Description

MARLOWE PLC (MRL LN)

IDEA

On 22 February 2024 Marlowe plc announced the divestment of certain compliance software and service assets. Post divestment, Marlowe will encompass a TIC (Testing, Inspection, and Certification) business alongside an Occupation Health (OH) business, generating EBITDA of GBP 39m and GBP 16m respectively. HQ expenses were GBP 6m pre-divestment culminating in a total EBITDA of GBP 49m for the company.  Currently, the market cap is GBP 477m, with the divestment proceeds resulting in a large net cash balance and an EV of GBP 294m.

We believe this valuation of 6x EV/EBITDA is very attractive for non-cyclical market-leading businesses poised for revenue and margin expansion. The divestment appears to signify the acknowledgement by the board and management that attaining a fair valuation within the small-cap landscape of AIM in London, especially with the amalgamation of TIC and GRC (Governance, Risk, and Compliance) businesses, proves to be challenging. Consequently, further divestments or a potential sale of the company remain plausible scenarios.

BUSINESS

Marlowe has been written up twice on VIC and I recommend reading these 2 insightful reports for a deeper understanding of the company’s background.

Marlowe is a UK-based company, providing business-critical services and software solutions to offer customers peace of mind by helping to mitigate risk and ensure regulatory compliance. Operating under two divisions: GRC and TIC, Marlowe serves a client base exceeding 50,000, primarily in the UK. [NS1] The company’s leading market positions are the result of an ambitious roll-up strategy.

Source: 2023 Investor Day Presentation

TIC Division

The TIC division specialises in ensuring compliance with fire safety, water, and air hygiene regulations. This segment generates GBP 330m in revenue and GBP 39m in EBITDA. While Marlowe holds a leading position in the UK TIC market, its share remains modest with a TAM estimated at GBP 3.5b.  

Within the TIC division, Marlowe’s engineers conduct on-site assessments, verifying the functionality of vital systems such as alarms, sprinkler systems, and extinguishers. Notably, 70% of fire revenue stems from recurring maintenance tasks, including minor replacements covered under maintenance contracts. The remaining 30% involves more intricate tasks such as insulation or advanced fire safety and security systems. For the water business, experts conduct comprehensive assessments, testing water samples for bacterial contamination, and provide consultancy services like risk assessments to mitigate water quality or hygiene concerns. These services yield recurring revenues. Assessments are mandatory for all commercial properties. The water business also has project-based revenues, for example from wastewater treatment, accounting for 20-25% of revenue.

In a fragmented market, larger players enjoy significantly higher profitability due to scale advantages and efficiency gains derived from optimised route density and investments in IT infrastructure. Maximising each engineer’s daily revenue by reducing travel time is key to boosting profits in this field.

Marlowe’s TIC services operate in expanding markets, fuelled by evolving regulation and increasing complexities, necessitating ongoing maintenance and testing of critical systems. Moreover, heightened insurance requirements further drive demand for Marlowe’s services. Approximately 80% of TIC revenues stem from recurring sources, typically contracted over 3-5 years, ensuring a stable revenue stream for the company.

OH Division

Marlowe’s GRC division primarily revolves around customer’s employees, with advice and support on Employment Law/HR, Occupational Health and Health & Safety. This division also encompasses the rapidly growing compliance software business. All the GRC businesses have been sold except for Occupational Health (OH). We estimate OH generates GBP 105m in revenue and GBP 16m in EBITDA.

Source: 2023 Investor Day Presentation

Marlowe is the leader in the occupational health and wellbeing sector in the UK. A team of over 800 occupational health practitioners provide health monitoring, health surveillance and assessment activities to customers across the UK to optimise workplace wellbeing and ensure compliance with The Health & Safety at Work Act, HSE, COSHH, Noise at Work Regulations and the Working Time Directive. The work undertaken is not sector-specific and can range from pre-employment health assessments for prison guards or rail workers to, employee assistance programmes and mental health support through to recurring health surveillance programmes for food processing workers to ensure they are not suffering from flour-induced asthma.

The Occupational Health market enjoys robust structural tailwinds. An estimated GBP 90b+ is lost due to absence and presenteeism in the UK. The backdrop for the UK workforce is one that is getting older and progressively less healthy, and organisations are requiring external expertise to not only fulfil their legal requirements but to improve on absenteeism and productivity.

Marlowe works across a range of sectors, both public and private from the financial sector to energy and utilities. The majority of its revenue is recurring and delivered through multi-year inflationary linked contracts.

GROWTH

TIC

Marlowe targets HSD organic revenue growth through a combination of 3%-5% structural market expansion and market share gains. As regulatory frameworks continue to evolve and become ever-more complex with an increasing enforcement burden, Marlowe capitalises on its scale advantage to capture market share, especially with more than 50% of the market still dominated by small regional players.

While the potential for acquisitions remains substantial, the impact of smaller bolt-on acquisitions diminishes as Marlowe grows. After 7 years marked by active M&A, the company is now directing its focus towards organic growth. This entails completing integration programs and driving margin accretion, facilitated by the scale it has attained.

Marlowe sees the potential to improve TIC margins from their current level of 13% to the high teens. With a well-invested national infrastructure now in place, route density allows Marlowe to be more efficient in delivering services and increase revenue per engineer per day. Approximately half of the targeted margin improvement is expected to come from these efficiency gains with the remainder stemming from operational gearing. From our prior experience in this sector, we’ve learned that companies can achieve 20% margins when they reach a certain level of scale. PTSG, for example, attained a 21% operating margin on revenue of GBP 125m.   

OH

Marlowe’s OH business underwent a significant transformation with the large Optima Health acquisition in 2022. With pro-forma revenue of GBP 91m and EBITDA exceeding GBP 19m (source: Jan. 2022 company presentation), Marlowe established itself as the market leader in OH in the UK. At the time of the acquisition, the company emphasised the creation of a robust platform for future growth, highlighting the OH business’s impressive organic growth rate of 12% annually and EBITDA margins of 20% (factoring in synergies).

The OH segment benefits from numerous structural growth drivers, including increasing regulatory demands, a GBP 1b market with projected medium-term growth of 4-5%, a mounting corporate and societal emphasis on employee health and well-being, and the substantial economic toll of absence and presenteeism amounting to a cost of GBP 90b to the UK economy.

While the FY23 segment results did not disclose separate figures for OH, as it was incorporated under GRC, the disclosure within the press release about the divestment sheds light on OH’s performance. For FY23, OH generated GBP 110m in revenue and GBP 20m in EBITDA.

Although FY24H1 OH results remain undisclosed, management remarks indicate challenging organic revenue growth during the first half, with expectations of continued volume impact in H2 due to a significant customer’s decision to insource a substantial portion of their corporate health & well-being requirements, resulting in an estimated revenue loss of GBP 4-5m (as mentioned by departing CEO Alex Dacre during the earnings call).

Over the medium term, Marlowe anticipates HSD organic revenue growth, fuelled by both new business and the upselling of additional services across their range of corporate health & wellbeing services.  Furthermore, the company foresees OH margins expanding to the low 20s, driven by the realisation of significant synergies through an ongoing integration program.

VALUATION

At the current stock price, the market cap is GBP 477m. Prior to the divestment, the company’s net debt was GBP 194.8m with lease obligations of GBP 27m. With net proceeds of GBP 405m from the announced divestment, the resulting EV now amounts to GBP 294m. The company intends to use the proceeds of the divestment to retire in full its current debt facility and return in excess of GBP 150m of surplus cash to shareholders.

During FY24H1, the TIC segment generated revenue totalling GBP 153.8m with an EBITDA of GBP 19.3m. The company forecasts continued organic growth and margin enhancement for H2. As such, we regard our projections for FY24, estimating revenue at GBP 298m and EBITDA at GBP 38.8m, as conservative.

For the fiscal year ending April 2024, we assign GBP 16.5m in EBITDA to the OH segment, considering the uncertainties surrounding the impact of a significant client loss. We believe a decline in EBITDA of GBP 3.5m compared to FY23 is conservative considering the estimated revenue loss associated with the client departure, estimated at GBP 4-5m, while acknowledging the organic growth in the remainder of the OH revenue.  

Considering the run rate HQ expenses of GBP 6.2m, and the aforementioned assumptions, the new Marlowe is valued at an EV/EBITDA of 6x.

MANAGEMENT

Alex Dacre, who owns approx. 5% of the company, will transfer with the divestment and resign as Chief Executive of Marlowe on completion. Kevin Quinn will take up the position of Executive Chair on an interim basis. The Board has begun a search for a new Chief Executive, which will include both internal and external candidates.

NEGATIVE MARKET SENTIMENT

Despite experiencing a >40% surge in response to the divestment announcement, the stock price has only recently recovered to its November levels from the previous year. This suggests that market sentiment remains very subdued.

Several factors have contributed to this subdued sentiment, including Marlowe’s status as a UK small-cap listed on AIM, substantial adjustments to earnings due to restructuring and integration efforts, concerns surrounding the debt structure, FY24H1 results falling short of expectations, and questions regarding the credibility of the CEO, whose communication may have been perceived as overly promotional.

For further insights into the reasons behind this negative market sentiment, we recommend reviewing previous write-ups and Q&A.

Marlowe's slower pace of M&A will lead to lower restructuring costs and clearer visibility of earnings. The company's shift to a net cash balance sheet post-divestment reduces debt concerns and improves its position for negotiating loan terms. Additionally, Marlowe's focus on improving operations supports steady growth and better response to market opportunities, without heavy reliance on acquisitions or financial leverage.

CONCLUSION

We consider an EV/EBITDA valuation of 6x to be highly attractive for 2 market-leading businesses specialising in non-discretionary services. Both businesses (TIC and OH) exhibit substantial potential for organic growth, strategic M&A, and have a clear roadmap for enhancing profit margins. Although our valuation is based on adjusted EBITDA (with significant adjustments), we perceive a high margin of safety at the current valuation. A valuation based on profit margins lower than historicals (OH) and peers (TIC) mitigates the risk of overestimating earnings potential. Marlowe claimed 2% organic revenue growth from cross-selling prior to the divestment. Even considering this risk of a potential decrease in organic growth by 1 or 2%, the risk-reward remains highly favourable. Additionally, the valuation remains attractive even in the improbable scenario of the deal collapsing.

Catalyst

CATALYSTS

-sale of the company

-declining integration and restructuring expenses as the pace of m&a slows down

-improving profit margins