Headlines in local financial news have recently featured stories of takeovers, mergers, and acquisitions. The beginning of this decade, marked by a significant downturn, has led to an economic cycle ripe with such activities. This bustling environment presents rich opportunities for unique non-blue-chip companies, especially those with smaller market caps.
In today’s market, both public companies and private equity firms are actively seeking to expand through strategic acquisitions. Competing businesses are eyeing specific assets to boost efficiency, while overseas entities, aided by favourable exchange rates, are acquiring at reduced costs. These acquisitions can enable companies to integrate new segments or enter new markets swiftly, bypassing the challenges of organic growth.
However, it’s important to remember that not all takeovers result in shareholder value. While some deals offer attractive premiums, others serve as a reminder of the risks and complexities inherent in M&A activities.
Adamantem Capital Wins Out in QANTM Bidding War
QANTM Intellectual Property Limited (ASX: QIP) announced last Thursday that it had agreed to enter a binding scheme of arrangement with Fox BidCo Pty Ltd, an entity owned and controlled by funds managed and advised by Adamantem Capital Management Pty Ltd.
Adamantem Capital winning the battle to acquire QANTM for $1.817 per QANTM share with the opportunity to elect to receive either 100% cash, or a 50% cash 50% scrip combination. This follows on from just days earlier having received an unsolicited non-binding indicative proposal from IPH Limited (ASX: IPH), a leading intellectual property group, expressing interest in acquiring all QANTM shares through a scheme of arrangement.
IPH’s proposal included offering 0.291 IPH shares and a fully franked special dividend of up to $0.11 cash per QANTM share, valuing the company at $1.90 per share. A premium to the accepted Adamantem Capital offer.
This takeover represents a significant premium for QANTM shareholders with the company trading hands for under $1 less than 6 months ago.
IPH announced their disappointment to the market in an update stating:
IPH is disappointed that it did not have an opportunity to engage with QANTM to pursue a combination of QANTM and IPH. IPH believes the combination has the potential to create material value for both QANTM and IPH shareholders by bringing together complementary member firms’ service offerings, greater diversification of clients, opportunities to accelerate growth in Asia Pacific through an enhanced combined platform and the unlocking of meaningful synergies.
QANTM’s bidding war ends despite IPH’s bid surpassing a previous offer from Adamantem Capital.
300 Million Reasons to Smile
Pacific Smiles Group Ltd (ASX: PSQ) has been subject to a drawn out takeover by Genesis Capital which took a turn at the end of last month.
The dental group which currently operates 120+ dental centres was subject to an initial bid from Genesis back in December 2023. The bid of $1.40 per share followed notification that it had taken up an 18.75% position in the Pacific Smiles. The attempted acquisition was quickly rebuffed by the board with the suggestion that it did not adequately reflect the strategic value of the Pacific Smiles business and appeared opportunistic in nature.
Genesis was not deterred.
While it took some time the private equity group returned with an increased offer of $1.75. It had also increased its position size in the company in January to 19.90%. This improved offer appeased the board which granted Genesis the opportunity to conduct further due diligence, on a nonexclusive basis, to enable it to put forward a binding proposal.
Enter National Dental Care (NDC).
At the end of April Pacific Smiles entered into a scheme of implementation with NDC to acquire 100% of the shares in Pacific Smiles for cash consideration of $1.90 cash per share, valuing the company at a touch over $300 million. Pacific Smiles will also have the discretion to pay shareholders a fully franked dividend of up to a maximum of 12 cents per share, with any dividend declared reducing the cash consideration of the $1.90 per share under the arrangement. The increased bid has received a unanimous recommendation by the board.
Will we see a return offer from Genesis? We wait with bated breath.
A Perpetual Nightmare
Not all takeovers end positively.
The recent narrative surrounding Perpetual, a stalwart in the funds management sector for 138 years, serves as a poignant reminder that not all takeovers culminate in success. A six month internal review culminated in a deal to sell its corporate trust and wealth businesses for $2.2 billion to Kohlberg Kravis Roberts & Co (KKR).
Perpetual’s ambitious foray into M&A with its acquisition of rival fund manager Pendal for $2.32 billion proved to be a pivotal misstep.
Despite hefty investments and strategic manoeuvring, investor sentiment remained tepid, and Perpetual’s share price languished, failing to recapture its former glory. The KKR bid follows the rejected bid from major shareholder Washington H. Soul Pattinson of $3 billion back in November 2023. The decline in offer serves as a timely reminder to shareholders that not all takeovers end in wealth creation.
The TAMIM Takeaway
Amidst an ever-evolving market characterised by sustained acquisition activity, the pivotal role of a capable and adept management team cannot be overstated.
While a number of examples of recent takeovers have indeed yielded value for shareholders, they also serve as a reminder of the inherent risks and complexities embedded within mergers and acquisitions. Despite the allure of premium valuations and envisioned synergies, the outcomes of such transactions may diverge from initial shareholder expectations. The cautionary tale of Perpetual vividly underscores the imperative of conducting comprehensive due diligence and exercising strategic foresight when navigating the intricate realm of corporate takeovers.
Prudence and discernment remain paramount in safeguarding shareholder interests amidst the allure of potential growth opportunities.
Disclosure: Pacific Smiles Group Ltd (ASX: PSQ) and QANTM Intellectual Property Limited (ASX: QIP) are held in TAMIM Portfolios as at date of article publication. Holdings can change substantially at any given time.
This week’s reading and viewing list Big Tech Capex and Earnings Quality, How Walt Disney Built His Greatest Creation: Disneyland and Berkshire Hathaway’s 2024 Q&A Session.
📚 Big Tech Capex and Earnings Quality (John Huber)
📚 Broken Record: An open letter to Western politicians on Russia. (Doomberg)
📚 There’s More to Warren Buffett’s Game Than Just Picking Great Stocks (Jason Zweig, WSJ)
Technology advancements, particularly in artificial intelligence (AI), have been pivotal in driving market dynamics recently, with notable companies like Nvidia (NASDAQ: NVDA), Meta (NASDAQ: META), and Alphabet (NASDAQ: GOOG) experiencing significant stock price surges of 210%, 102%, and 58% respectively over the past 12 months.
Amid this transformative era, the necessity for improved infrastructure becomes obvious, positioning specialty contractors like EMCOR Group Inc. (NYSE: EME) as essential. With an impressive 123% share price surge over the past year, EMCOR stands out for its strategic role in modernising and sustaining the frameworks critical to supporting these burgeoning technologies.
Company Overview
EMCOR makes high-tech manufacturing possible. The company operates through over 80 dynamic subsidiaries, boasting more than 35,000 skilled employees across 180 locations. The company’s operations are segmented into three primary divisions, each specialising in critical aspects of construction to serve a diverse range of corporate and public sector clients:
EMCOR Construction Services (ECS)
ECS provides innovative design-build services that meet fast-track schedules and unique engineering demands. ECS specialises in electrical construction, mechanical construction, and fire protection
The division is a nationwide group of mechanical and electrical contractors with experience in virtually all U.S. markets— commercial, healthcare, institutional, education, hospitality, manufacturing, transportation, and water and wastewater treatment.
EMCOR Building Services (EBS)
EBS ensures facilities across the U.S. operate at increased efficiency through a blend of self-performed and supplier-managed services. This division handles everything from HVAC maintenance and energy upgrades to comprehensive interior and exterior services, supporting a wide variety of facilities.
EMCOR Industrial Services (EIS)
EIS provides comprehensive maintenance, construction, engineering, manufacturing, and fabrication services across North America. From an investment standpoint, EIS’s approach to providing integrated solutions through a single-source provider delivers significant value to major industries. This division’s ability to offer bespoke contracting strategies is particularly advantageous, allowing EMCOR to meet diverse client needs with precision and effectively manage complex projects, which can enhance profitability.
Strategic Positioning and Growth Opportunities
EMCOR’s strategic positioning within the infrastructure sector is significantly enhanced by legislative tailwinds provided by the Infrastructure Investment and Jobs Act (IIJA) and the Inflation Reduction Act (IRA). These acts represent a monumental federal investment totaling US$1.25 trillion, earmarked for revitalising and expanding the U.S.’s transportation, energy, water resources, and electrical infrastructures. EMCOR is poised to benefit from these initiatives, as the company’s extensive capabilities in mechanical and electrical construction align directly with the U.S’s renewed focus on infrastructure improvement.
Additionally, EMCOR’s expertise in high-tech sectors such as data centers and semiconductor manufacturing positions it at the forefront of industries increasingly driven by AI technologies. These projects demand sophisticated electrical and mechanical constructions—areas where EMCOR excels.
Additionally, the increased focus on indoor air quality maintenance, driven by concerns over wildfires and public health issues like the COVID-19 pandemic, places EMCOR in a prime position to capture new revenue streams in this essential service area. As these sectors evolve, EMCOR’s diverse capabilities and extensive reach enable it to effectively leverage macro growth trends.
By aligning its operations with significant federal investments and the frontiers of technological integration, EMCOR is not just participating in the hot trend of AI and digitisation; it is actively shaping the future of industrial and energy infrastructure, ensuring relevance for the coming decade.
The Infrastructure Decade
Dubbed the ‘Infrastructure Decade’ by the Biden administration, this period is defined by significant legislative acts and fiscal stimulus like the CHIPS act, IIJA and the IRA. Despite a divided Congress, the groundwork laid by the previous legislative session has initiated a large-scale overhaul of American infrastructure, with enormous investments across various sectors over the next 5-10 years.
Industry insights, such as a 2023 survey by Construction Dive, indicate that contractors including EMCOR, are beginning to see the tangible benefits of these federal investments. In the recent earnings call, EMCOR’s Chairman and CEO Tony Guzzi shared the company’s engagement in projects that leverage these federal investments in sectors such as solar energy and electrical infrastructure, as well as the recent reshoring trend. Guzzi highlighted,
“The solar is just starting to reengage in our part of the world, and we have great capability there, supported by the IRA and government incentives. We are privileged to be able to leverage union labour or apply our prevailing wage experience and apprenticeship programs in the nonunion world to execute these projects.”
Moreover, EMCOR has experienced significant momentum in data center construction, driven largely by the AI boom.
“We’ve been leaders in data center construction since the early 2000s,” Guzzi noted, “These facilities have evolved from 5 to 100 megawatt capacities, driven by increasing demand for cloud services and AI-powered systems.”
The growth in data center construction is substantial, with the market expected to reach US$55.36 billion by 2028, growing at a compounded annual growth rate (CAGR) of 11%. Similarly, data storage capacity is projected to more than double by 2027, highlighting the critical need for EMCOR’s services in an increasingly digital and AI-driven world.
The surge in needs to support advancements in AI, electric vehicle supply chain, and cryptocurrency mining creates a dual opportunity for EMCOR. On one hand, the booming demand for manufacturing facilities, data centers, and other infrastructure aligns perfectly with EMCOR’s expertise in building services. On the other hand, the corresponding spike in energy requirements presents a significant opportunity for EMCOR to leverage its capabilities in infrastructure services. As energy demands escalate due to the expansion of high-tech industries, EMCOR is well-positioned to address both the building and modernisation of essential infrastructure, effectively turning these challenges into a growth engine for the company.
Recent Results Surpassing Expectations
EMCOR concluded fiscal year 2023 with robust results. The company reported annual revenue of US$12.6 billion, a 13.6% increase from the previous year, with organic growth nearly matching at 12.6%. Notably, earnings per share (EPS) surged by 65% over the same period, highlighting significant profitability improvements.
This upward trend continued into the first quarter of 2024, with EMCOR surpassing expectations. The company achieved quarterly revenues of US$3.43 billion, up 18.7% year-over-year, and a remarkable 79.7% increase in diluted EPS to $4.17. These strong performance metrics led EMCOR to revise its 2024 guidance upwards, now anticipating revenues between US$14 billion and US$14.5 billion and EPS in the range of US$15.50 to US$16.50.
EMCOR’s outlook is supported by a solid balance sheet, characterised by a low debt-to-capitalisation ratio and substantial cash reserves of US$840 million. This financial stability positions the company well for sustained growth and investment in key areas.
Investments in energy efficiency, sustainability, and advanced technologies like BIM software, prefabrication, automation, and robotics are driving operational improvements. These technologies not only enhance project efficiency and reduce timelines but also align EMCOR with evolving regulatory trends and market demands for greener practices and energy-efficient infrastructure. The successful integration of these technologies is evident in EMCOR’s improved operating margins over the past two years, positioning the company for continued competitive advantage and potential profit margin expansion.
The TAMIM Takeaway
Looking ahead, EMCOR is well-positioned to capitalise on the expanding infrastructure and technology sectors. The company stands to benefit significantly from federal investments like the IIJA and IRA, which are expected to drive demand for EMCOR’s services in large-scale infrastructure projects. Additionally, EMCOR’s involvement in technological advancements, particularly in data centers and AI, positions it at the forefront of industry developments.
In essence, EMCOR represents a convergence of opportunity and stability, making it an attractive long-term investment for benefiting from infrastructure development and technological progress.
Disclaimer: EMCOR Group Inc. (NYSE: EME), Meta (NASDAQ: META) and Alphabet (NASDAQ: GOOG) are held in TAMIM Portfolios as at date of article publication. Holdings can change substantially at any given time.
While flashy industries and businesses often capture the imagination of investors, it’s the understated, “boring” businesses that often form the backbone of solid portfolios.
These companies may not make headlines, but their stable, predictable revenue streams and resilient business models, serve as the bedrock of many portfolios. Renowned investors, such as Warren Buffett and Peter Lynch, have often lauded the virtues of these unglamorous yet resilient enterprises.
Buffett, the “Oracle of Omaha,” champions the philosophy of investing in businesses with enduring competitive advantages and predictable cash flows. His conglomerate, Berkshire Hathaway (NYSE: BRK), thrives on acquiring and holding onto such boring yet dependable companies like insurance giants and consumer brands.
Similarly, Lynch, known for his prowess at Fidelity Magellan Fund, advocated for investing in what you know and understand. He favoured businesses with simple, understandable models that consistently deliver results, often found in industries like utilities or consumer staples.
Investors flock to these stalwarts for their reliability and ability to weather economic storms with steadfast resolve.
Across the globe, stalwarts like Procter & Gamble (NYSE: PG) in consumer goods, Johnson & Johnson (NYSE: JNJ) in healthcare, and Berkshire Hathaway in diversified holdings exemplify the power of boring businesses. These companies thrive not on the hype of innovation, but on the bedrock of reliability, making them sought-after gems in any investor’s portfolio.
The Company
A little closer to home, small cap company Servcorp Limited (ASX: SRV) fits this mould.
It is a leading provider of Executive Serviced and Virtual Offices, Coworking, and IT, Communications, and Secretarial Services. The company was founded in 1978 and is still led to this day by Alf Moufarrige. Servcorp began as a solution to the overhead costs of traditional office setups. Since then, it has expanded globally, pioneering concepts like the Virtual Office in 1980 and boasting a presence in 129 locations across 40 cities in 20 countries. With a commitment to supporting businesses’ growth and success, Servcorp offers premium locations, state-of-the-art facilities, cutting-edge technology, and dedicated support teams.
The Headline Thieving Competitor
In a highly competitive market, one rival readers will likely be familiar with for all the wrong reasons is global player WeWork.
Founded in 2010 by Adam Neumann and Miguel McKelvey, WeWork initially thrived by offering shared workspaces tailored to freelancers, startups, and companies seeking flexible office solutions. Its innovative business model, fueled by low-interest rates, saw rapid growth, achieving unicorn status with a valuation exceeding US$1 billion by 2014. However, intensified scrutiny ahead of its planned IPO in 2019 exposed concerns over leadership, spending habits, and governance, prompting Neumann’s resignation and a postponement of the IPO.
SoftBank Group’s subsequent bailout and restructuring efforts failed to reverse the company’s fortunes, exacerbated by the COVID-19 pandemic’s impact on office space demand.
Despite a strategic pivot towards catering to larger corporate clients, WeWork’s market capitalisation plummeted post-IPO, accompanied by substantial net losses. With its sustainability questioned amid a changing real estate landscape and macroeconomic challenges, WeWork faces an uphill battle to regain investor trust and viability in an environment of excess supply, diminished demand, and heightened competition.
Since then, the outed CEO, Neumann, has attempted to buy back the business making a bid of over US $500 million and making a Bunnings style offer to beat any other deal by 10%.
It now appears that attempted repurchase has failed with a bankruptcy court judge approving a deal whereby WeWork’s creditors take control of the reorganised entity and invest fresh capital.
The longevity of Servcorp, experienced management and responsible cost control give us confidence that the business will not suffer the same fate as WeWork.
Saudi Arabia Listing
Servcorp is in the process of restructuring its operations in the Middle-East.
The company recently updated the market with details regarding the establishment of a new holding company for the region. Securing a regional headquarters licence from the Saudi Ministry of Investment marks a milestone, granting Servcorp full support for its international initiatives through its Saudi entity.
This progress aligns with Servcorp’s strategy for a planned listing of its Middle East and European operations in 2025. With Servcorp retaining a 55% stake in the new entity, profit targets for 2024 are on track, supported by the construction of four new locations to meet demand. The potential listing promises value enhancement for shareholders, leveraging strong growth market multiples in Saudi Arabia.
A Strong Financial Position
Servcorp reported their first half results in February with total revenue growing by 8.5% to $157 million.
The company stated that the effective execution of Servcorp’s business model, centred around delivering prestigious experiences and tailored workspace solutions to meet each client’s specific needs, not only propelled revenue growth but also facilitated steady improvements in client satisfaction and retention, resulting in heightened business efficiency and reduced business development costs. This was a key driver in the 31% increase in earnings per share for the first half to 20.2 cents.
Servcorp is supported by a strong cash position with $95 million in cash on hand as of 31 December 2023. Furthermore, it has consistently returned capital to shareholders paying a dividend of $0.12 per share in each of the previous 6 months with a dividend yield of 5.71% at the time of writing.
The company reaffirmed its FY24 guidance despite the highly competitive market. Servcorp expects an additional 7 new operations to commence in FY24 which supports the forecast underlying net profit before tax between $50 million and $55 million with the expectation to produce at least $70 million in free cash flow.
The TAMIM Takeaway
Servcorp epitomises the essence of a “boring” yet robust business model that stands the test of time.
The company’s global footprint highlights its strong geographical diversity and resilience in navigating diverse market landscapes. As the company continues to deliver premium solutions tailored to meet the evolving needs of businesses worldwide, its virtual office tailwinds position it for sustained growth and success. Moreover, Servcorp’s dedication to returning capital to shareholders, underscored by consistent dividend payments and a strong financial position, reinforces investor confidence in its long-term sustainability.
Amidst the market headlines and high multiples of flashy technology like AI, Servcorp’s steadfast performance and prudent management instil confidence in a company that can navigate challenges and deliver value to stakeholders, making it a compelling investment proposition for steady, dependable enterprises.
Disclaimer: Servcorp Limited (ASX: SRV) is held in TAMIM Portfolios as at date of article publication. Holdings can change substantially at any given time.
Sometimes the macroeconomic outlook changes like the weather, and investors find themselves sailing in a crosswind of uncertainty.
The Reserve Bank of Australia (RBA) is ensnared in a catch-22 dilemma: whether to raise rates to tame inflation and risk plunging the economy into recession, maintaining the current status with the hope that inflation will abate and the economy will grow; or yield to calls for cuts due to cost of living crisis. The delicate balance between addressing inflationary pressures and safeguarding against economic downturns underscores the RBA’s reluctance to adjust interest rates, especially given the alarming rate of growing national household debt. In the broader global context, despite speculation surrounding the US Federal Reserve’s potential influence by election cycles, historical data reveal a consistent pattern.
Since 1980, the Fed has both hiked and cut rates in every election year except 2012, when rates remained at zero amid post-financial crisis recovery.
Often we see media speculation around interest rate movements which can tend to be overblown in either direction. Headlines calling for multiple rate rises could signify that we’re closing in on peak interest rates. Furthermore it wasn’t long ago that there was discussion around multiple rate cuts occurring during the 2024 calendar year.
Predicting inflation rates often hinges on the relationship with unemployment figures.
Logically, when more individuals find employment, increased disposable income propels consumer spending, thus stimulating economic activity. This interplay underscores the pivotal role of interest rates, which central banks manipulate as a lever to regulate economic growth and inflation. During periods of economic overheating, central banks may raise interest rates to mitigate inflationary pressures, while lowering rates during downturns stimulates borrowing and spending, bolstering economic activity.
Meanwhile, inflation, the measure of price increases for goods and services, exerts its gravitational pull on interest rates. High inflation erodes purchasing power, prompting investors to demand higher interest rates to offset the loss in value. Conversely, low inflation or deflationary pressures may warrant lower interest rates to stimulate consumption and investment, thereby fostering economic growth.
Given the fluid nature of interest rates and inflation, investors must adopt a strategic approach to prepare for varying scenarios.
Rising Interest Rates and Inflation
In this scenario, central banks hike interest rates to rein in inflationary pressures.
Investors typically face headwinds as higher borrowing costs dampen consumer spending and corporate earnings. Industries sensitive to interest rates, such as financials, growth stocks and utilities, may experience heightened volatility. In an environment like this, sectors such as healthcare act as a safe haven and are widely regarded as a reliable and defensive investment which tend to fare better during periods of economic tightening.
Falling Interest Rates and Rising Inflation
Central banks may respond to sluggish growth by slashing interest rates despite mounting inflationary risks.
Equity markets may experience a temporary boost as lower borrowing costs stimulate economic activity. However, sustained inflationary pressures could erode purchasing power over time, especially for fixed-income investments. Investors will often see strength in inflation-resistant assets such as commodities which can act as hedges against rising prices.
Stagflation
Stagflation is characterised by stagnant economic growth coupled with high inflation.
It poses a unique challenge for investors where traditional asset classes may struggle to generate meaningful returns in such an environment, prompting investors to explore alternative strategies. Historically, investing in dividend-paying stocks with strong cash flows and pricing power can provide a buffer against inflationary pressures. Additionally, allocating a portion of the portfolio to gold or inflation-linked bonds can serve as a hedge against the erosion of purchasing power.
Higher For Longer
A narrative that is being pushed lately is the likelihood that we see extended periods of higher interest rates.
This can impact investors in several ways. Firstly, stocks become less attractive relative to fixed-income investments like bonds, leading to a potential decrease in stock prices. Secondly, companies face higher borrowing costs, reducing profitability and potentially dampening stock prices. Additionally, the present value of future cash flows from stocks decreases due to higher discount rates, exerting downward pressure on prices. Prolonged higher rates can also slow economic growth, negatively affecting corporate earnings and overall market performance. Sectoral effects may vary, with interest-rate-sensitive sectors experiencing more significant declines compared to others.
What Action Should Investors Take?
Feeling anxious about macroeconomic developments is natural, but making investment decisions based on emotions is detrimental.
Reflecting on Howard Marks’ insights from his 2022 memo, “What Really Matters in Investing,” we’re reminded of the lesser relevance of macroeconomic news in daily investment decisions. Despite the media’s focus on fluctuating interest rates and economic forecasts, Marks argues that these elements are often unpredictable and inaccurately assessed in terms of their market impact. He emphasises the importance of adopting a long-term investment perspective, avoiding the pitfalls of speculative trading, and prioritising the intrinsic value of businesses. This aligns with the time-tested investment philosophy of Warren Buffett, who champions long-term ownership over short-term gains, suggesting that consistent, thoughtful investment outweighs the erratic nature of economic cycles and media hype.
In other words, the titans of the investment world advise we tune out market noise, concentrate on company fundamentals, and maintain a rational, disciplined approach to investing.
The TAMIM Takeaway
The tug of war between interest rates and inflation presents both challenges and opportunities for investors.
By understanding the dynamics of this relationship and preparing for various scenarios, investors can position their portfolios to weather market fluctuations and capitalise on emerging trends. Flexibility, diversification, and a keen awareness of macroeconomic indicators are essential tools for navigating the ever-shifting landscape of global finance.
As the battle between interest rates and inflation rages on, savvy investors stand ready to seize the moment and unlock the potential for long-term wealth creation.
