Description

I am recommending a short in Hubbell.

The thesis primarily pertains to their recent $1.1bn acquisition of Aclara Technologies, the former GE meters business owned by Sun Capital Partners that was a cost take-out and roll-up of several metering assets over the past few years. Meters are an attractive business, probably entering an attractive growth cycle over the next few years, and the 12.2x purchase price appears reasonable in light of transaction comps in the space. Despite the deal being “accretive” to EPS and well received by investors and sell-side analysts, I believe there is a major vulnerability with Aclara’s competitive positioning that will begin to unfold over the next few years, and that investors will come to view the acquisition as value destructive.

The utility market is gradually moving towards adoption of “smart” meters, where the basic meter gets attached to a sophisticated networking communication module. This module establishes a communication network over a utility grid and allows the meter to communicate and send data directly to a utility’s central office. Smart meters allow utilities to quickly and efficiently identify theft and outages in the grid network, while also allowing a utility to remotely manage revenues / billings for a residential customer without having to manually deploy truck rolls and hire a corps of manual meter readers, thus generating attractive savings for the utilities.

Aclara’s central problem is that it lacks robust networking technology of its own. It basically pairs its commoditized basic meters with Silver Spring Network’s communication modules, which are considered state-of-the-art in the industry. Silver Spring Networks makes the modules but does not make the basic meter, and has historically chosen to bundle itself primarily with Aclara meters largely because Aclara is weak on technology and does not pose a competitive threat in the networking layer. Aclara has developed a large backlog over the past few years by leveraging its relationship with Silver Spring. 

Itron’s recent acquisition of Silver Spring will be highly disruptive for Aclara in ways that I believe investors and sellside analysts currently underestimate. As the “value” really resides in Silver Spring’s networking module, I believe you will see Itron start to vertically integrate its own basic meters with Silver Spring’s modules and displace Aclara as the underlying metering provider, capturing that upstream revenues and EBITDA for itself. With reduced access and leverage to Silver Spring’s technology, Aclara will face increasing revenue and margin challenges as the current backlog rolls off. The business likely faces an earnings cliff sometime in 2021. Furthermore, Aclara spends minimally on R&D and will have a difficult time trying to bridge the technology gap on its own without significant impacting its margin profile (~18% EBITDA margin). Hubbell bought the asset primarily to expand the product portfolio for its utility customers, a strategic market for them, but the acquisition brings minimal cost and revenue synergies, as they have acknowledged, and so their ownership offers no easy fix. 

Catalyst

Competitive loss