Thread by @puppyeh1

Been a while since I've done one of these so let's do a deep dive on a newish position I've built the last few weeks: Simonds Group, $SIO.AX

The quick + dirty: Aussie homebuilder at 3x EV/EBITDA w net cash and likely 'in play.' I think its good for at least a double.

THREAD 👇

This is a quintessential deep value Raper Capital special. The assets are so so but we're in a great point in the cycle; meanwhile the valuation is undeniably cheap, and there are some real near-term catalysts....

...meaning the odds of permanent capital impairment from here are vv low (just what I like), and if the catalysts unfold we get a super-normal return. In the middle is the 'nothing happens' type outcome where we don't lose a lot, and don't make a lot.

Downside protection is enhanced by the fact that stock is 50-51c today, the family bid 40c to take out the whole thing a few yrs ago (when biz was on its knees, its wayyy better now); and founding fam continues to hoover up stock in the open market.

Ok enough about the setup...

Quick background: $SIO.AX listed back in 2014 at 11x LTM EV/EBITDA (and ~7.5x fwd) and is now at ~3x CY, 2.5x fwd, so it's been derating for years. What went wrong?

Murphy's Law hit this one hard...bigtime...quick laundry list of what happened:

- Expansion into non-core mkts (NSW, Qld) - lost $$ and focus
- Escalation in costs due to over-expansion
- Shut down low-margin, low-end brand (Madisson), big writeoff
- Ancillary training biz, BAA, hit hard by regulatory change
- tons of exec turnover, aborted take out in 2016

Why do I like it now? Three reasons:

1) Biz has stabilized;
2) market is on 🔥🔥;
3) (most importantly) the co is in play

1) Biz has stabilized. Straight-forward. new starts only -6% last yr (COVID); will return to growth. Core margins 2.4% -> 3.2% before COVID, after yrs of cost-cutting/right-sizing.

Mid-3s % margin and LSD growth in starts gets you to $20mm EBITDA normalized in core homebuilding

1a) In addition to homebuilding, $SIO.AX has a training biz (training builders, carpenters, tradesmen), BAA, that has sucked wind for years but now obvi turning corner. 1H saw enrollments +53% off low base, revs +23%, and segment EBITDA margins up to 25%....

Lots of this biz transitioned online during COVID so margin profile should be accretive going forward (as per other EdTech). This is not going to trade at 10x revs but it doesnt have to.

Run-rating $3-4mm of EBITDA this could easily be worth ~30-40mm to the co near-term...

2) Market is on fire. Pretty easy. Aussie house prices have been on fire (+20-30% YoY), like 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...

...main risk here is shortage of labor, cost increases, etc but given end market strength should be able to pass these through. This is kind of environment a co like $SIO.AX should be making peakish earnings (huge HPI, full utilization, etc).

3) the co is IN PLAY. this is where it gets really interesting so let's spend a bit of time here...

As prev mentioned, the Simonds family tried to buy out the minorities back in 2016, at 40c a share:

afr.com/companies/infr…

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.

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...

...by acquiring up top 3% of the co's shares every six months, using 'creep' provisions in Australia's takeover laws.

So basically today Simonds owns 47%, McDonald owns 25.5%, and the rest floats.

Why is all this interesting NOW? Well, matters are coming to a head...

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:

afr.com/property/japan…

But Asahi just upped their stake to 80% a few weeks ago 🤔

afr.com/property/comme…

So now MDJ gets access to Asahi's balance sheet (massive) and more importantly has a mandate to grow.

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 above

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:

afr.com/property/comme…

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...competing against your own capital is pretty rare, and doesnt make a ton of sense...

SO HOW DOES IT ALL END?

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).

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 big synergies to an outfit like McDonald 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% 🤑

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)...

ikely 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.

That's it. Just another really cheap stock w some catalysts. Obvi I am long...

...so as always, DYODD, this is a somewhat illiquid Aussie smallcap. GLTA 🙏🙏