The risks in Trimantium Growthops

I came across the Trimantium Growthops upcoming IPO recently. It is a consulting business whose listing process reminds me of National Vet Care (ASX: NVL) and Automotive Solutions Group (ASX: 4WD) in that it involves getting agreements from a list of business owners, raising the funds for IPO, and then using the IPO funds to acquire the businesses from these business owners.

Trimantium Growthops, or TGO for short, will be acquiring 8 businesses, half in cash and half in convertible shares (“CRPS”) that will vest over three years. The founders + vendors of the businesses are also migrating to the TGO brand and will continue to run their individual businesses. If their businesses grow profits sufficiently the vendors stand to double the number of shares they are awarded, while if the businesses underperform badly enough they will receive zero shares. I have a number of thoughts about this IPO.

In short my opinion is that:

  • It is potentially overpriced, given the lack of forward revenue visibility, change of control provisions, and dilution from the CRPS. See my comments below about ‘the consulting business’ and ‘retainer fees’.
  • There is some uncertainty over related party transactions with major shareholder, Trimantium Capital. See comments about ‘related party transactions’.
  • There is significant uncertainty regarding the licensing terms of the Trimantium brand name. See comment on ‘The Trimantium GrowthOps brand name.’
  • It is not clear why existing shareholders should keep >20% of the combined company, as their financial contribution appears to be less than this. See comment on ‘existing shareholders’.


The consulting business

TGO’s businesses do a grab-bag of executive coaching, app development, digital media and things like creative content and marketing. The idea is to bring the businesses under the one brand umbrella and use them to cross-sell each others’ offerings. There will apparently be limited cost-saving synergies, but the cross-selling opportunities are expected to be significant. The list of clients is respectable:

click to enlarge.

In general I’d agree that this is a growing market and that Trimantium Growthops has a well thought out pitch. I also am a fan of the way they will increasingly look to align with customers, e.g. via equity-like remuneration arrangements. Still, the risk and complexity involved in integrating 8 different businesses under a single banner is quite high – Automotive Solutions Group (ASX: 4WD) made a colossal mess of an almost identical IPO 12mths ago and was recently bought out 65% below its IPO price.

Additionally, the consulting business as a whole is cyclical. That’s hard to see at the moment because consultants like McKinsey are bringing in the $$$ and have been for years. However in downturns, companies bring in-house the functions that they should have had in-house the entire time, with obvious implications for consultant demand. I’d struggle to determine the risk/reward tradeoff between a growing change-consulting market and the possibility of declining overall consulting budgets, because the demand for tech + change solutions appears unlikely to abate.

Consultant demand is booming and there appears to be a shortage of candidates – I know that because I have recently been researching MBAs and the job market.

Still, I think the fundamental question for prospective shareholders is “Is this a semi-cyclical business with limited forward revenue visibility, being sold close to the top of the cycle at a price that is above average?” I don’t know the answer but in my opinion, given what I point out below, it’s something that should be considered.

The Trimantium Growthops consulting business

In my opinion there are a number of key risks with Trimantium Growthops consulting business specifically. First is the limits to the visibility of future revenue. From the prospectus, I have underlined relevant sections:

5.2.3 SHORT SALES HORIZON AND DIFFICULT TO PREDICT REVENUE: GrowthOps’ forecast revenue consists of a portion of revenue arising from existing contracts with clients, a portion of revenue which is expected to arise based on historical trends and track records with existing clients and a portion of revenue arising from the conversion of pipeline opportunities. In addition, certain of GrowthOps’ existing contracts include retainer or monthly service fees and can be terminated on relatively short notice. While some clients have annual plans for technology spend which give some visibility to expected spend, many projects or contracts which the GrowthOps Businesses have with clients arise on an ad hoc basis and are around 3 to 6 months in length. In addition, a number of the existing contracts that GrowthOps has with clients rely on the issue of specific statements of work which specify the product to be supplied or the services to be rendered on a particular project. These contracts typically do not guarantee minimum levels of work and there is a risk that the level of work requested by clients through statements of work or purchase orders may decrease or cease entirely. As discussed further below, a number of the contracts GrowthOps has with clients are terminable on short notice or will be up for renewal during the Forecast Period, which means these contracts may be terminated or not renewed for unexpected reasons.

Second is the change of control provisions. While these are not unusual, they appear an extra risk in a company that already lacks locked-in revenues (relevant parts underlined again):

(from section 5.2.8 CHANGE OF CONTROL FOR COMMERCIAL CONTRACTS): A number of contracts to which a GrowthOps Business is a party (including client contracts and premises leases) contain change of control provisions. The change of control provisions in these contacts may be triggered on completion of the Acquisitions. For certain of the relevant contracts, GrowthOps has sought the consent of the counterparty to the change of control arising from the relevant Acquisition as it considers commercially appropriate. In a number of cases, the Company has made the commercial decision to not request consent for change of control. To the extent that the required consent is not obtained (in all circumstances including where the company has not sought consent), GrowthOps may be in breach of the contract in question, which may entitle the counterparty to terminate the contract. In addition, in providing a consent  (consent to a change of control) the relevant counterparty may seek to renegotiate the relevant contract on terms which are less favourable to GrowthOps. Any such termination or renegotiation may adversely affect the operations, performance and position of GrowthOps.

This is normal in most consulting businesses. Short contracts and limited forward visibility is a key risk of the consulting business model, which is why I also pointed out the cyclicality of the industry above. However it’s worth bearing in mind that the change of control provisions, lack of consent from some clients, and possibility of renegotiation, are additional risks for the company. It is tough to determine if TGO is a good investment without knowing which customers are going to quit or renegotiate and the impact of this.

Trimantium Growthops will have a fully diluted market capitalisation of $142.6m to $166.4m when listed. It has a proforma forecast NPAT of $8 million (loss of $16.2m on statutory basis). This prices the company at 17.8x proforma NPAT at its lowest market capitalisation. The multiple is about 13x if you exclude the CRPS. I do not think it is prudent to exclude the CRPS because there appears to be no real mechanism for which they get cancelled (unless the acquired business badly underperforms). As a result I would be inclined to consider these part of the market capitalisation.

While this multiple does not seem expensive, it could prove extremely expensive in context of the additional risks created by the change of control provisions as well as the short forward visibility of the consulting business model. Any lost or renegotiated contracts would be felt keenly, in my opinion.

There is also an additional risk and/or benefit – I couldn’t decide which, probably both – in TGO’s retainer fees.

Retainer fees and high margins

When I first looked at Trimantium Growthops I was surprised by the margins it was getting for its consultancy work, which is typically people-intensive and low-margin. The company’s EBITDA and NPATA margins have been 15.9%/18.2%/22.8%/23.3% and 10.7%/11.8%/15.8%/16% respectively over the past 4 years from FY15/FY16/FY17/ to forecast FY18. A 16% NPATA margin is staunch for a consultancy firm; in general I would expect around 10% margins. Historical NPAT margins have also been around 14%-17% over the last 3 years (lower on a proforma basis once corporate overheads are accounted for). I believe that the key ingredient to these high margins could be the retainer fees. Look at this chart:

source: TGO prospectus

36% of all revenues come just from retainer fees. The retainer fees sound like they are primarily associated with the advertising business, where AJF partnership (creative agency) has the client accounts of companies like Officeworks and so on. I’m just guessing but I imagine they get a fixed retainer as long as they have the account, plus more conventional fees each time they run a campaign.

I’m not certain of the level of service and ongoing cost involved in a retainer arrangement, as it was not clearly explained. Still, the cost of providing a retainer could be quite low (because the customer has already been acquired and agreed to stick around on retainer) and it may be a highly profitable revenue stream.

If this is the case, then margins on actual consulting work may be lower, and retainer fees could be key to Trimantium Growthops’ higher levels of profitability. At least some of these retainers are locked in via multi-year contracts, but some can be terminated at short notice, and the ongoing viability of the retainer fee model may be crucial to understanding whether Growthops will generate value for shareholders.

“Client concentration is particularly prevalent in relation to retainer-based revenue streams, which generally arise out of fixed term contracts. Upon the expiry of the relevant retainer term, the renewal of the contract is not assured and is not within the unilateral control of the applicable GrowthOps Business. It is difficult to quickly replace revenue from large retainer-based contracts which are not renewed or are terminated with new business as there are relatively few contracts of that type available.”

If retainers are a more profitable revenue stream, which is hard to evaluate given that there was limited data on the individual businesses, then this places extra importance on their continuation (esp. in context of change of control provisions, reliance on KMP, and so on).

If retainers are not likely to continue, TGO could simultaneously be looking at less work and lower margins, which would be a double-whammy for the value of the company.

The Trimantium GrowthOps brand name:

Trimantium GrowthOps has an arrangement with its backer, Trimantium Capital, that I think will prove troublesome (relevant parts underlined):

GrowthOps is a party to a co-existence agreement with Trimantium Capital under which Trimantium Capital grants GrowthOps rights to use the TRIMANTIUM brand. GrowthOps is required to use the TRIMANTIUM brand in the form TRIMANTIUM GROWTHOPS, such that the word “GROWTHOPS” is given equal prominence to the word “TRIMANTIUM”. Trimantium Capital consents to the use and registration of GrowthOps’ trade mark application for TRIMANTIUM GROWTHOPS as well as any business names, company names, domain names, social media names and other trading names containing the brand TRIMANTIUM GROWTHOPS. In addition, each party may, with the other party’s written consent (not to be unreasonably withheld), use or apply for registration of a trade mark, business name, company name, domain name or otherwise, which contains the TRIMANTIUM brand

This is a concern for several reasons.

First, it muddies the Growthops brand name by making Trimantium the first word. In my opinion if you are an investor you’re going to be calling TGO ‘Trimantium’ for short. This has obvious implications for brand recognition etc especially in light of my second concern:

Second, if Trimantium Capital or its majority shareholder Phillip Kingston (who will also be the managing director of TGO) separate from TGO on bad terms for whatever reason, what happens to the TGO company name? It is not hard to imagine having to rebrand the whole company from ‘Trimantium Growthops’ to ‘Growthops’.  Much was made in the prospectus of the importance of brand, reputation etc for the consulting business. A change of name could result in reduced name/brand recognition and reduced contracting work. Alternatively, TGO could have to pay a fee to keep the brand name and this gives Trimantium Capital significant bargaining power. If this latter outcome occurs, it could result in TGO paying basically a perpetual licensing fee to Trimantium Capital. Phillip Kingston sounds quite entrepreneurial according to media reports, so it is not hard to imagine him leaving for new opportunities in a few years, which would bring this uncertainty to the fore.

Third, it’s unclear on what terms the Trimantium name is licensed to Growthops. I could not determine if there were fees for this or what the terms of ‘separation’ were, if Trimantium Capital/TGO wished to part ways. Given the importance of the brand name to the company, this seems a big omission from the prospectus.

For contrast, look at Oliver’s Real Foods (ASX: OLI), a 10foot holding. In the OLI IPO, the founders sold the Oliver’s brand to Oliver’s the company in return for shares in the company. Now even if these individuals are fired, the brand (which underpins the entirety of the company) is secure.

Related party transactions:

One thing I liked about TGO was that management will retain significant shareholdings, and salaries for the managing director are quite low at just $15,000 a year (yes, fifteen thousand). However, some of the transactions between related parties I did not fully understand.

First is the purchase of Unit Co by TGO. Unit was previously considering an IPO that was subsequently abandoned earlier this year. From the prospectus (key things underlined):

GrowthOps intends to acquire The Unit Co Pty Ltd for $1 and the assumption of its outstanding liabilities. The Unit Co Pty Ltd, a controlled entity of Trimantium Capital, has loans outstanding of $5.0 million to Trimantium Capital and associated parties which relate to costs incurred in preparation for and the development of the current GrowthOps IPO, which will be repaid from the proceeds of the IPO. These costs comprise $2.1m of pre-IPO costs paid to advisers which form part of the transaction costs of this Offer, and $2.9 million incurred in developing the GrowthOps opportunity and its associated knowledge base.

It’s not explained clearly in the prospectus exactly how the $2.9m was spent to ‘develop the Growthops opportunity’. Growthops is buying established businesses and, while there are due diligence concerns, the fees for these were identified and are included in the listing costs. I would have thought there was relatively little to do in terms of establishing the Growthops ‘opportunity’ and it is not clear how this $2.9m (4% of raised capital) was used.

source: TGO prospectus

I also have some thoughts on the holdings of existing shareholders:

Existing shareholders

At the midpoint of the offer ($1.085 per share), there will be 98.5 million shares on issue. 33.9 million of these will be owned/held in trust for existing shareholders (management and Trimantium Capital). The remaining 64.6 million shares will be owned by those who apply for the IPO. This is a fair split; at the midpoint, IPO investors contribute ~45% of the fully diluted market cap and will own 45% of the company.

However, it looks as though IPO investors are funding the entire business (the acquisitions) while existing shareholders still get 33.9m shares that are worth $37m, and they get all of their costs refunded. This is important because TGO doesn’t appear to have much of a business until it raises cash to acquire the 8 new businesses – Trimantium Growthops was only incorporated in August 2017.

It is hard to tell from the prospectus, but it looks as though existing shareholders may not have invested much $$ in the company at all.

So Trimantium Growthops was only incorporated 5mths ago, major shareholders did a bit of work preparing for IPO (~$5.1m in costs, which will be refunded), convinced a bunch of investors to hand over $70m, buy a bunch of businesses, and hey presto, now the whole company is worth $150m and the original shareholders of TGO are worth $37m on paper.

I may be missing something, but I really don’t like the way that this looks.

To my mind this also raises the question of whether a $150m market capitalisation is justified, if the businesses can be acquired for less than $70m. It appears as though TGO is attempting a private-public multiple arbitrage + roll-up business, only this one looks riskier than most.

As a result, my opinion is that Trimantium Growthops appears overpriced and risky, and I will be avoiding it.

I have no financial interest in Trimantium Growthops, any related company, or any company providing services to it (e.g. its broker). I will not be taking a position during or after the IPO. I own shares in Oliver’s Real Foods. This is a disclosure and not a recommendation.

**edit**  Unbeknownst to me, my work was lucky enough to feature in specialist media outlet Mumbrella’s coverage of the Trimantium IPO. If this is something you are interested in, Mumbrella fills in a lot of background info – and if you look closely, you can see me in there.

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