[APG] APi Group
I was going to combine APG and APH into a single write-up but now I’m breaking them up into two shorter ones…so APG today, APH next week.
Another note: In my Schwab post a few days ago, I was trying to get at a reasonable base assumption for changes in bank deposits in 2023 in the lead up to my bear case scenario and I used changes in avg. interest-earning assets as a rough proxy for changes in deposits. That's too noisy to be useful, especially over very short time periods like 2 months, so just ignore. It doesn’t change the analysis.
Every few months on FinTwit there is a new stock or two outside the big tech complex that is heaped with adulation and sucks all the oxygen out of the room. So far this year, Floor & Decor wins the blue ribbon. But APi Group is a pretty close second. If you manage a SMID-cap fund, you will no doubt have been pitched this stock numerous times. And no wonder. With aligned management, sticky recurring revenue, a low hanging margin expansion opportunity, and acyclical attributes in a mature but consolidating industry, APG has a little something for everyone.
Just over 70% of APi’s revenue comes from its Safety Services segment, whose main business consists of providing statutorily mandated fire safety inspections and maintaining fire safety systems (sprinklers, fire extinguishers, water pumps) for a diversified set of commercial clients. The life of a Fire Safety system starts at building construction, when the general contractor hired to construct an office complex or warehouse or whatever calls a subcontractor to install fire sprinklers, alarms, pumps, backflow devices, etc.
After completion, the general contractor will turn the building and specs over to the owner, who is free to hire whoever they want to inspect these fire safety systems on a regular basis, as mandated by law. It’s probably fair to say that the subcontractor who installed the sprinkler has first dibs on aftermarket revenue, especially during the first year or two while the work is still under warranty. They will have to train the building owner on how to operate the system and hey, while we’re here, how about we schedule your first inspection? But this shouldn’t be taken for granted as inspections, which tie so strongly to high margin services (the guy who identifies a corroding pipe during a sprinkler inspection is best positioned to repair it), are bid very aggressively. I suspect that service work attaches far better to inspections than either inspections or service attach to installations.
“Installation”, where a fire system is newly installed or undergoes major renovation, is the riskier, more cyclical phase of the lifecycle. “Risky” because the provider is committing big dollars to a project that could take a year or more to complete and who knows what happens to the price of labor and materials in the mean time. “Cyclical” because it is tied to new construction and major renovations that can dry up with short notice.
“Inspections and Service” is the good stuff that APi and everyone else wants more of. The work is dependable because inspections are mandated by law to happen at least once a year, no matter the economic backdrop. It is sticky because clients, who are far more preoccupied with running their core business, will stay with their current inspection and service guy barring major mess ups or extortive pricing (APi reports that 90% of their customers retain every year). Finally, inspections and services are far more profitable than installations, generating 10 and 20 more points of gross margins, respectively.
The general rule of thumb is that every $1 of inspection work leads to $3 of services, so operators will often discount the former to grab more of the latter. A national operator like Cintas, who farms out most of their Fire work to subcontractors1, will go a bit further, bundling Fire protection services with cleaning supplies, first aid kits, and other facilities management sundries. Johnson Controls is evangelizing a futuristic vision of smart eco-friendly buildings loaded with sensor laden Fire and HVAC systems that communicate maintenance telemetry in real time to their 15k frontline service technicians.