Description

Shagrir is an Israeli micro-cap only suitable for PA and very small funds. SRRPF is listed in the US (OTC) but isn’t liquid, so the only way to actually buy shares is directly on Tel-Aviv Stock Exchange. SRRPF was created when Shagrir was spun-off from Nasdaq-traded Pointer Telocation in 2016, and there was a need to find a solution for non-Israelis who owned the shares. The quoted price above is for the Israeli-listed shares (SHGR:IT) and the figures mentioned in the wirteup are in Israeli Shekel unless noted otherwise.

Background

Shagrir is the leading roadside assistance service company in Israel, with an estimated 30%-35% market share as of the end of 2017. Shagrir was spun-off from Pointer in July 2016, after controlling shareholder DBSI acknowledged that the market is struggling to properly value the combination of Pointer, which is a high-margin and global business, with the local, low margin operations of Shagrir. The decision has proven to be wise and timely as both Shagrir and Pointer have rallied since the spin-off took place (Shagrir is up 150% and Pointer just below 100% in exactly 2 years).

Investment Thesis

With shares down ~30% from their recent highs, we recommend buying Shagrir as we think the market is missing the bigger picture, and specifically the reasons behind the y/y decline in consolidated EBIT for Q1. Shagrir today is a combination of two discrete businesses -

Shagrir - the leading roadside assistance services provider in Israel. Currently a profitable, high-single-digit growth story with favorable free-cash-flow dynamics.  

Car2Go - a 72%-owned subsidiary which is still in startup mode and losing money as it’s increasing investments in technology (no relation to the similarly-named subsidiary of Daimler).

In May, Shagrir reported Q1 results that showed a y/y decline in consolidated EBIT from ILS 6.4m to ILS 4.1m. Decomposing that number shows that Shagrir’s core business grew EBIT by 27% while Car2Go swung from a ILS 2.8m profit in Q1-17 to a 0.5m loss in Q1-2018. This was a combination of one-time factors inflating Q1-17 results as well as heavy investment in technology in 2018, as Car2Go is ramping up its technology subsidiary GoTo (more on that later).

We believe that the market is currently ascribing negative value to Car2Go as it’s valuing Shagrir based on consolidates results. While Car2Go could be losing money for several more quarters, after discussions with management as well as with controlling shareholder DBSI, we’ve grown comfortable with the assumption that Shagrir’s “good” cash flows will not be used to fund Car2Go operations, and that Car2Go stand-alone value is almost certainly higher than zero. To be clear, we’re not trying to come up with a valuation for Car2Go. It’s a venture-like business that will require a venture framework for valuation and perhaps venture money as well (more on that below). Our main focus was confirming that Shagrir will not be the one funding this venture, and once we were able to gain conviction on that, the main exercise was valuing Shagrir as a stand-alone business, after which we realized that at the current price we’re paying well below fair value and getting the Car2Go stake as a free bonus.

In our base case, we’re using a conservative 8x EBIT on Shagrir’s stand-alone results and ascribe zero value to Car2Go, to arrive a price target of ILS 21.5, a 35% upside from today's price. Valuing Car2Go at ILS 27m (similar to what Shagrir paid for the business just before the spin-off too place) provides another ILS 3.3 per share, resulting in a 55% upside from current levels.

We also think there’s further upside to the core business and more levers to pull on the cost side, that may result in higher growth rates over the next couple of years and possibly warrant a higher multiple as well. In terms of near-term catalyst, we expect an external investment in Car2Go to be announced in the next few months, assuring the market that:

• Shagrir’s cash flows will not be used to fund Car2Go.
• Car2Go does have a positive, perhaps significant, value to at least a certain type of investors.

Shagrir

It’s hard to explain the strength of Shagrir’s brand in the local roadside services market, but perhaps the best illustration is that “Shagrir” is basically how you call a generic towing service down here (i.e, if a car needs towing you might say “let me call Shagrir”, even if your insurance is actually with another company). Shagrir was established in 1984 and was majority owned by a consortium of the big insurance companies until it was sold to Pointer in 2005 for approximately ILS 200m (50% above current value). Since then, Shagrir’s results and market share have seen ups and downs as the previous decade saw the entrance of several new independent players to the industry and pricing has been trending downwards.

Up until a couple of years ago, the biggest competitive pressure on Shagrir was the direct sales channel. While historically Shagrir has only sold its subscriptions via insurance companies as part of your car insurance policy (i.e. indirect channels), some insurance brokers started selling roadside assistance subscription marketed by the smaller companies directly to consumers - effectively bypassing the insurance companies. Luckily for Shagrir, this direct channel was practically shut off in a reform that took place in the local insurance market in early 2016. The reform not only put an end to the alternative sales channel, but also forced insurance companies to provide each prospective client with two different alternatives for roadside assistance service provider. The effect of that was another positive for Shagrir - as the most recognized brand in the industry, Shagrir was the default choice to add as a 2nd provider for insurers that weren’t selling its products before, while the company kept its leading position with their existing insurance clients. As the result of the reform Shagrir subscriptions are now 1 of 2 alternatives for each of the 13 insurance companies in Israel, while all other competitors combined split the 2nd half of the pie.   

Below is a table showing the massive growth in subscribers over the past couple of years. The towing service is Shagrir’s core product and the more expensive subscription, while “Other insurance products” include complimentary products like Windshields insurance, Rental coverage and Lights, badges & mirrors insurance. We do not expect this massive growth to continue but with the local auto market growing 3% per year, and with Shagrir still taking share from smaller competitors who now find it harder to compete under new regulations, we think there are still a few more years of high-single-digit growth in the cards. In a conservative scenario, we see top-line growth slowing down to mid-single-digits with EBIT growing 7%-8% due to operating leverage.

The business also enjoys favorable working capital dynamics as it grows, since premiums are paid upfront (or under extended credit terms of 90 days), while revenues and expenses are incurred and recorded throughout a 12 months period. Through 2017, Shagrir’s core business produced 14.5m of EBIT with FCF of 19.8m. At current EV of ~100m (for the stand-alone business assuming Car2Go is a zero), that’s a 20% FCF yield. Q1-18 saw EBIT of 4.6m and FCF of 7.5m mainly due to working capital dynamics and a significant decrease in Capex spend. We expect 2018 FCF to be at least 22m as capital requirements are coming down following heavy fleet investments during 2016 and 2017.

With a net cash position of ~30m (on a stand-alone basis) and expected FCF of ~22m in 2018, it’s easy to see market cap reaching 200m which is worth ILS 24 per share (50% upside).

It’s worth mentioning that Shagrir’s largest shareholder (28%) is DBSI, perhaps the most successful small-cap investor in Israel in recent years. DBSI is a permanent-capital, private-equity-like investment company, so it’s impossible to come up with their historical returns. However all of their acquisitions/disposals are reported in the local financial newspapers, and it's easy to assamnle a list and see that they were involved in several multibaggers in the past 5-7 years (Danel, Rada & Pointer to name a few) with no known screw-ups -- so it’s probably safe to assume a very impressive IRR. More importantly for our thesis, DBSI has put in place a well-structured compensation package for Shagrir’s incoming CEO (previous CEO retired in April after 23 years with the company). Compensation package includes options for 2.5% of shares outstanding with exercise price of ILS 21.33 (33% above current price), an annual bonus based on ambitious EPS targets, and a relatively low fixed salary.  DBSI is very much involved in capital allocation and strategic decisions in Shagrir and specifically within Car2Go. Yossi Ben-Shalom, DBSI co-founder, acts as an active chairman for both companies and has personally negotiated the lucrative agreement with the Tel-Aviv municipality which is described below.

Car2Go

Car2Go was founded in 2008 as an urban, short-term, car rental start-up. A couple of years (and struggles) later, Pointer acquired 51% of the business for an equity injection of ILS 6m. Pointer later increased its stake through additional convertible loans, and prior to the spin-off of Shagrir in 2016, it transferred its holding to Shagrir in a deal that valued Car2Go at ILS 27m. Shagrir currently owns 72% of Car2Go, with the rest of the business still owned by the founders (who are no longer involved).

For more than a few years it was unclear how Car2Go ever intends to make money. While the number of subscribers was growing and the service was adopted in a reasonable pace, parking spots in Tel Aviv are extremely expensive and it was up in the air whether the company will ever get enough scale to make this a viable, profitable business. Especially since Pointer/Shagrir had no intentions to pour massive amounts into sales & marketing and the start-up was basically funding itself (with the exceptions of the two convertible loans). The story got a major twist in 2016, when Car2Go signed an agreement with the Tel Aviv Municipality to launch a large-scale, car sharing initiative with a unique business model that includes A2Z short-term rentals (i.e. you can take the car from point A and park it at any legal parking spot around the city, paying just for the minutes within this single leg). The project, now named “Auto-Tel” (different branding than Car2Go), launched in late 2017 with 260 vehicles and 520 dedicated parking spots that were freely awarded to the venture by the city (this is in addition to the option to park anywhere you want). The Auto-Tel agreement included a multi-million Shekel fixed payment to Car2Go for the development of the required technology and back-end infrastructure to run this one-of-a-kind initiative, and a future revenue-share mechanism with the city. These one-time amounts were recognized mostly throughout 2016-2017, pushing Car2Go to GAAP profitability for the first time. Other than the large one-time payment, Car2Go benefited in several other ways from this contract:

1. It provided enough scale to absorb the company’s fixed costs, while also allowing the legacy Car2Go service to reduce the number of paid parking spots within Tel Aviv while focusing on adjacent cities.
2. It prompted RFPs for car sharing initiatives in most of the other large cities in Israel  (although at much lower scale) - Car2Go was the sole participant in all of these tenders and hence won them all (most either recently launched or should launch later in 2018, including a larger project outside of Israel, in Malta).
3. Perhaps most importantly - throughout the development process the company realized it has a unique opportunity to leverage the proprietary IP for licensing purposes. The A2Z rental model was pretty much the first one to go live worldwide, and Car2Go had both the IP/Software as well as the “miles driven” track record to start exploring licensing deals. DBSI was supportive of this move and a technology subsidiary, GoTo, was established, with the sole purpose of further developing and packaging the IP for future licensing purposes.

Fast forward a couple of quarters, and the ramp-up of developers within GoTo is the main reason Car2Go swung to an operating loss in Q1. Management expects this trend to continue in the near future as they start ramping up the sales team as well. That being said, there is no intention to self fund this start-up as DBSI clearly understands that this is a very different animal than Shagrir, and that capital markets will not be supportive of such a move. As far as we can tell, it’s likely that either venture-capital or strategic investment will be announced in the coming months. We don’t know whether such investment will be directed to GoTo or to Car2Go itself, and whether Shagrir will drop below 50% due to the investment and hence stop consolidating Car2Go. We’re not sure it really matters though, as such a deal should be accretive at current valuation either way.

An external investment seems even more likely following Shagrir's announcmenet from last month that GoTo has signed its first 3rd party licensing agreement for the car-sharing technology in Spain, Italy and Portugal, with initial deployment in 200 vehicles in Madrid. The contract is not material in terms of revenues, but we suspect that the counterparty is Emov, which is owned by PSA group, certainly an attractive strategic investor. Even is PSA does not turn out to be an investor, we could argue that a contract with one of the largest automobile OEMs should be sufficient to draw some interest from the VC community.

We can go on and speculate on how this will be valued in the case a VC gets involved, but it seems redudant at this point. It's probably better to just sit tight and wait.

Shagrir stand-alone quarterly financials (excluding Car2Go)

Car2Go stand-alone quarterly revenue and EBIT

Catalyst

• Venture/strategic investment in Car2Go.
• Spin-off of Car2Go.
• Continued growth in roadside assistance services business.