Description

Long Juniper Industrial Holdings Warrants – JIH/WS

This idea is not really that hard to understand. Which is great for me because I can already feel myself slowly losing it, even in my late 20’s. I’m gonna be a veggie by the time I’m as old as SpocksBrainX. Or bowd57. Or chatham123. Those dudes just sound old. It sucks. But whatever. Such is life, play the hand you’re dealt.

In reflecting on what I’ve learned and on my own investment philosophy via a few VIC situations that I’ve happily participated alongside in, I’ve noticed two common themes – at least for me – in these ideas that have had extraordinary outcomes:

1. The first is that the ideas often hit me upside the head with a 2x4 with their obviousness very quickly after initially reading them. It didn’t really take days, weeks, months of researching and digging – it took just seconds to grasp the real scope of the idea. Of course, it required much more reading up, researching, checking, and re-checking afterwards, but the big picture opportunity was very easy for me to quickly understand.

2. The second is that I actually DIDN’T know what the securities should be worth, but what I did know was that they almost definitely weren’t worth where they were trading at. F*ck if I know if this is worth 25x or 30x or 20x. What I do know is that it’s almost definitely not worth 10x. I suppose this is just another way of saying “aLWaYs InVeST WiTh A lArGE mArGiN oF SaFetY” but it took my dumbass this long and these experiences to really internalize it.

Anyway, enough babbling, onto the idea: For me, these Juniper Industrial Holdings (JIH) SPAC warrant securities (JIH/WS) meet both of the criteria above and feel to me like potential multi-baggers waiting to happen (notice though that I don’t say when). Unlike tons of the shady sh*t deals getting done out there today, these guys are buying a real business in the middle of a thematic trend that also seems to have a moat around it. And they’re offering it to the public at a very visibly discounted price to where peers trade. Oh, and there’s real potential upside to their official forward estimates (their ‘Noke’ product; accelerated upgrade cycle). It’s not all totally perfect and super squeaky clean, but it’s real. And when you marry “boring but beautiful” businesses with the embedded high torque of warrants, the outcome has the potential to become a parabolic success (just pull up the UTZ/WS chart… they make potato chips for god’s sake. zzZZZzZ). Perhaps it was a similar insight that struck Mike Milken (and subsequently the Private Equity industry) in the 1970’s before he became the Junk Bond King.

I’ll start with the business they’re buying first, and then touch on management (who we had the chance to speak with last week) and valuation.

Business Overview

JIH announced on 12/22/20 their intention to acquire a stake in Janus International from Clearlake Partners (a PE firm). A point to note here is that Clearlake will actually be maintaining meaningful ownership of Janus (~51%) PF for this transaction, so that’s a good sign that they’re not entirely trying to drop the bag on us. Janus is THE market leader in the self-storage space, providing self-storage operators (from big public co’s like PSA all the way down to individual operators) with products and services ranging anywhere from doors for the units to consulting services for designing the interior of the storage unit. The business sounds like a total snooze at first glance, which I think is why the reaction to this deal’s announcement has been somewhat tepid as far as SPAC’s go (or as one guy commented, “Hugh Janus International”). Turns out, the opposite is true – the business has supported 10% organic growth for years (which is expected to continue) and earns surprisingly high margins for what it does (25-30% EBITDA margins).

Janus organizes itself into 3 segments: Commercial, R3, and New Construction. The Commercial Business sells doors for commercial warehouses which is obviously a big and fast-growing business because of the trend in eCommerce. Janus is not the market leader here given the size of the end market; they have just 5% market share but that’s growing over time. Historical sales CAGR for this business has been ~16% organically and management’s forward estimates call for only 9% growth. Note that when I asked them about this slowdown, they said it was purely for conservatism’s sake; they were not trying to make a point about the end-market. The New Construction and R3 segments focus entirely on the self-storage facility end market where they do have dominant market share (80% market share in Institutional Facilities; 55% market share in Non-Institutional Facilities). The New Construction segment focuses on new self-storage facilities being developed and has grown MSD organically historically, with more of the same going forward. The R3 segment focuses on remodels/renovations of existing self-storage facilities and has grown organic sales ~16% historically, with management expecting a slight uptick going forward. So put all together, management expects this business to be at least a roughly M-HSD organic grower going forward, if not 10%+.

It’s clear that the two most important segments for Janus’s future growth are R3 and Commercial. The Commercial business I’m a little less worried about given how clear the secular trend/tailwind of eCommerce is.

So let’s look a little deeper at the R3 segment. Is there any way we can we confirm management’s projections that R3 organic sales growth will not only continue to be strong, but might also accelerate a bit (from 16% organic CAGR to an ~18% organic CAGR)? I would point to several things:

1. In December 2020, Elliott Management actually went activist on PSA (letter is here). In it they argue PSA needs to be reinvesting more into their storage unit base, which would lend some credence to the JIH thesis and the idea that the tailwinds to the R3 segments remain favorable. On 1/5/2021, PSA announced that they would be cooperating with Elliott (no surprise there). Here are a couple snippets from Elliott’s initial activist letter:

1. “Public Storage has — and has had for quite some time — the best assets and platform in the industry. Yet, despite that critical advantage, its total shareholder return has dramatically underperformed its peers over the last decade. Through our time- and resource-intensive diligence process, we have concluded that Public Storage's underperformance derives from two main issues: (i) a failure to invest more aggressively in its strong asset base and (ii) lagging sales growth. Substandard corporate governance and a lackluster investor relations program have compounded these problems, deepening the underperformance. By underinvesting in new stores, existing stores, store-level employees, innovation and customers, the Company has failed to capitalize on the considerable first-mover advantage, leaving its shareholders to pay the price of that opportunity cost.”

2. “Our research, surveys and personal experience have shown that the customer experience at any given Public Storage location significantly lags peers. We believe this is a direct result of its conservative approach to costs, including under-incentivizing retail workers and skimping on store experience. In our view, targeted spending increases throughout the store base will drive stronger revenue growth and position Public Storage to thrive and compete.”

2. Even before Elliott’s PSA activist campaign, you can already see some interesting things by looking at the trends in maintenance capex and rentable square feet for PSA and EXR – two of the largest public self-storage players (shown below). Generally speaking, you can see the trend in maintenance capex is generally flat-to-up over time and that drawdowns don’t seem terribly significant (even through the GFC). Then, beginning in 2016, you can see a clear upgrade cycle beginning. Another interesting point to note is that PSA’s rentable square footage only grew 20% since 2010, but their maintenance capex has grown 115% over that same time period. Remember, this is before Elliott’s campaign for pushing for even more reinvestment.

3. Historically, self-storage has been amongst the best risk-rewards in real estate. NOI growth is amongst the highest of RE asset classes – 1.7%. AND capex spend as a % of NOI is amongst the lowest (5%). Even though the risk-reward of self-storage is expected to continue to stay strong, increased competition over the years is expected to drive forward absolute returns lower. This increased competition and continued attraction towards the space should help continue the trend of modernizing your facility in order to remain competitive.

4. Lastly, the existing self-storage facility footprint skews old – 60% of the current installed base is >20 years old, with 2/3rds of that 60% >30 years old. When you combine this with the fact that Repairs & Maintenance of self-storage facilities is only a ~HSD % of the facilities’ overall expense base, that makes for an even easier decision on the part of the self-storage facility operators’ to reinvest more into upgrading the facilities, especially in the context of an increasingly competitive asset class.

So now we know that the opportunity set and macro trend-level data for the R3 segment seems real. The Commercial segment forward guidance seems conservative enough and the secular trend of eCommerce is clear. And with cost of financing at generational lows, that seems like it could only be a tailwind to the New Construction segment. What else to consider as far as organic revenue drivers going forward?

The big one – and one where management’s forward guidance seems to be very conservative, thus leaving open a lot of upside optionality – is their Noke product. Noke is their smart-lock “Security-as-a-service” business that they acquired in 2018. Noke is the first product of it’s kind and thus Janus has the first-mover advantage. The product is meant to replace a traditional padlock system with a much smarter electronic system which allows users to lock or unlock their unit with just their phone and also gives the ability to digitally share access keys. The product does seem really innovative, and you can search a bunch of videos on Youtube or look at the corp website for more detail (ex. see here and here). Janus generates a fee for installation of the smart lock (about $200/unit) in addition to some annually recurring revenue via modest annual fees as well as servicing fees. From the self-storage facility operator’s standpoint, upgrading to the Noke system seems like a no-brainer, especially when you consider that it could help lower your payroll expenses which are one of the biggest components of the operator’s expense base (~30%). In addition, it allows you to drive price and possibly even new pricing models (usage-based pricing). Payback period for most big public industrial customers is only 2-12 months, which makes for an ever more compelling upgrade decision.

As seen above, management is baking in barely any success with the Noke product, assuming only ~1% market penetration by 2023. In our discussions (and also just based on gut feeling) 5-10% penetration by 2023 does not seem out of the realm of possibility. This is a real source of upside to forward numbers; if we assume that 10% market penetration is achieved by 2023, that alone would add ~$400m in extra revenues and say an extra $125-150m in EBITDA to management’s current $205m 2023 EBITDA estimate (or 60-75% upside). There is a wide range of potential outcomes here but, in most cases, seems to point directionally north as far as intrinsic value is concerned.

Management

We had a chance to speak with the management teams of both Janus as well as JIH last week. They seem competent and able in carrying out this vision of turning Janus into the absolute go-to provider for anything self-storage, taking advantage of this modernization/upgrade cycle, and in rolling out the Noke product. It’s worth putting some added emphasis on the JIH SPAC management team’s background. The JIH Chairman, Roger Fradin, is an ex-HON executive and served as Vice Chairman and CEO of their Automation & Control Solutions (ACS) segment for 14 years. While at HON, he worked for years alongside JIH’s CEO, Brian Cook, who served in more of a corporate development/M&A capacity. They are no strangers to this type of deal that they are doing with Janus; this playbook of buying smaller industrial-tech companies with potential and improving them is a strategy they’ve been running over and over for years in one capacity or another, and their experience on that front would suggest to me that this time is probably not that much different. In fact, there is another SPAC precedent here with similar dynamics – Roger Fradin bought Vertiv (VRT) through a previous SPAC he’s been involved with, Goldman Sachs Acquisition Holdings. VRT is an industrial-tech business providing electrical, power, and other IT solutions to the datacenter, telecom, and other industrial end markets. In fact, in many ways I’d argue Janus is a much better acquisition target than VRT. Janus has DD organic sales growth in a fast-growing end market, with 25% margins and dominant market share, whereas VRT has MSD organic sales growth in a market growing 3-4% and low teens margins.

Valuation

As mentioned before, part of the appeal of this investment right now is the tepid response the deal has thus far received, combined with favorable fundamentals and a very visibly discounted price versus peers. While there’s no peer out there that’s exactly quite like Janus, management has identified a group of similar publicly traded comps which are listed below. They are broken out into two groups – the more high quality building products/industrial-tech businesses (HSD-Midteens sales growth, 25-30% EBITDA margins) and the lower quality ones (M-HSD sales growth and midteens to maybe low 20’s EBITDA margins). In either case, the median EBITDA multiple of BOTH groups is higher than JIH’s current valuation (~14.5x management’s 2021 EBITDA estimates, fully-diluted for all sponsor earnouts and warrants).

Regressing comp valuations against both sales growth and EBITDA margins would suggest, JIH “should” trade closer to ~20x 2021 EBITDA, which would put the stock at $18.50 (~50% upside) and the warrants at $7 (~150% upside) based on management’s current numbers. The other assumptions to note in my return calc below: (1) I use the midpoint of management’s 2021 net debt target, (2) I assume no further M&A and that cash just builds onto the B/S [~$100m/yr], and (3) I am fully diluting the share count for all sponsor earnouts and warrants [149.5m shares, vs the 136.2m shares in the deal presentation].

Yes, I am aware 20x EBITDA in an absolute sense is high and that comp valuations have gone up over time. But the distance between that “should trade at” valuation and the current valuation seems very large, and when I consider the current interest rate environment and how favorable it is to the RE estate space, that gives me some comfort as to the margin of safety here. There’s no reason that this shouldn’t trade in-line with it’s higher quality peers. Plus, even if we say valuations for the entire space takes a strong turn for the worse, and that JIH never gets a forward EBITDA multiple above 15x, even at 15x the risk of permanent capital impairment seems muted over a multi-year hold period.

Also keep in mind that the numbers I am using in the return calc scenarios in this section are straight from the deal presentation. From my discussions with management, I got the strong sense that they were trying to say “we’re being conservative enough that we’re not not going to beat numbers” without actually saying it. Plus, management’s forward projections on the Noke opportunity bake-in seemingly barely any success which, as discussed, leaves considerable room for upside optionality to numbers. I could case this out into more detailed bear, base, bull scenarios across all the various variables but to do so feels like I would just be creating some sort of false sense of precision. To me, this idea goes to the core principles I highlighted up front – the story is fairly easy to understand, there are considerable drivers of upside that are also easy to understand, and the valuation discount to peers seems unwarranted. I don’t want to make a call on when the stock/warrants move higher, but over a multi-year hold period, the data would seem to suggest both forward estimates and valuation multiples are more likely to head north than south.

Risks

- Weak execution on the part of management

- Comp valuations turn hard for the worse and stay very meaningfully below currrent levels

- Noke adoption fails to take off

Catalyst

- Deal close 1H21 (likely closer to March/April)

- Consistent execution; self-storage upgrade cycle

- Noke roll-out