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Chandan Dubey
Chandan Dubey
Articles (150) 

UGL - Demerger Will Help Realize Value

December 08, 2013 | About:

Net Debt: $580M
Employee Benefit : $(193M+36M)
FCF: $14M
Shares/Price/Cap: 166M/$6.23/$1B
EV: $1.8B
Dividend: 5.44%
UGL Limited (ASX:UGL) is a global diversified service company, with two major business interests -- property service and engineering. The key figures for the company are show in the table below.
UGL, founded in 1970, served exclusively the engineering markets and mostly the mining industries of Perth and Western Australia. It became known as United Construction Limited in 1988 and the shares were floated on the Australian Stock Exchange in 1994.

The current Chairman & CEO Richard A. Leupen took the reigns circa 2000. He was instrumental in changing UGL from a highly cyclical service company to a diversified service company. The restructuring of the business was completed in 2002. Over the next five years UGL purchased 18 companies.

2002 Engineering, construction and facility management company KFPW for $92M. This was the leading property service group in Australia, managing 25,000 properties spread over seven million square meters of real estate.

2004 Paid $15M for Thames Water Project’s operations in Australia, Malaysia and Singapore. The groups rail division continued growing outside Australia. It secured $23.5M contract with GE to supply rail trains and platforms for China’s railroad ministry.

2005 Bought Premas International, a real estate service company based in Singapore for $45M. Also acquired Alstom’s Australian and New Zealand operations for $200M. By the end of 2006, UGL had revenues of A$2.2B.

2011 UGL acquired UK-based DTZ holdings for £77.5M. This purchase expanded operations in Asia, North America, UK, Europe and Middle East.

2012 The property segment was rebranded as DTZ under a single global brand.

In the last decade, the revenue of the company has grown at a compounded rate of 20% and the shareholder return at 19.9%, compared to 6.9% for S&P/ASX 200 index.

DTZ, employing 45,000 people across 52 countries, is a leader in integrated property services. It provided leasing, facility management, investment, valuation, consultancy and project management solutions for real estate.

UGL’s engineering business provides engineering, construction and maintenance services for rail, transport, water, power, defence etc. It employs 8,000 people across Australia, South East Asia, India and New Zealand.

UGL’s Operations & Maintenance business is a provider of asset management and maintenance services to for social and economic infrastructure.Zh-Vo0ISvwG50BjFupfx5wDmEqtYoePDumKL1Tqy
The following is the cash flow situation of the company. It is important to note that acquisitions are not included in capex. This distorts the picture in the following sense. The company has followed an acquisition based strategy, but it has not “paid” for them [see nyu].
KyF7eqQ7B_ZdHypYkzHpLRcbzqA2W4gVTij4nRBaThe company has paper thin operating and net margins - averaging 5.13 % (Operating Margin Average 2003-2012) and 3.12% (Net Margin Average 2003-2012) respectively. It is also interesting that the company has never made a loss in the last 10 years.

This “anomaly” is explained by good management and the quality of the business. A significant part of the revenue of the company is from “sticky” maintenance contracts. The order group of the company at the end of June 2013 shows $7.5B of recurring revenues. These contracts also have 90-95% renewal rates. The “moat” can be explained by two important observations (a) their offering serve a critical need of their customers, and (b) the price of the service is small compared to the overall cost of the contract.

Customers can put off management and repair for a while but if they don’t want to face serious problems, they will need to do them sooner or later. People have a tendency to find shop for a manufacturer -- but they keep their service providers. Although not extremely high, their return on invested capital is consistently around 8%.

The company also boasts a large insider holdings. The CEO holds 3.4M shares, which at current prices are worth $21M. To keep it in perspective, the CEO made around $2M in 2012. In this respect, the holding is 10 times his annual salary -- a significant stake.

The company also has a good balance sheet. Following is the debt situation of the company, take from their investor presentation. g3wElZOiUEL8mrfLmCGBtH1-s36IcfmEfjd9SIy-
There are two things which could be affecting the drop in share price. On terms of cyclical downtrends in the engineering segment of the business, the company had one of the worst years in history. The company had to cut its dividend and make some restructuring promises to cut off “excess fat”.
The second important issues is the pending demerger of the company. Last year, after review, the company decided to split its property business DTZ with the engineering business. The management wants to aggressively pay down debt in the next “12-18 months” to ensure that DTZ and engineering will have sustainable capital structures after the demerger. The company also wants to build DTZ’s global headquarters before the demerger.


I want to do a back of the envelop calculation of the value of the company based on its earning. The company had a revenue of $4.4B in 2012. It has an average net margin of 3.13% for the last 10 years. Assuming a return to that margin implies earning of $137M in earning or $1.4B of value at 10x earning.

Given that the demerger is going to be complete circa 2015, it is better to look at the business on a sum-by-part basis. The revenue and EBIT data of DTZ and Engineering is given below.

Unfortunately, other figures for the respective businesses are not available. But it is clear that the DTZ business it still in its growth phase. If we look at the capex figures of the company - most of it has gone to the engineering segment. In this sense, DTZ business should trade at higher multiple than the engineering segment. Assuming a high tax rate of 28% (the company has averaged 25% in the last 10 years) the earning of the respective segments is $81M for DTZ and $107M (2013) for Engineering (2012). A 12 times earning for DTZ and 10 times for Engineering leads to a value of $2B for the company. One also gets the operations and management business for free.


The growth in engineering business mostly comes from competitive contract wins. This make the business highly cyclical and dependent on the whims of the economy. A further problem is the dependence of engineering on the mining sector of Australia. This was the main reason of lower margins and EPS in 2013.

The demerger will mean that the company will support one more management team. The current management got paid around $20M in 2013, so this probably will not be a huge expense.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 3.9/5 (7 votes)


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