SPIE: An Overview

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Good morning,

Today i wanted to branch out from my usual genre of company and provide an overview for something a little different. As per the survey, subscribers voted for Beyond Meat, Microsoft, Shopify and Etsy as the next four company overviews. Before we jump into those, i wanted to provide something different from the European markets, in SPIE.

SPIE was a recommendation from a subscriber who; A) wanted to see me cover this position and; B) wanted me to cover some EU stocks. So i happy obliged with that request.

Business Overview

The SPIE group (operating under the name ‘SPIE’) is an independent leader in electrical and mechanical engineering and HVAC services (Heating, Ventilation & Air Conditioning), energy and communication systems. SPIE are currently a mid-cap with a market value of ~ €2.5 Billion.

SPIE report their financials on a consolidated basis, which comprises 184 companies. As of 2019, the company employs ~ 47,200 people and earned €6.9 Billion in revenues, with EBITA of €416 Million. SPIE is headquartered in Cergy-Pontoise, France.

Breaking down the revenues, SPIE attribute that €6.9 Billion as 33% from Germany and CE, 39% from France, 21% from NW Europe, and 8% from their work in oil and gas and nuclear.

The history of SPIE is one that is now 120 years in length. Celebrating their 120 years in existence, SPIE are promoting their look forward in their ‘Ready for the next 120 years’ marketing. If that is not a bullish sentiment, then i don’t know what is.

The Group has an extensive network of employees and offices spread across Europe, with additional projects for their oil and gas services in the Middle East, Asia, and Africa.

As you may have noticed, SPIE report in Euros. This is the first time i have covered a € denominated financial report here at IT, as i typically cover $ or £ denominated filings. However, the exchange rates are available online for those interested. I won’t be converting them for obvious reasons.

The goal of SPIE is to offer support, to their customers, and facilitate the design, build, operation, and maintenance of energy-efficient and environmentally friendly facilities.

SPIE’s desire is to support the assets of their customers throughout their lifecycle, which typically breaks down to 80% spent in the support of existing assets (replacing, upgrading and maintaining), and 20% devoted to the creation of new facilities (engineering, installation and consulting & design).


Historic Context

After being founded in 1900 as ‘Société Parisienne pour l’Industrie des Chemins de Fer et des Tramways’ it was later named ‘Société Parisienne pour l’Industrie Electrique’ (SPIE) in 1946. This roughly translates to the Parisian Society for the Electrical Industry. In 1968, SPIE merged with a company Batignolles Construction Company and formed as SPIE Batignolles. In 1997, the main shareholders in the merged entity sold over the company to employees, as well as a British company, AMEC, who were specialists in engineering, project management and consulting. The following year, in 1998, the company was once again renamed ‘SPIE’. During this period SPIE operated in three business sectors;

1) SPIE Batignolles specialized in the construction market.

2) SPIE Enertrans focused on rail transport/traffic and the energy market.

3) SPIE Trindel, a specialist in electrical engineering and facilities services.

In 2003, AMEC purchases the shares of shares of the minority shareholders and SPIE thus became the Continental Europe division of AMEC, under the name AMEC SPIE. In that same year, AMEC SPIE continued to expand its oil activity with the acquisition of Ipedex and sold SPIE Batignolles, its construction subsidiary, to its executives.

In 2006, AMEC SPIE was sold to the PAI Partners fund. Since that date, the Group has conducted business under the SPIE name. In August 2011, a consortium composed of an investment fund managed by Clayton, Dubilier & Rice, LLC, the investment fund managed by Ardian (formerly AXA Private Equity) and Caisse de dépôt et placement du Québec acquired control of the Company for an amount of approximately €2.1 billion.

In 2002, the Company began to refocus its strategy to become one of the leaders in the multitechnical services markets. Between 2002 and 2006, the Group sold or abandoned five of its business segments, including its civil engineering operations (in 2002), the French construction market (in 2003), the energy projects market (in 2004), pipelines (in 2006) and its rail business (in 2007).

The Group continued this policy to dispose of operations that are no long part of its core business. For example, the Group sold its Spanish subsidiaries in July 2011. At the same time, the Group continued to pursue external growth, both as an independent provider of multi-technical services with the acquisition in 2007 of other companies present in its business sector, such as Matthew Hall and Controlec, in the United Kingdom and the Netherlands. More recently, the Group has made several acquisitions in North-Western Europe, Germany and Central Europe.

In 2012, the Group acquired the Dutch companies Klotz BV and Gebr. Van der Donk to strengthen its position in multi-technical services for buildings and the cable network market, respectively.

In 2013, the Group acquired the IS&P division (installation, maintenance and management of data and voice communication and data centre infrastructures) of the Dutch operator KPN, which expanded its operations and presence in the Netherlands. In addition, in 2013, the Group acquired Hochtief Service Solutions activities (multi-technical services), making Germany the largest Group market outside France.

in 2015, the company declared an initial public offering on the Euronext Paris. For those interested, you can find the initial offering presentation here.


The SPIE Group focus their activities across four different segments at current. These include:

Note: The %’s shown in the above image represent the % of consolidated production for the financial year ended December 31, 2019.
  • Mechanical and Electrical Services: This includes electrical, mechanical and HVAC engineering services.

  • Information and Communications Technology Services: This includes the installation, upgrading and management or voice, data and image communications systems.

  • Technical Facility Management: The includes the technical management of facilities and related services.

  • Transmission & Distribution: This includes the delivery of a comprehensive range of transmission infrastructure and energy distribution service, primarily in the electricity segment.

SPIE focus the development of these activities across four key markets in smart city, energies, E-fficient buildings and industry services. We can define the below markets, as the ‘sources of revenue’ for the company, which will be discussed in a later section.

Note: The %’s shown in the above image represent the % of consolidated production for the financial year ended December 31, 2019.
  • Smart City: This includes the ‘smart’ layout of cities, with emphasis on communications infrastructure, mobility, group equipment and safety.

  • E-fficient Buildings: This is a service offering for energy performance ranging from design to the operation and maintenance of low-consumption buildings

  • Energies: This includes serviced offered by the SPIE Group in the areas of energy, with emphasis on nuclear and renewables, as well as oil and gas.

  • Industry Services: This covers various different areas of industry services

Non-Financial Goals

SPIE claim to have three commitments towards major contributions they seek to make as part of their business plan. Each of these contributions relate to the goals set forth by the United Nation’s Sustainable Development Goals. These goals cover a wide array of areas from a global context; from poverty, to education, to gender equality, clean energy, the seas, climate change and clean water.

SPIE’s three commitments focus on various segments of the UN’s SDGs, most notably:

  • Gender Equality (5)

  • Affordable and Clean Energy (7)

  • Decent Work and Economic Growth (8)

  • Industry, Innovation and Infrastructure (9)

  • Sustainable Cities and Communities (11)

Commitment 1): Preparing the Energy Future

SPIE have undergone various changes in 2019 that strike various goals within the 7th SDG of Affordable and Clean Energy, as well as the 11th goal of Sustainable Cities and Communities. In 2019, SPIE reduced the level of energy efficiency of their own buildings by 12% to 86 KW per SQM. Moreover, the company observed an 18% decline in C02 emissions from 2017 to 2019.

This commitment relates to SDG 7.2, which aims to “increase the share of renewables in the global energy mix”. SPIE generated €50 Million from renewable energy projects in 2019.

Moreover, SPIE are also directly working towards SDG 11.6, which aims to “reduce the adverse environmental impact of cities”. Under the operations of LED lighting projects, SPIE have generated €144 Million in revenues.

Commitment 2): Supporting New Utilization Through Innovation

Under commitment number 2, SPIE target SDG 9.4 which is to “upgrade infrastructures”.

Under their roll-out of fibre optics projects, SPIE have generated €312 Million in revenues.

Moreover, the group also target SDG 11.2, “provide access to transport systems”, through the installation of 4,500 EV charging stations across 2018./2019.

Commitment 3): Promoting Inclusion Through Employment

The company cite that they employ, on average, 5,000 direct, permanent jobs each year, which relates to SDG 8.6, “achieve full and productive employment”.

Lastly, in pursuit of their commitment of SDG 5.1.1 , “promote equality and non-discrimination”, SPIE offer a range of programs to ensure opportunities for underrepresented parties. One example being the 1,000 female students involved in the “elles bougent pur l’energie” day that raises awareness of careers in the energy sector.

Okay, so after a brief look at the higher level of the company, we can now start to break down the more granular components of SPIE’s business.

SPIE’s Strategy

Before we address the strategy of the firm, i think it would be prudent to first examine the stakeholders in SPIE’s environment. During 2019, SPIE created a department set up with the sole purpose of mapping the firm’s stakeholders. Through this, they seek to understand the most important issues within their ecosystem and open up dialogue with stakeholders.

Stakeholders

  • Talent: Consisting of employees, employee shareholders, managers, representative bodies, applicants, interns, retirees, alumni and school ambassadors. SPIE claim that talent, is their greatest asset. They aim to retain this talent by focusing on employee aspirations, career & skills development and health & safety. SPIE also offer all employees a chance of employee share ownership, to allow them a say in the strategic ownership.

  • Customers: Consisting of public, private and prospective customers. The keys here are satisfaction and trust. SPIE are big advocates for longevity when it comes to customer relationships, so do their best to support that.

  • Investors: Consisting of institutional, private and retail investors, as well as financial analysts, rating agencies and financial ecosystems. This includes the typical compliance related, investor relations, posturing activities that come with being a public company.

  • Suppliers: Consisting of strategic suppliers and subcontractors. SPIE operate in a fairly unique, and competitive environment whereby the expertise from specialists is a resource in that of its own. Thus, SPIE aim to build strong relationships with these suppliers.

  • Regulators: Consisting of national and local authorities and regulators. As a leader in the EU, SPIE has to set an example of compliance and regulation within the host countries it operates in. As such, SPIE have close ties with market regulators. Moreover, they are vocal in their efforts to provide transparent and trustworthy regulatory information.

  • Partners: Consisting of peers, competitors, industry organizations, universities, school and start-ups. SPIE take an active role in many different industrial organizations, such as the NPWF and Gimelec.

  • Civil Society: Consisting of local communities, media, users, NGOs and associations. SPIE have a reputation, which alone is an asset to the company. SPIE seek to nurture that reputation by maintaining regular and open dialogue with civil society as a whole.

The Business Model

So how does SPIE actually serve these stakeholders?

The business model of SPIE (shown below) is centered around 6 key slices of the pie shown in the middle of the diagram.

The stem of the business model is underpinned, first, by the four key activities of the company operations in; mechanical & electrical services, technical facility management, information & communications technology services, as well as transmission and distribution services. We touched on these earlier on in the newsletter.

It is these core activities that allow SPIE to leverage their teams’ expertise and know-how. The proximity aspect centers around their desire to capture and consolidate the fragmented marketplace across the EU (as well as other locations).

The expertise, and proximity of that know-how allows for superior service provided to their EU customers. In addition to that, SPIE operate under the premise of diverse contract offerings to serve the customers needs. Fixed-price contracts are the bulk of the contracts issued, with service contracts and framework agreements being 5% apart.

The finally, as we mentioned in the introduction, SPIE are driven by their relationships with customers, seeking the support their clients through file lifecycle of their assets. As we mentioned earlier, around 80% of this involves asset support, with the remainder being focused on the facilitation of new assets.

All of these efforts are then targeted towards SPIE’s four key markets in; e-fficient buildings, energies, industrial services and smart cities. We cover these four markets in greater detail in the ‘revenue sources’ section a little later on.

SPIE also believe on of their core strengths is their virtuous financial model which is driven by their organic revenue growth and their bolt-on acquisition strategy.

Let us quickly examine their bolt-on acquisition strategy, before we move on to discuss the revenue sources some more.

Bolt-on M&A strategy

SPIE operate a bolt-on acquisition strategy, which simply means they like to acquire smaller companies, often in the same line of business, with the purpose of increasing strategic value, synergies, market share, amongst other things.

We can see that in 2019, the company acquired 4 companies, which combined supposedly contributes an annual sum of €210 Million in revenue to the business.

- On May 21, 2019, SPIE DZE acquired the Christof Electrics group in Austria, Christof Electrics offers complete solutions in the fields of electrical engineering, measurement, control and regulation technology as well as automation. The firm enjoys an excellent reputation on the market and has long-standing business relationships with a broad and loyal customer base in the energy, industry and the public sectors. The company employs 154 people and generated revenue of approximately € 36 million in 2018, The consideration paid was 20 million euros.

- On June 14, 2019, SPIE DZE acquired the TELBA Group located in Germany. TELBA Group is one of the leading German companies for technical services in the fields of information, communication and security technology and has a broad and loyal customer base. With around 400 qualified employees, TELBA Group generated total revenues of around € 67 million in 2018, The consideration paid was 35.6 million euros.

- On July 8, 2019, SPIE Industrie & Tertiaire, a subsidiary of SPIE France, acquired the French group Cimlec. Cimlec is specialized in design, manufacturing, installation and maintenance of robotic, electrical and automation solutions. With 310 employees, Cimlec generated a turnover of around 42 million euros in 2018. The consideration paid was 25.4 million euros

- On September 9, 2019, SPIE acquired OSMO-Anlagenbau GmbH & Co. KG (“OSMO”) in Germany. Founded in 1970 and located in Georgsmarienhütte, Lower Saxony, OSMO provides a range of technical services to industrial customers and public authorities, including traffic engineering, electrical systems, automation technology, switchgear and power supply assembly, energy supply systems and communication and security technology. OSMO generated total revenues of approximately 65 million euros in 2018 and employs more than 270 highly qualified employees. The consideration paid was 49.3 million euros.

The acquisitions made in 2019 where made with the intent on adding value to SPIE’s existing operations. We can see from the below illustrations where each of these smaller acquisitions contributed in relation to SPIE’s strategic priorities.

SPIE claim that the TAM is in the region of €220 Billion, of which their €6.9 Billion in 2019 revenues only scratch 3.1% of that.

This supposed €220 Billion opportunity is largely fragmented however. Part of the rationale for the acquisition strategy is that they can capture more of this large market via the consolidation of the fragmented pieces. From the visual below, it appears that SPIE only hold a modest market share across each of the EU geographies. France, their largest market with a ~7% share of the €40 Billion TAM, Germany with~2% of the €80 Billion TAM, ~2% of the UK’s €20 Billion market, and so on.

In addition to that, SPIE identify the extent to the fragmentation within each market. You will note that Germany, in particular, appears to be highly fragmented, whereas France appears to be more consolidated.

This is the very reason that SPIE want to acquire the smaller fragments of the market, in an effort to drive up their collective market share under one consolidated parent, which is SPIE.

The overall goal of this strategy of bolt-on acquisition is to consolidate highly fragmented markets via the acquisition of smaller players. From 2006 onwards, SPIE have now collected 126 bolt-on acquisitions up until the end of 2019. You can see, from the below illustration, that in each year SPIE have acquired more revenue than they spent on acquisitions.

Moreover, the bolt-on strategy is a key driver of SPIE’s revenue growth. Interestingly, and perhaps a little concerning to some, is that we can see from 2008 onwards (with the exception of 2011) SPIE’s revenue growth has been directly linked to these bolt-on acquisitions. Organic growth, from 2013 has been negative, only reverting to positive in 2018 and 2019.

To me, this is a red flag. I gather that SPIE are in the business of some fragmented markets, and consolidating those businesses is a good thing, but for me growth by acquisition is rarely a good thing longer term. It has been the downfall of many a strong company when the tough times arrive. However, that being said, SPIE have been deleveraging recently, in addition to their goodwill being fairly constant over time. In 2013, the level of goodwill as a percentage of total assets was 38%, which is 1% different that in 2019. The level of goodwill to fixed assets was in the same ball-park too.

This is not uncommon in businesses such as SPIE. There are a few things about this method of growth that are great, and a few that are not so great in my opinion.

We have discussed this a few times in the IT newsletter, but the growth by acquisition model typically leads to a large build up of intangible assets, namely goodwill. In the case of SPIE, they report goodwill as differences between:

1) The acquisition price of the shares of the acquired company plus any contingent price adjustments, and;

2) The Group's share in the fair value of their identifiable net assets on the date of the control being taken.

The temporary fair value of assets and liabilities acquired may be adjusted within a maximum twelve-month period following the date of acquisition (the “evaluation period”), in order to reflect new information about facts and circumstances that existed at acquisition date, and that, if known, would have affected the measurement of amounts recorded at that date. This may result in adjustments to the goodwill determined on a provisional basis. Price adjustments are measured at fair value at acquisition date, with a counterpart through equity, at each closing date. After the end of the one-year allocation period, any further change in this fair value is recognized in income.

As we may know, goodwill is a difficult asset to value, as well as something that is subject to impairment charges. Impairments will arise when the carrying value of the asset (ie, the value on the balance sheet) becomes significantly larger than the fair value (the price it would reasonably sell at today). During cyclical periods of economic decline, this can lead to some heavy write-offs and impairment charges.

In line with SPIE’s policies Goodwill is tested for impairment at least once a year and whenever there is an indication of impairment. For this test., goodwill is allocated to Cash Generating Units (CGU) or groups of CGUs corresponding to homogeneous groups which together generate identifiable cash flows.

From the IPO in 2015, whereby the goodwill of SPIE amounted to €2.16 Billion, the amount of goodwill as of June 30 2020 now stands at €3.2 Billion. This accounts for 39% of total assets, and a stonking 63% of fixed assets.

We will discuss this a little more in the financial overview section.

Revenue Sources

As we have alluded to, there are four strategic markets that SPIE target. Using these four markets, we can break down their revenue composition.

SPIE identify four leading secular drivers that will supposedly underpin their longer term revenue growth. Personally for me, i feel the shift in the mixture of energy production and distribution strikes me as the most clear. It is likely that most bodies across the globe, including the EU as we have detailed, have some form of mandate to increase the composition weighting of renewables which is an area SPIE have strong expertise in.

Now let us discuss each of the revenue segments.

SPIE recognize the challenges faced by cities in the modern age. The two largest hurdles appear to be the growth or urban populations which lead to rising denticity of populations and overloaded networks, as well as the need for more sustainable development in these urban areas. The issues essentially revolve around the idea of accommodating the influx of new residents into cities, whilst maintaining, or even improving, mobility.

Smart city projects generated €2.6 Billion in revenues in 2019, representing 38% of total revenues for the year. SPIE estimate that by 2050, around 80% of Europeans will be living in cities, and that by 2025, there will be around 4,800 daily interactions with smart devices per person.

Some of the core challenges that come with this rapid growth center around how to deal with this rising urban population, how to preserve the local appeal of cities, how to adopt cities for new purposes as well as reducing the level of CO2 emissions at a city-level.

Some of the activities that SPIE have in this space are; smart public lighting, connectivity & telecommunications, video protection, transport & mobility, educational & healthcare infrastructure, public services & equipment, and water & waste treatment.

This is a service offering for energy performance ranging from design to the operation and maintenance of low-consumption buildings. Powered through the demand for new infrastructure to accommodate the growing population, as well as demand for expertise in managing increasingly complex buildings, this sector is growing. Buildings are gradually becoming smarter, through the smart systems, video surveillance and data management in an effort to provide users with the highest quality security and experience. SPIE is actually one of the few players in the EU market that are capable of offering consumers an integrated approach that includes all the tools to optimize building functions.

E-fficient buildings generated €1.3 Billion of 2019 revenues, or around 18%. SPIE are anticipating a 40% increase in building energy efficiency by 2040. This demand is driven by the fact that 50% of energy used in buildings is typically lost due to poor management systems today.

Some of the activities that SPIE have in this space are; high energy performance electrical & HVAC systems, information & communications systems, control & security systems, and energy-related multi-technical services.

As an example, in 2019, SPIE completed a project to modernize the UK headquarters for Cisco, whereby SPIE upgraded technical facilities at the Cisco UK flagship office in Bedfont Lakes, Feltham with the aim to offer their employees a better work quality. These upgrade works were carried out in a live building environment and had to be undertaken with minimal interruption to the client.

As another example, SPIE has a solid relationship with lawfirm, CMS dating back to 2014. Back in 2014, CMS Francis Lefebvre Avocats, was one of the first business law firms to assign the outsourcing of its IT infrastructure and the storage of its data on a private cloud to SPIE ICS, a digital services subsidiary of SPIE France. The aim of this highly innovative approach was to protect the storage and transfer of sensitive data while guaranteeing very high data availability. To access the cloud securely, SPIE ICS also deployed a high-speed internal network connecting the head office in Neuilly - as well as the sites in Strasbourg and Lyon - to two data centers hosting the infrastructure. In 2019, SPIE completed a private cloud transformation for the law firm.

This includes serviced offered by the SPIE Group in the areas of energy, with emphasis on nuclear and renewables, as well as oil and gas. The EU has a planned budget of €1.15 Billion in annual spending on environmental energy projects to reach their 2030 energy mix objectives. SPIE is supporting a range of energy markets players during this transition. As a big advocate for green energy, SPIE are aiming to grow the aggregate market share of renewable energies.

Energies brought in €1.8 Billion in revenues last year, or 27% of total revenues. For context, in 2017, the share of the EU’s renewables within their energy mix was 17.5%. The EU are stating that by 2030, this number is targeted to increase to 32%.

Some of the activities that SPIE have in this space are; hydrocarbon extraction & production, nuclear cycle & power generation, thermal & renewable energies, and electricity transmission & distribution networks.

Here is the deal with industry services. Industrial players have two glaring issues facing them as we advance forward. Number one, being the requirement to adapt their production methods for the transition into cleaner, more environmentally conscious operations. Number two, being the need to make this alteration, before it is too late. SPIE have the expertise, the capabilities, and the presence in wide-range of industrial sectors to take advantage of these challenges faced by players both big and small.

Industrial services raked in €1.2 Billion last year, reflecting a 17% slice of he total revenue for the year.

In relation to industrial services, SPIE are active in; local engineering, mechanical & electrical installations, automation, robotics, control & industrial IT systems, industrial maintenance & process improvement and energy consumption optimization in industrial processes.

Financial Performance

Okay, so i feel that we have a suitable idea regarding the operations that SPIE engage in, as well as their core strategic focus, target markets and stakeholders. Now that we are somewhat familiar with the overview of SPIE’s business, we can now take a peak at their financial performance. Here, we shall dig into their profitability, liquidity, and cash flows.

Profitability

Considering how SPIE only became public in 2015, the operating history which is publicly disclosed is relatively short. There are some instances, such as the chart below, whereby SPIE will provide data further back than 2015, but for the purpose of this piece, we will use 2015 as our bedrock.

Those who read my newsletter fairly often, will likely be used to some more attractive top line growth rates, given the nature of the companies i typically cover. However, not every company is a high flying payments or e-commerce company.

SPIE revenues have compounded at an annual rate of 6.1% from 2008, when revenues were €3.6 Billion, to 2019 whereby revenues were reported at €6.9 Billion.

This is still an attractive rate, at the very least they are expanding. Moreover, if you recall the discussion pertaining to the acquisition strategy of SPIE, you will remember that they drive revenue growth via organic and bolt-ons, with the last decade being largely driven by their acquisitions.

Breaking down the revenue growth (+3.8%) from 2018, we can see that organic growth accounted for 1.6%, acquisitions added 2.2% of revenue growth, disposals of assets reduce 0.2% of revenue growth, and FX nullified that 0.2% loss.

For the first half-year period (HY) SPIE generated €3.041 Billion in revenues, compared to the €3.26 Billion generated one year prior. SPIE has withdrawn guidance for 2020 after the events of Corona were seen to materially impact their operations. This also led to the cancelation of the final dividend payment for the 2019 period. As such, i think it is somewhat likely that SPIE fail to improve their revenue figure of €6.9 Billion from 2019. If i am being frank, i don’ think that is the hugest setback for the company. They appear to be focused on maintaining liquidity for now. As the EU economy regains footing once more, and they engage in more micro acquisitions, i am sure their sales will begin to climb upwards once more.

One nuance that is perhaps beneficial to point out is that SPIE report both ‘recurring’ and ‘other’ operating incomes and expenses, so that readers of the reports may better understand the nature of their operations.

The recurring segment excludes items that have little predictive properties, such as gains and losses on disposals of assets or operations; - Expenses resulting from restructuring plans or operations disposal plans approved by the Group management; - Expenses relating to non-recurring impairment of assets; - Expenses of acquiring and integrating companies acquired by the Group; - Any other separately identifiable income/expense, which is of an unusual and material nature.

These items will be recorded as ‘other’ operating items. I am highlighting this incase i mention the operating items in a segregated fashion, and more so to simply highlight this quirk of reporting, which i don’t see very often.

SPIE do go on to provide some more granular insight into the composition of the operating and other incomes and expenses. From Note 8 to the financial statements we can see that the €6.65 Billion in other expenses is broken out into purchases, external services, employment costs, taxes, amort & dep expenses and provisions and other items.

Note 8.2 then breaks down the employee cost line item in wages, social security, employee benefits and the profit-sharing scheme.

Moreover, note 8.3 also provides some color on the ‘other’ operating items, which typically net out to be a negative figure over the 5 year sample i observed.

Operating incomes are fairly tight, ranging the lower-end of 4% to closer to 6% over the past 5 years period. In comparison to some companies, there are a large number of moving parts that impact the operating income figure. Within the operating expenses, there are the typical employee costs, purchases and so forth, but when we arrive at the other operational expenses, there are significant impacts from the sale and acquisition of assets, including those deriving from acquisitions.

The level of operating income from 2019, €336 Million, was largely bolstered by an additional €259 Million in revenues. This lead to an additional €27 Million in recurring operating income. Then we we arrive at the total other operating income (expenses) line item we can see that in 2018, this figure nets out at (€41 Million), but in 2019, it nets to (€11.7 Million). This difference is largely driven by the reduction in business acquisition costs as well as a reduction in other operating expenses, plus benefitting from the fact that other operating incomes were €8 Million higher than the previous year due to a €14.6 Million gain in a disposal of an asset, as well as other items.

This is all well and good, and typical of SPIE’s operations, but one thing i struggle with, as an analyst of the company, is the unpredictability of these items from year to year. With the operating margin being so tight, a difference of €20/€50 Million is quite substantial from one year to another. With SPIE actively pursuing a bolt-on serial acquirer strategy, i doubt this will change anytime soon.

Excuse the rudimentary drawing, but the below illustration displays what i typically look for in net income growth over time.

I prefer a steady incline in earnings as the company grows in market cap and revenue base. This is not possible for all firms, and i don’t think it is possible for SPIE given their strategy. This is not to say SPIE are doing anything wrong, more so to state what i personally prefer to see in companies i invest in. Taking a zoomed out approach, we can see that net income is looking healthier in 2019 (€152 Million) than it was back in 2013 (€47 Million), but in between all that we have negative earnings and even a year where SPIE earned €184 Million followed by two sequential periods of decline.

I guess what i am saying here is that with such a thin bottom line, small differences in expenditure can make a large difference, and that is not something that attracts me as an investor. That being said, we have to remember that SPIE are a smaller company, in the mid cap space. Their market share in EU markets is still relatively low due to the excess fragmentation of their target markets. With time, after the market becomes more consolidated, i dare say the earnings base might be larger for SPIE.

For now, it looks lumpy, which doesn’t fill me with confidence, for the kind of investments i personally prefer to make.

Liquidity

SPIE are really interesting from a liquidity standpoint. Admittedly, prior to performing some due diligence on the company, my first inclination was that they would be fairly illiquid as a company. My premonitions were somewhat correct and somewhat mislead in other aspects.

Surprisingly, SPIE operate with fairly low capital expenditure requirements. The level of Capex to Revenue is more often under 1%, with the latest level of capex in 2019 being €52 Million compared to €6.9 Billion in revenues.

Another interesting quirk of SPIE is that they operate under a structural negative working capital balance. We have talked about this in previous newsletters, the benefits of efficient working capital, but in some cases, negative working capital can be a sign of efficiency too. In these occurrences, it can effectively mean that SPIE have some superior cash conversion taking place. IE, they are borrowing from suppliers, and reaping the cash from those supplies before having to pay suppliers as per their credit terms. Amazon are great at this. This can be a positive thing for firms who do it well.

Back in 2017, when SPIE were acquiring SAG, moody’s stated the following, relating the credit rating of SPIE’s debt:

“Spie's Ba3 corporate family rating (CFR) reflects: (1) the positive growth dynamics dominating the technical services industry; (2) Spie's position as a leading independent multi-technical service provider; (3) its recurring revenues from a large number of small contracts leading to stable financial performance in the past; (4) good customer diversification; and (5) steady cash flow generation underpinned by negative working capital needs and the business's low capital intensity leading to expected deleveraging on a net debt basis.”

Citing the negative working capital as a positive trait.

Moreover, this has long been a goal for SPIE. As far back as 2016, during a HY earnings call the then CFO, Denis Chene, stated:

“The other one which I would take here has to do with working capital and the cash conversion. And so the -- we are very clear and firm on the fact of the standard for SPIE is 100% cash conversion, which means obviously a very firm stamping or touchstone, if I may so speak, on the quality of the earning. This is a long term, multi-year target, and it is also yearly targets because of the rapid turnover of our activity. We have an excellent level of working capital. I reiterate that it is a stable one. It is made up of a multitude of very small items. There is no big one-off item with renewal risk on it. It is based on a deeply ingrained culture that we are, if anything, making more and more efforts to get ingrained in the core business and in the acquired business. So we are getting better at managing working capital than in past years. This means that working capital may not improve, and we have no target on that in terms of days from this situation. But we do not have cash flow invested in working capital. We will continue to have a 0 or positive impact from working capital in the future. This will be notably backed by the improvement of acquired companies and by possible growth when it comes to the top line, which is beneficial when you have negative working capital.”

You will note that the working capital balance is typically altered seasonally, with the latter end of the year being where they add pressure.

If we observe the most recent balance sheet filing from the HY 2020 report in June, we can see the underlying cause of the negative working capital figure. Of course, the sum of current obligations (€3.44 Billion) are in excess of the current assets (€3.12 Billion).

The level of cash in the books, of €726 Million, is pretty pale, but this is how SPIE do business. You’ll notice a fairly large receivables balance of €1.89 Billion, which eats up the majority of the current assets at any given time. Stalking back over the years, i noticed that SPIE never really hold any significant cash balances on their books. This is likely due to their negative working capital model.

We already touched upon Goodwill, but its worth repeating. Goodwill of €3.2 Billion in HY 2020, reflects 63% of fixed assets, and 39% of total assets.

I am not stating that this is the case here, with SPIE, but i have witnessed my fair share of goodwill meltdowns over the years. Albeit, in much more speculative industries than that of the markets SPIE serve.

I often think back to Aurora Cannabis, whom during the cannabis boom, acquired many smaller companies, bolstering their balance sheet with goodwill.

After the market corrected and the goodwill was impaired, the value of the assets fell, as did the overall value of the company.

Granted, Aurora were buying up pretty poor quality businesses at that point in time, with little market share, next to no profits, and that were fairly young businesses. SPIE’s strategy is not the same. They are legitimately seeking to consolidate the EU market amongst the key four markets they target. One interesting point is that we can see from the above chart, that Aurora’s goodwill balance grew rapidly over the course of two years. SPIE, on the other hand have gradually built their goodwill over time, with the goodwill as a percentage of total assets being roughly similar to what it was back in 2013.

Still, its not something i am super excited about as an investment.

We can see a partial breakdown of the carrying value of goodwill in the table below. Notice the French subsidiary, ‘SPIE Industrie & Tertiaire ‘ gained an additional €2.25 Million? That was from the acquisition of Cimlec that we mentioned earlier in the newsletter.

The three German acquisitions added €1.29 Million. In the same table you can see a €12.7 Million deduction in goodwill due to the disposal of Trios companies in the UK.

In terms of leverage, SPIE’s management are vocal about the demand to reduce their overall dependence on debt. Net Debt/EBITDA has fallen from 4.5 times to 2.7 times as per 2019 year end, that is including the acquisition of SAG in 2016.

During the HY 2020 earnings call, CFO Michel Delville stated:

“Our financial position remained strong. We are facing no debt maturity before 2023. Our liquidity is still very high at EUR 1.1 billion, of which EUR 725 million of net cash at end of June. Please note that we have recently extended by 2 years the maturity of our revolving credit facility from 2023 to 2025. The facility amount is EUR 600 million until 2023. It will be EUR 410 million after, which is quite sufficient since this line is partially used at midyear as a buffer to cope with the usual seasonality. At the end of June, the amount drawn was EUR 200 million. You see it on the chart, this is the green bar. Today, as we speak, it is 0 because it has been fully reimbursed in July.

Lastly, covenant is not an issue for us. Our only covenant is measured only at year-end and pertains to a leverage ratio less than or equal to 4.”

So the fact the covenants on the debt are fairly lax, as well as the fact there are no maturities for another 3 years, shows that SPIE have some ample liquidity for now. As of June 30, 2020, there is €390 Million in interest-bearing debt outstanding, as well as €108 Million in current lease debt, which is comfortable covered by cash.

Interestingly though, both Standards and Poor’s and Moody’s have SPIE’s credit rating down as speculative junk bond status at BB and Ba3. That is something to consider.

For a little flavor of why Moody’s are ranking SPIE at Ba3, we can simply look up Moody’s periodic review filings and search for SPIE. Here we can find some deeper insight into why they are Ba3 rated.

“The Ba3 CFR of Spie SA ("Spie" or the "company") reflects Moody's expectation that the lockdown will have a temporary impact on the company's revenue and margins. Total organic revenue decreased by 9.0% in the first half of 2020, mainly because of the strict nationwide lockdown in France, which Moody's does not expect to repeat. A normalization of revenue levels will also allow for a greater absorption of fixed costs and Moody's expects the company to mitigate the additional costs and productivity losses related to sanitary measures.

However, the Ba3 CFR is weakly positioned, given the current pressure on margins, as well as the company's high Moody's-adjusted gross debt/EBITDA, which Moody's expects will be around 6.5x in 2021. Moody's considers the company's high cash balances (€724 million as of June 2020) and a high level of excess cash, which offsets the company's high gross leverage to some degree.”

The credit rating reports issued by the likes of Moody’s and S&P’s are gold mines for nuggets of insight in my opinion.

Credit analysts are directly seeking to assess the ability and willingness of a company to pay their debts on time. It’s worth listening to what they have to say. Here is an excerpt from S&P’s BB rating. If you are interested, you can find the whole file here. It’s a short read.

Lastly, as we stated, the dividend payments have also been halted until 2021, to ensure further liquidity during this period.

Dividends

I don’t think i would be investing in SPIE if your mandate is strictly dividend accumulation. Despite stating that paying dividends to their shareholders is one of their strategic capital allocation goals, they have a fairly rocky dividend history. In fact, as per their 2019 annual report, they state the company aim to pay out 40% of their adjusted net income each year.

The company typically pay semi-annual dividends, with one smaller interim payment and one final payment. In order to meet the societal challenges imposed by the Covid-19 crisis and its effects on all of the Group’s stakeholders, SPIE’s Board of Directors decided on April 8th, 2020, to propose to the Shareholders’ Meeting not to pay a final dividend for 2019 as well as all future dividend payments until 2021, when they plan to resume the dividend payments.

2014: No Dividends

2015: €0.50 per share

2016: €0.53 per share plus one interim payment of €0.16 per share

2017: €0.56 per share plus one interim payment of €0.71 per share

2018: One interim payment of €0.17 per share (€0.61 was cancelled)

2019: No Dividends

2020: No Dividends

I think when you consider the dividend payouts for SPIE, without the rich history of consistent payouts, i would largely ignore the dividend. Rather, treat it as a bonus. If it is paid, that is splendid, if not, don’t beat yourself up about it.

I can’t personally see SPIE being a consistent dividend payer, or an attractive one at that, so if i were investing, it would largely be under the premise of share price appreciation, over any anticipated dividend yield. The history is too murky to consider it a suitable dividend stock.

Summary

SPIE represents an interesting opportunity into a wide array of industries. This could be a position for those interested in the future of energy, or with a particular focus on European players.

There is clearly a level of competency amongst management, high quality employees, niche services, and so forth, but for me, the market is not large enough to warrant investment. It just doesn’t suit my style of portfolio allocation.

Low margin, slow growth, uber competitive within fragmented markets, growth by acquisition, lumpy earnings, and in a market i, as an analyst, am not familiar with. I tend not to invest in areas i know little about. This also excludes pharma and oil from my portfolio, in respect of the fact i have limited insight into how the market forces behave.

This could fit well within a diversified portfolio, given that SPIE themselves are fairly diversified. However, do i think the company will beat the market over the next 5 years? I am unsure. Returns over a 5 year period are actually less than flat for SPIE, losing 5% over that period.

I think this one, for me, would go under the adage of “great company, but not a great investment”.

Anyway, i hope you enjoyed that. I wanted to provide a high level insight into a company i never typically study in my normal work.

Until next time,

IT