Water Intelligence

Lynch's scalability dream?

We all dream of finding that multibagger company that grows by opening stores, replicating its success across a large and homogeneous market. The story with Water Intelligence has that ingredient, additionally combined with a less glamorous sector: plumbing. It seems like Peter Lynch's dream come true.

I have a small position in the company and was waiting for the 2024 Annual Report to clarify some uncertainties and decide whether to increase it. I'm going to be critical, very critical, so it might not be good for your anchoring bias, but at least it's necessary to know the facts. The decision afterward is up to each individual.

This is not a complete thesis but rather brief reflections on positive and negative aspects. Let's get to it.

👎Return of investment

A numerical exercise based on 2019:

ΔOwn loc. Sales vs 2019: 48.4m
ΔEBIT vs 2019: 7.71m (Before unallocated head office expenses)
Franchise reacq+new acq: 53m (Excluded Dallas (11/24)

Profit: 14.5%
Profit After unallocated head office: 7.6%

Cost of Debt: 7-8%

It's not just a matter of growth buying franchises, but of containing structural costs and increasing the profitability of operated locations. For this, we have the next points: the Dallas "template" plan and the Streamlabs collaboration. Review your conviction on them and reinforce it with more information.

👍 Dallas “template” plan

The acquisition of the Dallas franchise as the central pillar of ALD's future:

• It becomes the HQ.

• It will be used as a model for best practices for the rest.

• The former owner becomes CEO of American Leak Detection (90% of group sales).

This makes a lot of sense. Will Knell managed the largest acquired franchise, which had the highest growth and best margins. He is an industry insider with extensive experience. As part of the payment (~10%), the Knells accepted 200k options at an average exercise price of $7.47 (↑16% over current price) exercisable from 2028. This means they remain tied to the company's performance. Knell Sr. is a non-executive director.

👍 Streamlabs collaboration

The collaboration with Streamlabs provides Water with technology for the early detection of breakdowns. Water would install and maintain the devices and carry out the necessary repairs. Will Knell is familiar with the day-to-day business and explains the great fit with insurance companies, as it allows for significant savings on repairs by serving as preventive maintenance, generating recurring revenue and loyalty for Water.

👎 Head office costs

Structural costs grew 14% versus 2023, outpacing sales. We will see if the HQ in Dallas caps this growth or if we can start to see cleaner incremental EBIT results from the acquisitions.

Between 2019 and 2024, we see that a large part of the incremental EBIT from inorganic growth has gone into structural expenses. We will see if the Dallas HQ stops this. For now, no.

👎Lack of expenses visibility

There has been some improvement in the 2024 report, as well as an intention to improve communication in 2025. But the truth is, there's very little visibility, both in general expenses and capex. $7 million has been spent between 2023 and 2024 on intangible assets for "product development."

👎Limited M&A

In 2025, financial costs are going to increase. With an average cost of debt of 7-8% and very demanding maturities in 2028 and 2029. I am not questioning the group's solvency but rather its capacity to continue repurchasing franchises. By refinancing without significantly increasing their debt, they could acquire franchises at a rate of 3 per year. They desperately need interest rates to fall.

❓US listing

Despite investors' expectation that Water will eventually be listed on NASDAQ (which makes sense), for now, in the web conference held a month ago, Patrick did not make it clear that this would occur, nor did he specify any timelines. Link to full interview

Let's move to the conclusions, but first, don't forget to subscribe.

💭So, is Water Lynch's scalability dream?

I believe the stock at its current price has some upside potential, but it's too narrow and fraught with many uncertainties. If you've read my latest article on "The Art of Execution," the conclusions are clear.

🎯The Art of Execution

I don't like to be a maximalist; the market can prove you wrong, so I'll leave the answer to this question up to you.

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DISCLAIMER: All the information provided in this document is purely informative and does not constitute a buying recommendation (according to Spanish Law Article 63 of Law 24/1988, of July 28, on the Stock Market Regulator, and Article 5.1 of Royal Decree 217/2008, of February 15). DuckPond Value Research is not responsible for the use of this information. Before investing in a real account, it is necessary to have the appropriate training or delegate the task to a duly authorized professional.

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