NYSE Listing

• Equity Research Coverage

• Management Engagement with Investment Community

• Accretive M&A and other cash flow deployment

• Index Inclusion

• Liquidity