RPS Group – Takeover Target? An Update.
RPS Group (RPS) – Latest share price: 57p, market cap £157 million
It’s been a while since I’ve put pen to paper, so I thought it timely to provide an update on my July 2019 piece RPS – Takeover Target?.
Anyone who bought RPS stock at 118p in July 2019, at the time of my article, would have seen the valuation of the business increase 50% by the end of 2019 as the share price moved up to my estimated fair valuation of 170p.
In January 2020, I took some profits at 176p but not exiting the position fully at this valuation was the start of a number of il-considered and costly oversights made by me during this current year.
Just one month later, on 19th February 2020, the Group issued their full year results highlighting difficult trading conditions and exposing an increasingly stretched balance sheet. This swiftly knocked 15% off the valuation and the world was then hit by the CV-19 pandemic with the stock eventually falling to a low of circa 31p during early April 2020. With 80% wiped off the valuation in 6 weeks, this was a brutal correction!
Whilst the market volatility induced by CV-19 was testing for any investor, I strongly believed that the bargain-basement pricing of some excellent businesses during February, March and April 2020 would in hindsight be a superb opportunity so I picked up more stock in the majority of my portfolio constituents including D4T4, GAW, SDI, DRV and of course RPS, buying at prices as low as 34p and resulting in what was a initially a speculative modest-size holding ending up as almost 15% of my portfolio with an average price of 55p.
September 2020 then saw a £20 million placing announced to help with an impending working capital squeeze and to reduce debt, bringing with it some new investors including Gresham House Strategic who provide some commentary around their investment rationale here (c. 13 minutes in).
Since the September 2020 placing the stock has risen some 50% as investors warm to the potential for the business to recover from the pandemic and to benefit from a mixture of international infrastructure investment and climate change and from the Group’s healthy exposure (appox. 50% of sales) to the public sector.
The October 2020 Trading Update brought some good news to investors noting that “there are pleasing signs of recovery within RPS. The contracted order book continues to improve, with all segments either holding or improving their three-month order book” and highlighting net bank borrowings at 30 September 2020 had fallen significantly to £32.8 million (30 September 2019: £108.1million) although debt is forecast to rise again in Q4/20 as a resumption in sales growth drives an increase in working capital and tax deferrals taken advantage of during the pandemic are settled.
A welcome return to some stability but what about the takeover potential flagged back in July 2019? Well, I guess its worth looking at the sector dynamics and the motivation for any deal making.
Let’s start with John Douglas the CEO of the Group since September 2017.
Prior to joining RPS, John was CEO and Managing Director at Coffey an Australian Engineering Consultancy prior to it being acquired by US based TetraTech back in October 2015. John is 58 and since joining RPS has purchased in the market no less than £1.36 million of RPS stock at prices between 44p and 158p. He also has options over another 1.7m shares bringing his total potential benefical ownership of stock up to around 3.5million shares valued at today’s prices at around £2 million. In the event of a takeover all options would vest and be payable. In summary, John has some M&A history, is of an age where he may well wish for a quieter life and he also owns a sizable amount of RPS stock at an average price of just 39p including his nil cost options.
Secondly, let’s recap on potential suitors for the Group, a number of which (WSP Group etc) were highlighted in my July 2019 article. One potential suitor I failed to mention in this article was TetraTech, the business that acquired Coffey and later also acquired UK listed Engineering Consultant WYG in May 2019.
Like most large engineering consultancy businesses, TetraTech has grown, in part, off the back of acquiring smaller peers and over the last 10 years have bought numerous businesses in the US, Canada, Australia and Europe and now has in excess of 20,000 staff located across 450 offices worldwide. The Group’s expertise and strategic focus includes the provision of Sustainability, Water, Environmental, Infrastructure, Renewable energy and Project Management services.
As well as being a prior WYG shareholder, I am keen follower of this sector having worked in it myself for the last 30 years and I have kept a close eye on TetraTech over the last 12-18 months under the leadership of their very competant and long-standing CEO Dan Batrack. Some interesting snippets on the theme of M&A and international expansion have jumped out from recent quarterly earnings calls:
TetraTech Q1/2020 Results – Earnings Call Transcript – January 2020:
“Our international net revenue was up 25% year-over-year, driven by growth in multiple geographies including water, environment and energy-related work in Canada and Australia and our expanded United Kingdom business from the acquistion of WYG last year”. “We’ve been able to invest in strategic areas, while growing the top and bottom lines and we have strong pipeline of strategic M&A opportunities, which will contribute further to an expanded geographic presence…”.
Analyst question during Q&A session – “So first, I was hoping you could comment a bit on the acquistion pipeline and what you are seeing in the market?”
Dan Batrack – “….and then there’s water opportunities in the UK and we would actually like to add additional water consulting capability in the UK so we have more folks on the ground there, and also more municipal work in Australia…”. And when talking about balancing ongoing share buy-backs with M&A activity he later notes “But if there is something larger and that we would want to put a priority to, we can….move agressively to add the right partners to the company”.
TetraTech Q3/2020 Results – Earnings Call Transcript – August 2020:
Analyst question during Q&A session – “Any update on the acquistion pipeline? Are there more sort of WYG’s and Coffeys coming up in the pipeline?
Dan Batrack – “we are really focussed on fulfilling the strategies that we’ve identified, both on this call and previous calls by building out our advanced data analytics in the Federal sector as presented and other areas in the water sectors. The pipeline in actually robust. It is quite full”. “We are looking for the best-in-class to join us. And so yes, there are other opportunities such as those that we’ve had greaty success with in Australia and the UK. I would expect our sequence of having the best and brightest join us to continue”.
TetraTech Q4/2020 Results – Earnings Call Transcript – November 2020:
Analyst question during Q&A session – “And then on the topic of the UK, could you give us an update on how you are thinking about the M&A opportunity there, I know you chatted a bit before about looking at a UK water acquisition to complement WYG. Just curious re: progress there and how you are thinking about that opportunity?”
Dan Batrack – “Well, we have had meetings with a number of firms. So there are opportunities out there. So I would say the pipeline is full or at least it is sufficiently full that we have alternatives. We are looking for just the right firm. And I think some of the characteristics would be strong technical reputation, existing contracts with the utilities as they exist and preferably, they would add a new sense of capability and expertise in the water sector we we might not currently be as strong. Some of it might be on the economics portion as we are not necessarily strong economists, but that is certainly part of some of the AMP cycle 7’s priorities for doing that analysis. So that is something that we would look to make progress on in fiscal year 2021.”
So, would RPS be a complementary or likely acquistion for TetraTech?
RPS certainly has the capabilities and geographic coverage that TetraTech are looking for. Currently only 10% of TetraTech’s $US3billion of revenue is derived from the UK, this rising to 30% when you include their operations in Canada and Australia. An acquistion of RPS would add over £400 million (US$ 530million) of international sales to the Tetra Tech Group and RPS’s expertise correlates closely with that of TetraTech as can be seen from the infographic below, with only the ‘Property’ segment (circa 35% of RPS Group sales) perhaps not of specific strategic interest:
(Source: RPS 2020 Half Year Results Presentation)
Of the specific acquistion ‘wish list’ put forward by Mr Batrack in these earnings calls, the Water segment is a signifcant part of the RPS revenues accounting for around 17.5% of annual sales or circa £90 million (US$ 120 million). RPS’s existing client list in this segment includes most of the major UK water companies including Thames Water, Welsh Water and Scottish Water.
RPS also has 22 Australian offices covering all of the territories and undertaking work for the major water suppliers/municipalities such as Sydney Water. They also have economic analysis expertise with Project and Program Management / Advisory and Management Consulting accounting for some 25% of annual Group sales or circa £125 million (US$ 165 million).
They also have a growing focus on the renewable energy sector as they further refocus away from the oil and gas sector (once a predominant element of RPS Group revenues) and tap into the growing global private sector investment in offshore wind, solar, geothermal and other green technologies. This is also a key area of Tetra Tech’s expertise.
(Source: RPS 2020 Half Year Results Presentation)
So in summary, it would appear RPS would indeed make complementary acqusition for TetraTech, so can Tetra Tech afford to acquire a 5,000 strong business with annual sales of circa £500 million (US$ 660 million)?
RPS’s current mcap is less than £160 million (US$ 210 million) but as noted in my July 2019 article, I believe RPS are worth 170p/share to an acquirer who can extract the double-digit margins RPS is capable of, strip out the costs associated with a UK listing and streamline operations including bringing RPS onto Tetra Tech’s own ERP. I would therefore hope for any deal to be in the £430-480 million (US$ 570-630 million) area although personally any valuation north of 0.5 x sales (100p/share) would be attractive to me.
With Tetra Tech generating £200 million (US$ 260 million) of cash from operations annually (and growing), Group net debt/EBITDA being only 0.5x and with access to over £610 million (US$ 800 million) of capital, I would suggest an acquistion of RPS is easily within their means.
(Source: Tetra Tech Q4/20 Presentation)
With Tetra Tech clearly planning further UK/International growth by acquistion and RPS not only having the expertise and capability (plus scale) that Tetra Tech requires to move the needle but also having a CEO who knows Dan Batrack from having sold his prior business (Coffey) to him in 2015, I would suggest there are certainly the ingredients for a potential deal.
One last observation from me comes in the form of an extract from the two most recent RPS Annual Reports (2018 and 2019) which add a further dynamic to the equation:
(Source: RPS Annual Report 2018)
(Source: RPS Annual Report 2019)
Whilst I typically dislike any reference by managers to the share price of a business, it’s evident there is some frustration at Board level re: RPS’s valuation even at a significantly higher level than the market cap today. Perhaps yet another year of frustrations, as will be evidenced by FY/2020, will be the necessary additional ingredient for the respective CEOs to come to the table?
Ony time will tell, but for investors willing to lock up their capital (currently without a dividend), I’m willing to add a third certainty to Benjamin Franklin’s idiom on death and taxes… M&A in the Engineering Consultancy/Advisory space!
At the time of publication, the author holds a long position in the company mentioned.
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