Description

(all figures in the tables above and in the discussion are in AUD).

Thesis summary: Simonds Group, the largest detached home builder in Victoria, trades at <3x CY EV/EBITDA (and 2.5x FY1 EV/EBITDA) with substantial net cash, despite likely entering a multi-year upcycle/recovery after a few tough years. This business was listed back in 2014 at >11x LTM EV/EBITDA (and 7.5x forward EV/EBITDA), and has derated ever since. More important though than the market turning is the fact that the company appears to be 'in play', and I believe either the founding Simonds family is likely to make a bid to take the company private again (as they tried once before in 2016), OR 25% owner McDonald Homes, a key competitor, makes a bid of their own (something they’ve discussed publicly as well). Both parties have been acquiring shares lately, and given the likely inflection in the business environment and McDonald's announced strategic imperatives, the ownership of SIO needs to be resolved sooner than later. In either of these scenarios the shares should be at least a double. In the worst case, you are likely to see a resumption in the dividend after many years of zero shareholder returns, which could result in its own catalyst (I think a div reinstatement would imply an 11% yield on current prices).

This is a quintessential deep value idea (meaning very low/no capital impairment risk, and large if indeterminate/hard to quantify upside). You are buying so-so assets at a good point in the cycle for a very cheap price, with potential near-term catalysts to extract value but some undoubted risk you bumble along cheaply for a while yet. There is substantial downside protection given the family owns 46% of the company, continues to acquire any loose shares they can (to be discussed), and bid 40c a few years ago to take out the minorities (when the business was in far worse shape and thinly capitalized), versus the 50c price now. Given the illiquidity of the shares ($50k ADV or so), this is for your PA only.

This is a simple idea, so this will be a brief writeup.

Background: Simonds Group (SIO) is an Aussie homebuilder. They build ~2500 detached homes a year under a few different brands, mostly in their home market of Victoria (Melbourne is the capital city) where they are the largest player in the state. Pure homebuilding is responsible for ~95% of revenues and 90% of EBITDA; basically all the rest is from their education and training subsidiary, BAA (Builders Academy), which started as an in-house effort to source tradesmen and grew into a larger business to train people to become 'tradies' as we say Down Under (carpenters, plumbers, etc). This is a family business, listed in 2014 when the Simonds clan sold down to 37% at $1.78 a share ($250mm EV at the time). You will note that the company was also building a similar number of homes back then, and yet today the EV is <$60mm - so the derating has been aggressive (in fact, the stock has never traded above the IPO price).

What went wrong? Basically everything. The Aussie homebuilding markets are all quite fragmented and there are no truly national players. SIO decided to beef up its exposures in NSW and QLD at the wrong time (2015) - two markets they had very small presences in and that were always tangential to their strong Victorian position - investing in a large number of display homes in 2015. A lot of the ~$16mm invested subsequently got written off within 2 years. Secondly, one of their lower-priced brands (Madisson) also had trouble competing with bigger players due to a lack of scale, and chronic cost overruns, and subsequently got written off and wound down. Thirdly, their education and training subsidiary, BAA (Builders Academy), fell victim to changing enrollment patterns as the Federal Government rewrote the amount of support they gave to those looking to get vocational training from RTOs (registered training organizations). The BAA segment did $23mm/$10mm of revenues/EBITDA in 2015, its record year, but three years later had cratered to $11mm/$0.4mm as enrollment plummeted, the company was forced to invest in more coursework/materials to go after more different vocations, and the average course time lengthened. Fourthly, they invested too aggressively for growth in 2015 (again, their record year), and built out the organization for 2800 starts when they only managed 2400-2500 the next couple of years, so margins went back down to the mid-2%s from the mid-4%s. 

This was all just on the business side. Along the way SIO went through a bunch of different CEOs (they are on to their third since 2014); a number of Board reconstitutions; and one semi-abusive attempted take-private by the Simonds family at 40c a share in 2016 (we will get to this).

Why is it interesting now then? Three main reasons: the business has stabilized; the market is hot; and the company is in play. The last is by far the most interesting so I will spend the most time there.

The business has stabilized: I’m not here to argue this is the world’s best business; simply put, though, the business’ worst days seem to be behind it. In the core homebuilding business, new starts fell 6% due to COVID last year (June’20 is the fiscal year end) but previously the last two years had been growing mid-single digits and more importantly segment EBITDA margins improved sequentially from 2.4% to 3.2% in the year pre-COVID (FY19). Since exiting (mostly) NSW, QLD; cutting a ton of costs during the FY16-18 restructuring years; and killing the lower-priced Madisson brand, it stands to reason ‘new normal’ margins should be at least north of FY19 (ie, 3.2%), all else equal. With ongoing mid-single digit growth in starts and at least a mid-3%s margin profile, the core Residential business should print close enough to $20mm in EBITDA in a ‘new normal’ type environment. I am not sure what the right multiple is for this business but 3x with no debt seems far too low.

Meanwhile the BAA segment appears to have clearly bottomed. Enrollments – which fell sequentially for basically four years, 2015-19, have started growing again, and rapidly, off a low base. 1H saw enrollments +53% and the main drag on enrollment falling – regulatory change and uncertainty – appears resolved. Against this is not the next EdTech giant that should trade at 10x revenues, but a lot of the business transitioned online during COVID, and the margin profile of the business has improved significantly (EBITDA margins from 4% to 20% last three years on flat revenues). In the recent 1H report, margins were up to 25%, and the business is now growing again (in enrollments and hence revenues, on a bit of a lag to enrollments, but still +23% YoY). I believe it is run-rating $3-4mm of EBITDA, so what’s that worth if it keeps growing? BAA is extremely capital light, most of the tuition gets paid ratably in advance and there is near-zero capex (course costs, etc, run through the PnL). It is not a stretch to argue BAA could be worth close to half the market cap, or more, today (ie 10x a recovering, growing EBITDA).

The market is hot: Aussie house prices have been on fire (+20-30% YoY), not unlike many housing markets post COVID. The Federal government threw some kerosene on the bonfire by giving first-time buyers a large incentive to buy ready-made homes (the HomeBuilder grant) which expired at the end of March, but apparently demand remains very strong. SIO’s product is largely designed for first-time home buyers so they are ideally positioned to capitalize on the surge on home-owning demand from millennials that has been one of the consequences of COVID. Whilst the supply/demand equation in Victoria is not as favorable (for builders) as in NSW or other states, given ongoing HPI and low interest rates, and skyhigh business confidence, I believe home prices will continue to rally. There are some obvious risks to the likes of SIO in all this – namely, a shortage of tradies, and general input cost inflation but so far it looks as if most all of these costs can be passed through in the form of higher prices.

The company is in play: this is where the story gets really interesting. As previously mentioned, the Simonds family tried to buy out the minorities back in 2016, at 40c a share (see here). At the time, the business was in real trouble – they took a lot of the restructuring costs and impairments through the PnL; raised a bit of debt; killed the div; and still the family was willing to pay $70m EV, or ~4.7x LTM EV/EBITDA (admittedly this was near-trough earnings).

Whilst the board and an independent expert recommended shareholders take the offer, McDonald Jones Homes, a competing NSW-based builder, had acquired a 16% stake and thought this valuation ludicrous, basically amassing enough votes to block the transaction by themselves (in Australia you only need 25% of votes voted in the transaction to vote ‘AGAINST’ to block it). The family gave up the attempt…for now.

Since then, McDonald has only increased its stake – in particular, they acquired a block in May’20, taking them to 25.5% of the company, which appears to have spooked the family, as ever since then they have been acquiring basically as many shares as they can under the ‘creep’ provisions on the ASX, whereby large holders can acquire up to 3% of a company every six months without launching a full bid. Today, the family owns 46% of the company, and even installed the son (Rhett Simonds) as the sole CEO in December last year, perhaps presaging a return to full private ownership.

There are two further accelerants to the situation here. McDonald Jones Homes is a predominantly NSW builder that sold 40% to Asahi Kasei, a large Japanese conglomerate with substantial interests in the building/construction supply chain, back in 2017 (see here). Recently (a couple of months ago), Asahi Kasei took their ownership to 80% by buying out a couple of the original owners; in so doing, McDonald obviously gets full access to AK’s huge financial resources (AK is a $17bn listed company). This is interesting, because AK has not been shy about their intentions: they intend to build a 10,000 starts a year national player, and are fully open to acquisitions to get there (see the article I mentioned). They have previously openly discussed Simonds as one potential acquisition target, given their ownership stake and obvious operational synergies.

Then, just a month ago, McDonald announced (via the AFR newspaper) they would compete directly in Victoria for the first time, without fully consolidating Simonds – in other words they would compete against their own capital. It goes without saying, this is a highly unusual situation, and I think this leak was probably to accelerate an end-game to the stalemate of the last few years. Whilst there may well have been a cultural difference between the two organizations, it would be extremely strange for McDonald to fully compete against the incumbent dominant player (in a new market for them) whilst also maintaining a large ownership stake in that business. Moreover, such a move would not make sense in the context of their recent decision (just a year ago) to increase their stake in SIO.

Basically I think we have something of a Mexican standoff here with the clock ticking and something is going to happen. Either the Simonds family is going to buy out McDonald (and everyone else), or McDonald is going to buy out Simonds (and everyone else). Either scenario is evidenced by the Simonds’ clan steadily increasing their stake (less to buy at a premium when they launch; or make more of on their sell-down to McDonald when it eventually happens). McDonald effectively has a blocking stake, meaning the price paid to everyone would have to be relatively fair. What is fair in this context?

I think the range of outcomes is probably somewhere between 5-7x EV/EBITDA. 4.5x EV/EBITDA was clearly insulting last time around (2016), the business is doing much better now and the environment is better. All that said, 7.5x LTM EV/EBITDA in 2015 was a disaster for anyone who bought into the IPO so I doubt the Simonds family would pay up there. On the other hand, there should be substantial synergies to an outfit like McDonald – especially within the larger AK umbrella – as they would be able to near-double their new starts per year overnight. Still, just 5x EBITDA on my estimates for next year ($23mm), with nothing for synergies, suggests 88c per share, or ~76% higher than spot. Realistically I don’t think either party would sell for that low a level, so that seems a very low bar and yet still generates a very substantial return from here. In reality I think any bidder would need to offer over $1 to get it done.

The downside risk is nothing happens – McDonald actually does enter the Victorian market; is happy to compete against its own capital; and the Simonds family does nothing. At that point we are just riding the cycle, but I think its quite likely 1) Simonds continues to hoover up 3% of the stock every six months (driving the stock higher); 2) a div gets reinstated – historically this was 65% of NPAT, implying 11% dividend yield on the current price (on my net income numbers for next year), thus likely also leading to a rerating; and 3) I expect the external environment to remain strong for at least the next year or so so it’s not the end of the world if you have a bullish view of the cycle.

You could also make the argument the only reason Simonds hasn't reinstated the div yet (now that net cash is now a large buffer) after 5+ years is because they want to take the company fully out first and don't want any value to leak to minorities/McDonald Jones.

Catalyst

buyout by either party, mcdonald or Simonds family

better operating results

div reinstatement

Risk: cost inflation/building delays