Specialist cleaning services provider React Group (LON:REAT) has enjoyed increasing demand for its services due to Covid-19. The purchase of Birmingham-based Fidelis Contract Services will be significantly earnings enhancing from day one and will help to increase scale.
The initial consideration is £1.7m – £1.5m in cash and £200,000 in shares at 2.1p each. Deferred consideration could be up to £3.05m depending on the performance in the year to March 2021 and next year. This will be paid in cash instalments between October 2021 and March 2024.
React is a specialist cleaning and decontamination business that focuses on work that requires greater expertise. Hygiene and safety have become increasingly important requirements.
Customers include rail companies, hospitals, local authorities, police and housing associations. Fidelis adds a predominantly education and healthcare customer base and no customer accounts for more than 8% of revenues.
React has one-off projects but there is a base of long-term contracts. Fidelis largely has three to five- year contracts and 87% of revenues are recurring.
Fidelis made a 2019-20 pre-tax profit of £253,000 on revenues of £3.3m. The targets for maximum deferred consideration are 2020-21 EBITDA of £500,000 and 2021-22 EBITDA of £1m.
React management has turned around the business in recent years and now it is on a firm footing it has felt confident enough to make its first acquisition. React has been improving gross margins and its cash collection.
There is minimal overlap in customers and services. Fidelis adds pest control and kitchen and duct cleaning. The main benefit of the acquisition will come from cross-selling. There will also be greater scale making it easier to bid for larger contracts.
Covid-19 has provided additional business for React, but it has been neutral for Fidelis.
In the year to September 2021, React pre-tax profit is expected to increase from £188,000 to £784,000. The Fidelis acquisition increases the earnings forecast by two-fifths.
At 2.1p, the shares are trading on 15 times prospective earnings and a full year contribution from Fidelis will reduce this multiple for the following year. A pro-forma earnings estimate of 0.17p a share – without any growth – suggests a multiple of 12.
Even after paying for Fidelis, net cash could be nearly £900,000 by the end of September 2021. The further cash outflows for the deferred consideration will come out of cash generated by the business over the next three years.
There may be some additional work from Covid-19, but the increased focus on deep cleaning by some customers is likely to mean much of this business will be retained. They are also likely to be more aware of the fact that they need to pay for a good service and not go for the cheap option that does not fulfil all the requirements. React has significant potential to continue to grow.