Lakehouse PLC – December 2016

Lakehouse – LON:LAKE
Share Price – £0.28
Market cap – £44.1m

Introduction

Lakehouse caught investors attention in early 2016 after it spectacularly imploded just months after going public in a well-publicised IPO that attracted many respected investors. Since seeing 60% of the value being wiped off the company in just one day, the bleeding has continued since then with several profit warnings being declared and the entire management team eventually being replaced. After such a fall, and a change of management, it’s natural to reappraise the company.

Let’s start from the beginning and talk about what Lakehouse does.

Lakehouse is a leading asset and energy support services group, focused on customers in the UK outsourced public and regulated services sectors. The Group delivers a range of essential services through a successful model based on long term contractual relationships with local authorities, housing associations and energy companies.

The above is taken from the Lakehouse website. Rather helpfully, the company breaks down the specific types of work that they’re engaged in, and how much accrues to the top line. Below are the most recent 6 month numbers with a description of the divisions activities.

breakdown

You can see there is a good mix of work, both public and private, across different sectors, but with a fairly heavy concentration in property. Out of the four areas that the company operates in, two of them are in trouble, Energy Services and Regeneration. The most recent trading update had this to say.

As reported in the Interim Results, the Board remains focused on resolving performance issues in the Regeneration division.  This includes a number of contract settlements on which there is a range of potential outcomes for the Group, both in terms of cash flow and impact on the Income Statement.  Management anticipate there are likely to be further write-downs, during the current financial year as we seek to close out these issues with clients.  Based on current discussions, this is expected to have an adverse impact of £4 million in the current financial year.  

The Board notes the ongoing consultation concerning the UK Government’s policy on Energy Company Obligations, which is due to enter its third phase on 1 April 2017. The outcome of this consultation is crucial to determining the levels of funding and, as importantly, the types of works that will be funded.  We remain in active dialogue with Government over the future direction of policy on energy efficiency, which we see as critical to achieving the legal obligations the UK has to deliver carbon savings and will influence the Board’s overall outlook for the Energy Division.

Performance issues in the Regeneration business is certainly understating the issue, especially given how that division has imploded so badly in the last year. The contracts settlements issue that will result in a £4M write-off is actually up from just £2M reported in an earlier trading statement from the year. Is this now capped? I don’t know, but I have noticed that the old MD of the Regeneration division has left the company. With a new person now running that part of the business, perhaps a line has been drawn under those problems and the division can return to positive EBITDA? Historically, the Regeneration business was by far the biggest part of Lakehouse before it went public. Perhaps with renewed management focus, things can be turned around?

The second part of the trading update sounds like there’s likely trouble to come in the Energy Services division. This actually worries me more than the woes that the Regeneration business faces. There is always going to be a need to have kitchens installed or roofs repaired. If Lakehouse slips operationally (as they have), this damage can be possibly be repaired. Energy Services on the other hand is something that’s much more out of the hands of management. If the government subsidies for the installation of smart meters and house insulation cease, then this revenue is not coming back. With the government now firmly focused on Brexit and preventing any economic fall-out, I suspect that green initiatives are the last thing on their minds. I am expecting more bad news to come on this front.

Financials

Going onto the financials, it’s worth saying that the support services industry that Lakehouse operate in has always been a low margin business. Lakehouse certainly doesn’t disappoint on this score with margins that are even worse than others in their industry. Below, I’ve presented a comparison of Lakehouse with peers in the support services sector. Clearly by industry standards, Lakehouse have very poor margins. I suspect the root cause here is the 6 acquisitions that the company did in 12 months. When you consider that the company already operated in a handful of other businesses, it’s not at all surprising that the ball was dropped and operationally things slipped quite badly. With better management, surely things at Lakehouse could be turned around?

capture

Shareholder Revolt

After the share price collapsed by 70% from IPO, and with the operational difficulties mounting and company liquidity tightening; it certainly wasn’t surprising that management were replaced by disgruntled shareholders. This was all well-publicised  and is thankfully water under the bridge. What is worth noting however is just who the company brought in to try and turn things around. Bob Holt, founder of the Mears Group, is clearly a proven operator who has been brought in to straighten the company out. If my suspicion holds true that Lakehouse can be tightened up operationally, then Holt is undoubtedly the man for the job. Unfortunately, Holt’s expertise comes at a cost, and it’s certainly worth reviewing his pay package.

  • 2% of the company granted at no cost just to take the Chairman position.
  • £75k salary.
  • Up to £150k in consultancy fees.
  • A bonus applies if the share price goes above 58.57p (£400k at least), above 78.48p and again above 98.4p (up to £1.3M).

The important thing is that other than the 2% golden hello that Holt received, additional compensation that would be considered egregious doesn’t kick in until at least the share price goes up by at least 60% from the current levels. The incentives are clearly performance led and I suspect are structured in way that Holt feels are achievable.

The only thing I am concerned about with Holt’s appointment is the potential for a conflict of interest given that Holt will be retain his role at Mears Group. The recent General Meeting acknowledged this, and had this to say about the matter. Personally, I didn’t find it very convincing.

Although the Board recognises that there may be occasions where such conflicts arise, your Board believes that the number and extent of any such conflicts is likely to be minimal as a consequence of there being limited overlap between the nature of the operations of Mears and the other companies’ operations and the operations of the Company.

Conclusion

Lakehouse clearly has problems. Low margins, operational weakness, a poor capital position, board turmoil, a difficult trading environment – these are all factors that make Lakehouse look an absolute mess from the outside. Having said that, there is possibly opportunity here. By and large, the majority of the business that Lakehouse do is real, stable with visibility into the order book. There are certainly risks with government spending cuts; but this is something that competitors have seemingly been able to handle, so why not Lakehouse too? If the company can hit just a 3% operating margin in-line with the average figure that Mears and Mitie Group do, we’re looking at income of £10M. If we put a 12x multiple on that – the share price is a 3-bagger from here. On a 2% operating margin, and with the same 12x multiple, the share price should double. The potential upside on hitting reasonable targets is clearly compelling.

For now though, I haven’t quite made up my mind whether I should buy ahead of the trouble in the Energy Services division, or should I wait for the bad news, hoping for further falls.

Northern Bear

The eagle-eyed folks here will undoubtedly be reading this though and telling me I have missed the point here completely. This post was initially just to learn more about Lakehouse and evaluate it as a potential investment. Instead, it only served to throw up another prospect. If you re-examine the comparison I did with other companies in the sector, the one that really stands out in the analysis is Northern Bear. While still tiny, this has been a fantastic business with decent growth that is trading at a very low price to free cash flow multiple. I have not had a chance to cover this in enough detail, but on initial investigation, it looks like an under-followed gem.

2 thoughts on “Lakehouse PLC – December 2016

  1. David

    i will sell you my shares if you want 😎 i own a small position and it has been one disaster after another. do you really think there are more bad results to come?i am not sure i can take any more bad news and am only hanging on for the divi.

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    1. tabhair Post author

      Appreciate the response.

      Yes, there is almost certainly bad news to come. The latest trading statement mentions the following charges that we should expect.

      Regeneration contract settlements issue – £4M
      Training costs for smart meter contract – £1.5M
      Domestic metering redeployment cost – £1M
      Severance costs for old management – £1.5M

      The cash burn at this company is also extremely concerning.

      March 2015: £21.1M
      September 2015: £6.6M
      March 2016: -£22.6M
      June 2016: -£30.6M

      As you can see, there has been a £50M swing from net cash to net debt. I calculate that about £38M of that comes from acquisitions (net of cash they held). Stripping that out, the company effectively burned through £12M of cash in just 15 months. Given that the total line of credit extends to £50M, if the current rate of cash burn was to continue, it’s possible the company could exhaust their credit facility by December 2017. The £8M of cash charges that I referred to further up could even accelerate that process. With £8M in cash charges to come in the annual report, and less than £20M available on the line of credit, I would be shocked if the dividend was paid out (£3M based on previous 1.9p dividend).

      It sounds like I have talked myself into waiting for the full year 2016 result before making a decision to buy or not. If the dividend is cut combined with the kitchen sinking of impairments, then we might see a possible buying opportunity as income-focused investors sell out.

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