Summary
I am positive on APi Group (NYSE:APG). My summarized thesis is that APG operates in a very attractive industry that gives it a steady recurring revenue stream. Its leading position in the market also equips it with a strong scale advantage that enables it to continue winning share from subscale players. The recent acquisition has also enlarged APG addressable market, further extending its growth runway.
Company overview
APG
APG is the No. 1 player in the growing fire protection systems market (~5% share) and a leading player in the broad commercial security and life safety markets (>$150bn global TAM). The business has operations in the United States (63% of FY23 revenue), 9% in France, and the rest in other countries. Operationally, APG has two main reporting segments: (1) Safety Services (~70% of FY23 revenues and ~85% of FY23 adj. EBITDA), in which APG provides design, installation, inspection, monitoring, and other services for life safety systems (e.g., fire sprinklers, alarms, and extinguishers); and (2) Specialty Services (~30% of FY23 revenues and ~31% of adj. EBITDA), in which APG provides infrastructure services, including maintenance, repair, design, fabrication, and installation of critical infrastructure such as underground electric, gas, water, sewer, and telecommunications infrastructure.
APG
Attractive industry dynamics
The inspection services industry that APG focuses on has a GDP+ growth rate profile and volume growth is largely tied to the increase in number of broad commercial construction such as schools, hospitals, apartment buildings, etc., and regulatory changes. Of the two, regulatory change is the most visible growth driver. To put things in context, every three to five years, the National Fire Protection Association (NFPA) updates its more than 300 requirements for new construction, which cover topics like sprinkler system installation and inspection, national fire alarm, signaling codes, and more. The result is a rise in the demand for APG due to the increased need (more demanding) for testing standards and equipment. Viewed another way, the mandated nature of this industry creates a recurring revenue stream for APG. APG captures this revenue stream via multiyear contracts with customers to perform the inspection work, with built-in pricing escalators (very strong price power).
API Group Corp: J.P. Morgan Industrials Conference (Bloomberg)
In my opinion, the strong pricing power stems from customers not wanting to take the risk of major incidents happening because they are not following the requirements, and that it is still a small-ticket item relative to other costs of maintaining the building (like monthly cleaning, utilities, etc.). Hence, APG has historically seen very little customer churn (according to the 3Q22 earnings call). Importantly, given that inspection is a recurring event, it essentially provides APG with a recurring opportunity to upsell other services.
As a reminder, in most cases, these inspections need to take place at least once per year or in some cases more frequently and we have data that every dollar of foreign inspection revenue leads to an average of $3 to $4 of subsequent service revenue. On average, foreign inspection and service revenue comes in at 10% plus higher gross margins than project revenue. Bank of America Global Industrials Conference
Scale is APG’s biggest competitive advantage
In my opinion, APG’s key competitive advantage comes from its scale, which enables it to deliver best-in-class service and turnaround times. Scale is important on multiple fronts. Firstly, having a large inspection workforce enables it to have faster turnaround times (especially for large enterprise accounts that need 24/7 service). And I believe this is a crucial factor that customers take into consideration, as they do not want to encounter any delays or risk being non-compliant. Secondly, the unit economics work better because of customer density. Hence, the cost of labor is cheaper for APG (the fixed cost is spread across multiple customers per trip). All of these translate to APG having more financial resources to reinvest in better technology to help field agents improve their technology. Given that the bulk of competitors comprise smaller regional players or mom-and-pops, they simply don’t have the overall scale to compete effectively against APG.
‘And at the end of the day, the majority of our competitors are still small family own businesses. And their willingness and ability to invest in that infrastructure to support that heavy inspection model is not great.” Bank of America Global Industrials Conference
Elevated Deal is EBITDA growth accretive
APG
APG’s recent acquisition of Elevated is a positive one. Comparing the elevator/escalator services industry to APG fire safety business, there are multiple similarities. For instance, both are statutorily mandated services, and the underlying revenue stream is typically contracted over multiple years. As such, this is a lucrative market that APG has relevant expertise in dealing with.
The common pushback is that elevator/escalator OEMs (like Otis and Kone) are best positioned to win the servicing contract, and as such, APG (or Elevated) will not be able to win market share. I can understand why some investors might think this way, given that OEMs are the ones installing the product after all. The important factor to note is that the OEMs’ priority is to win new install deals, as that is their main bread and butter. These OEMs have a lot of capital invested to acquire those manufacturing capacities; hence, making sure they can maximize utilization is important. If you look at the chart above, while OEMs are dominant in the new installation market, they only occupy 5% of the service market. As such, the competition is not against OEMs but with other service providers. I believe APG will be able to win share because it is able to ride on its legacy business (fire and safety inspection) to cross-sell the elevator service. Given that APG has already established a relationship with the key decision-maker (from its fire and safety business), it should be easy for them to pitch their own elevator service.
From a financial standpoint, Elevated generates around $220 million in annual revenue, with around 20% EBITDA margins. As such, this is immediately EBITDA margin accretive to APG, which has blended adj. EBITDA margins of 11.3% as of FY23. The growth opportunity remains large ahead as Elevated only operates in 18 states, creating a large opportunity to expand through more M&A or organic expansion.
Valuation
APG Source: Author’s calculation
I believe APG is worth 22% more than the current share price. My target price is based on FY27 ~$1.1 billion and a forward EBITDA multiple of 13.
Earnings bridge: I assumed APG would grow slightly above historical levels of high single-digits over the next few years as it reaps revenue synergies from the acquisition of Elevated, which gave it another large, addressable market to penetrate. I kept EBITDA margins flat for the next three years, but note that there could be room for margin to expand if APG is able to achieve better than expected up-sell results (these have high incremental margins).
Valuation justification: I assumed APG would continue trading at 13x forward EBITDA, a discount to other safety and specialty services peers. APG has historically traded at a discount because of its slightly lower growth profile (peers expected to grow at low teens and trade at 15x forward EBITDA). Peers include Cintas Corp., Quanta Services, Comfort Systems USA, and Emcor Group.
Investment Risk
APG has an M&A growth strategy in place. While historically deals have been executed well, if the M&A strategy were to change or deals were no longer as attractive, APG may not be able to demonstrate the same level of growth moving forward. The recent Elevated deal seems positive, but if it’s not well integrated with APG’s current business, it may cause organic growth to be a drag in the near term. Lastly, given the higher interest rate today, it is good to note that a portion of APG debt is variable; hence, APG is exposed to higher interest expenses if interest rates go up.
Conclusion
My positive view on APG is because of its leading position in an attractive industry with recurring revenue streams. I believe APG scale advantage enables it to offer best-in-class service and turnaround times, which translates to cost efficiencies, and more financial resources to reinvest into the business to strengthen its competitive moat. The recent acquisition of Elevated expands APG’s addressable market and presents significant cross-selling opportunities.
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