REACT Group PLC (REAT): Opportunity to Clean Up, or still a mess?

Hello,

I own a position in React Group PLC. While not a high margin or high ROIC company (I can hear Terry Smith reprimanding me in my head right now), an interesting shift has occurred at the company over the last 2 years. It would be great to get a discussion going in light of recent developments. I would love forum members to scrutinize/attack my idea, and let me know why I am wrong and what could go wrong with this investment, as well as provide their perspective. Note as a new member I cannot attach any company annual filings and can only link to max 2 documents, so members will need to seek out these documents themselves.

React PLC is a nano-cap at about 9.8M pound sterling Market Cap (based on current trading at 1.93p) that focuses on specialist cleaning services in the UK. They service judicial court houses, railroad tracks, and do reactive maintenance for emergencies. They have a reactive business (24/7 on call service), and a contracts business (recently won contracts to service rail and bus companies). After struggling mightily as a public company with constant losses, negative cashflow, and no focus, in 2019 Mark Braund became an advisor to the company and brought on a new CEO (Shaun Doak), and CFO (Andrea Pankhurst).

Mark Braund initially had a focus on recruiting services early in his career, and worked for Manpower and IBM. He founded Barker Personnel services and sold this to Carlisle group in 2000. He then moved on to Interquest Group PLC was CEO for 4 years. His career then shifted to focusing on turning around companies, first focusing on Coms PLC (later rebranded twice, first to RedStone Connect PLC, then renamed under future management to Smartspace software PLC). It appears he joined React to see if he could turn around the moribund company, and he is now Executive Chairman.

In 2019, Mark Braund and the exec. team had an interesting option warrant package where options with an exercise price of 0.25p would vest according to price targets ranging from 0.4p-2.8p. The options were set so that vesting was back end loaded to the higher prices (approx 50% above 2p), see below PDF from RNS:

https://6ccc6872-76b0-4ecb-8f77-2a7e25baa334.filesusr.com/ugd/d2e8da_04c084e649be4017a4214c1424f0942e.pdf

Yet another grant of 11.9M in options were made on Dec 9th, 2020, per below to Mark and Andrea at exercise prices of 0.25p with vesting conditions of pricing ranging from 2-2.8p. Please visit React website to review the RNS.

I will come back to the discuss of exec comp and this plan later in this post.

Since mid 2019, great progress has been made at the company. The 2019 Annual report came out on Jan 30 2020 with Turnover of 3.1M Pounds (6% decline from 2018), NPAT at -183K (down from -1.9M).
According to management, the company took this year to sort out collectability of AR and bad debt provision, while turning away business that was not profitable or core to the company’s focus on specialist cleaning. They also focused on improving the sales team and working more efficiently to acquire customers.

Again, please go to React investor relations website to view the RNS and annual reports…

The company continued to progress, with Mark, Andrea, Shaun, and a couple of directors purchasing shares in Dec of 2020, see below two PDFs from RNS:

Again cannot link to every document, go to RNS…

Decided to use my 2nd link to link to React PLC’s annual report issued for 2020 in January 2021, see PDF:

React Group PLC Annual Report 2020

Turnover grew 41% to 4.36M pound sterling, and the company produced its first NPAT in its history at 188K. Management stated that $440K of this was related to covid specific work. If you exclude this covid related revenue as one time in nature, revenue still grew 26% to approx $3.9M. Management has stated their intent to continues to grow the business and increase operating margins above 6%.

Management recently announced they are acquiring Fidelis Contract Services Limited on a cash free debt free basis. Fidelis Contract Services would bring in approx 3.2M pounds in revenue, and total compensation for the deal would be 4.75M pounds if all of the EBITDA related targets are met by Fidelis contract services (management paying for the deal partly through cash and stock, 1.5M is cash, they raised raised 0.2M at 2.1p for the initial 1.7M in consideration, the remaining 3.05M would be paid based on Fidelis hitting EBITDA targets). The addition of Fidelis would get React to approx 7M pounds in revenue next year assuming no more organic growth in the business at all (not a good assumption). Please visit React IR website for announcement.

The company has momentum, and would like to consolidate parts of the fragmented specialist cleaning industry. In terms of competitors, there are many local firms, with large companies like Rentokil and PCS at the very top of the market. Management have done a good job of cleaning up the business. Can they continue to execute, and acquire smartly? This is a big IF.

In terms of compensation, it is a negative that the exercise price for the options are 0.25p. At that price, they are already in the money at the current price of 1.93p. That being said, a large chunk of the options don’t vest (50% of the first tranche, 100% of the 2nd tranche) if the stock price does not go north of 2p. The exec chairman was asked on the Investor Meet Company UK Platform why management did not buy more shares on the open market. The response was that management had to do a lot of work to clean up the company back in 2019 (stock was trading below 0.25p at the time), the options have vesting at higher prices, and that it would be bad if the management buys shares while they know info about the turnaround before FY20 results were issued. I have mixed feelings about this response. Nevertheless, management has performed very well so far and have stated their intention to become the “362 kilogram gorilla” in this space. As operating profit and NPAT increases, React will finally have a positive ROIC. The question will be how effectively they can acquire small cleaning players, how high of an ROIC the business can achieve, and if the valuation will grow overtime as the company performs. Can this be become a 100M market cap company in 10-15 years? It all depends on continued stellar execution.

It would be interesting to hear the members’ insights, especially on competition in the UK.

2 Likes

Hi Anish

Many thanks for the write-up and welcome to the forum!

Not looked at REAT before, but always happy to provide the downsides on a share!

I think you have undersold the cleaning here. I had assumed it was office cleaners coming in after hours. Turns out these are specialist services where the clients (I presume) require a high standard of work and rivals cannot (I presume) set up overnight:

A few extracts from the group’s website:

“REACT is the extreme cleaning company that goes beyond the everyday to tackle cleaning problems that non-specialists just can’t cope with.”

REACT is one of the very few firms with cleaning specialists trained and experienced in dealing with trauma on the rail network, including dealing with the aftermath of both human and animal fatalities. Our cleaning specialists that work trackside are all Personal Track Safety (PTS) qualified."

React Specialist Cleaning provides an immediate response to urgent situations. Our services cover road traffic accidents (RTA), railway trackside emergencies, flood & sewage damage and decontamination of property & public spaces. These are just some of the examples of where our highly-trained team resolve emergency cleaning situations.

Legislation and safety standards in this field of cleaning requires deep specialist knowledge. React is an industry leader, providing these emergency services to a large proportion of the UK’s police authorities, railway and highways operators and property owners.

React is one of the very few firms with cleaning specialists trained in dealing with trauma on the road network, including cleaning in the aftermath of serious injury and fatalities."

From the 2020 annual report:

Presence of subcontractors:

“​We also launched a partner programme aimed at developing a network of trained and authorised subcontractors, to help us to more rapidly scale to meet the often-demanding needs of nationwide coverage.”

Could the client eventually go direct? Does subcontracted work involve lower margins and/or greater operational risk in what is a specialist activity?

Presence of ‘recurring in nature’ revenue is useful:

“REACT reports three main areas of business; the first two are Contract Maintenance, where the Company delivers regular deep cleaning regimes, (such as in the healthcare and public transport sectors) and; Contract Reactive, where REACT is the first responder to an on-call emergency response service operating under a formal contract or framework agreement, typically 24-hours a day, 7-days per week, 365-days of the year. These two areas together are recurring in nature and represent c.80% of our revenue and c.74% of our gross profit contribution.”

Dependence on significant clients:

"REACT generates a material proportion of its revenues and gross profit contribution from a limited number of customers, however the mix has improved and we have begun to reduce this dependency."

I could not find the note revealing revenue from the largest customer(s). Would be useful to know.

65 million options represent 13% of the (year-end) 499 million share count. 20 million warrants represent a further 4%. Buying today at 1.93p gives 45% upside to 2.8p before all options become exercisable. Is 45% enough upside, given 17% potential dilution could weigh on the share price in the meantime? Director buys of £10k (and less!) do justify the question “why management did not buy more shares on the open market.”!

Another measure is revenue per employee. This is a people business and productivity is all-important. Just how much can a specialist cleaner earn for REAT? Revenue of £4.3m and 87 employees = £49k which does not sound incredible for a specialist cleaner. Average staff cost = £2.5m and 87 employees = £29k, which again does not seem too impressive.

Productivity ratios improved from 2019, but how far can they improve during 2021 and beyond? Revenue per person will eventually plateau as employees can only work so many hours.

Costs are mainly staff, and I get the impression this will always be a lower-margin business – despite the specialist work undertaken.

Will Fidelis dilute the proportion of specialist services? Seems to me the purchase brings in more standard cleaning work:

"Fidelis has strong credentials in the education and healthcare sectors providing quality contract cleaning and hygiene services ranging from daily housekeeping and washroom hygiene services through to building and caretaker services, as well as specialist services such as kitchen and duct cleaning, industrial deep cleaning, and pest control."

Companies House reveals 233 employees in the 2020 annual report. Acquisition RNS said sales were £3.3m, so revenue per worker of just £14k. Seems like a lot of part-time workers, suggesting standard cleaning work. Not great.

The market cap could become £100m, but I guess that would be through ongoing acquisitions. And I suspect the issuance of extra shares to fund the expansion would mean the share price does not experience a commensurate increase.

The track record of quoted UK ‘facilities management’ companies is mixed. Their heyday occurred during the 90s as the outsourcing trend gained momentum and investors were attracted to long contracts and reliable income. But the likes of Serco (SRP), MITIE (MTO), Capita (CPI) and Rentokil (RTO) and many others have all suffered various difficulties despite supplying what ought to have been predictable, day-to-day services. I would look through their ups and downs to get a feel of what could go wrong.

Sorry about that. The initial limit is to mitigate bots and spammers. I will look to lift your limit!

Maynard

2 Likes

Hi Maynard,

Thank you for the comments. It was nice to see your analysis of revenue per employee, I will have to add this to my toolkit! The low margins have always been worrying, and if they move away from their core via acquisitions it could lead to Peter Lynch’s dreaded “deworseification.” They’ve been working to add more customers but customer concentration is always a risk as well. Plus, the management has experience with quick turnarounds in the past, and they may not have the skills needed to really grow the business. I will have to take a look at Rentokil and MITIE.

Anish