Thread by @DownunderValue

De.mem $DEM $DEM.AX are a decentralized water treatment company delivering high tech containers to remote locations.

A micro-cap operating in an unsexy niche market segment with a solid business model run by a venture capitalist.

Let’s take a deep dive.👇

Before we jump in, welcome to 2022.

This year expect more of the same: research-driven value-based investing ideas on sometimes off-the-beaten-track corners of the ASX. I also do updates on my companies in my portfolio.

Here's my index of deep dives👇
twitter.com/i/events/13777…

1. Investment thesis: Fast grower.
✅Growing and fragmented market
✅Early-mover tech advantage
✅Organic and acquisitive growth
✅Strong business model
🚨Risk: operational leverage?
❓Management

2. Recently I reviewed Rubicon $RWL $RWL.AX an irrigation company. At the time I highlighted why I wasn’t chasing for business-specific reasons.

But I believe in ‘land and expand’ strategies in the urban, industrial and agricultural water sectors.

3. The world is facing increasing water stress.

Accessible fresh surface water is only 0.3% of all water (rest is salty or underground) – and it’s getting worse because of pollution, over-use, misallocation, and poor regulation.

4. De.mem aspires to be a ‘one-stop-shop’ for water treatment solutions.

Osmotic technology has been applied for water purification (e.g. mining), waste-water treatment (e.g sewage), recycling, industrial (e.g. food and medicine), etc. Big TAM, but not sure of the SAM.

5. De.mem’s technology include hollow fibre nanofiltration, ultrafiltration and microfiltration. Different pore sizes enable filtering of different substances. Each filtration processes uses membranes cartridges that are scaleable (i.e. add more cartridges for more throughput)

6. While De.mem own some of their IP, they also license technology from NTUs award-winning technology designed and manufactured in Singapore.

To be clear: this is not a tech play, it’s a roll out strategy.

7. The folks at De.mem are pretty excited by their next generation graphene-oxide enhanced membranes.

This is still being piloted at industrial scale, though the research has been around for some time - as early as the 1960s from journal articles I saw.

8. A simple google search shows that De.mem aren’t the only ones with graphene on their minds.

Go to cheaptubes.com and buy some graphene yourself. Or head to Guochu Technology and buy the equipment to manufacture it yourself.

9. Clean TeQ Water $CNQ $CNQ.QX is another company that recently listed focused on water purification.

Their projects are typically international (e.g. oman, Congo, China and Aus) and are much larger in scale ($4-$10m, e.g. municipal level).

Should this be my next deep dive?

10. NematiQ, a subsidiary of Clean TeQ Water, is focused solely on graphene membrane.

Their products are not yet at market, and they may not directly compete due to the different scale. Though it shows the limited moat of De.mem’s technology.

11. Business model is similar to Delorean.

Strong focus on decentralised smaller-scale projects (fewer competitors); construction (non-recurring) complemented with O&M (recurring) and a razor-blades specialty chemicals wing.

12. Since 2018 they have shifted to a recurring revenue business model with ‘build own monitor transfer’ (BOMT, like BOOT) and consumables.

Annual recurring revenue (ARR) has increased from 38% (CY18) to 73% (Q421). Total rev is $19.8m (CY21, 19.8% CAGR)

13. Organic growth has come from product development and new market opportunities.

I like this example of the snow resort. Only $200k ARR, but it could be a platform for a lot more just like other products of theirs for miners, energy utilities, milk companies, etc.

14. Bolt-on acquisitions have generated some good results.

Pumptech a pump company (+100% from FY19 to 21) and Geutec a German industrial waste treatment company (+60% from FY19 to 21) have created synergies and cross-selling opportunities.

15. Capico a speciality chemical company is the most recent acquisition.

Valued at x1.3 sales and x8 EBITDA. But include with 10-20% cross-selling from CAP to DEM it becomes ~x6 EBITDA. Add the big opportunity of +50 new customers for DEM to cross sell too.🤯

16. De.mem have a diverse and growing customer base. I understand largest customer is 15%, but that's multiple smaller projects.

There’s big names there like $RIO $MND $AGL $ING $KO with plenty of scope to expand with existing customers, new customers and new markets.

17. Gross margins are slightly higher than Delorean, and have actually increased due to recent acquisitions.

For my modelling though I assume 20% base rates because of increasing competition and increasing depreciation of leased assets.

18. Operational leverage is a concern.

DEL has 19.8% EBITDA margins, whereas De.mem is still -10% largely because their SG&A is 2x per $1 of rev. Apart from 4Q20, cash flows have been negative every quarter.

🚨Chart Crime👇

19. A reverse DCF shows the market at 23c is expecting around 15% revenue growth; 20% margins; and fixed costs (SG&A) of around $9m.

Suspect that revenue will grow quicker, margins will remain higher for a while, though operational leverage may disappoint.

20. Andreas Kroell (CEO since ’16, 1.8% ownership) is a venture capitalist with roots in the German Mittelstand.

He is not a technologist. He is the capital allocator and business strategist with a Deloitte audit background. @CMicrocaps

21. Number one risk is operational levage.

If customer acquisition costs increase via SG&A; or marginal production costs increase; or if margins get squeezed via increased competition; then projected future cash flows will evaporate.

22. Overall, I like De.mem as a business model.

The current valuation is not stretched, but not cheap. However I find the risks of evaporating operational leverage too significant at the moment. One for the watchlist.

If you enjoyed this, bash the like / retweet / follow buttons.

A deep dive per *fortnight* is my commitment to FinTwit.

Questions and feedback always welcome. DM's open.

DYOR. Disclaimer, I have no position in $DEM