REACT GROUP Plc
A UK specialist cleaning firm run by superb management with a strong business model that has been drastically mis-priced.
REACT group plc should be close to a 50m market cap company, they have strong FCF, sub-sector leading margins, exceptional management, very high recurring revenue and a proven growth strategy. Their current market cap is 15 m. Efficient market theory, anyone?
The story: A turnaround for the ages
In 2019 React was on the verge of bankruptcy, losing £600,000 on £3.1 m in revenue with a revolving door of managerial turnover. Everything changed when Mark Braund came in, first in an advisor role in 2019 then as the appointed chairman in 2020. Mark has had a history in doing turnarounds, most notably of which was RedStoneConnect plc. That’s when it all began.
As of the 2024 financial year they now have revenue of 21m with 2.3 m in free cash flow (FCF), 87% recurring revenue, competing in an industry where almost all cleaning businesses (99%) are independently owned, indicating they are smaller businesses1.
What is the business?
React is a specialist cleaning business, which is much more technical cleaning work. React’s original business was ad-hoc emergency cleaning work such as cleaning up after a fatality on the train line or decontaminating an area after a biohazard. React’s original business did what other companies do not have the capabilities for. The problem with this is the nature of one-off work is that there is no stability to operations, as such it becomes hard to have a team of workers nationwide without stable work to be doing.
The catalyst for change: acquisitions (the timeline)
2021: Fidelis Contract Services Ltd, a Birmingham-based commercial cleaning, hygiene, and facility support services firm, for £4.85 million in cash and shares (1.7m initially and another 3.05m which they received as they fulfilled profit criteria)
Fidelis is a facility management firm, which was acquired to start providing stable work as it has high recurring revenue.
2022: LaddersFree, a window cleaning business which was acquired for an initial consideration of £5.65m, payable as £4.65m cash and £1.0m through the issue of new ordinary shares, with contingent consideration of up to £2.85m being paid as LaddersFree fulfilled profit criteria.
Image one: Laddersfree’s approach of using bosun chairs and rope access instead of the old fashioned way.
LaddersFree has been an excellent acquisition, where are transitioning the business to a more scalable online website through project sparkle as it was previously all done by paper. While this did cost a few hundred thousand to achieve, it is now halfway through being implemented for all customers and will result in a far better experience for the customer.
Laddersfree operates on a franchising business model, where they provide work for separate businesses nationwide to work under the ladders free name in exchange for a commission. Because they only organise for other businesses to do work it is a comically capital light business.
2024: 24 hr Aquaflow acquired for 4 m cash and 0.5 m in shares with deferred consideration of 0.5 m. Further 2.3 m in contingent consideration is payable if they meet performance conditions over a 2 year period. Total 7.36 m in payments.
Management is staying and have received half a million in shares as incentive which they cannot sell for 3 years.
24 hr Aquaflow is a drainage company located in South-East England and appears to have high potential, with Shaun Doak saying it would be 31% accretive to earnings in its first full year on board (2026) as well as giving the company a more differentiated value offering now.
The current business is divided into three segments, contract maintenance, contract reactive and ad-hoc. This will be important later on.
Management
Just as important as the acquisitions has been Mark’s appointment of managers in the company, most notably of which is Shaun Doak. Shaun is sales orientated and has been helping the organic growth numbers, with a proven track record of creating high levels of growth in the cleaning industry evidenced by react having more than 17% in organic growth every year since 2020.
The other important figure is Spencer Dredge, the chief financial officer who previously worked with Mark at RedStoneConnect. Spencer previously worked at SmartSpace Software PLC as a COO and is a qualified accountant.
Competitive advantage
Economies of scale – when each acquisition strengthens the overall offering
REACT have built a competitive advantage due to the several companies they own now being able to operate under one banner and consequently, one payment. This allows REACT to undercut the market as they charge significantly less than if a company got several different contractors to do it as these contractors end up subcontracting to REACT.
The largest contract won during the 22-23 period was with a nationwide fast-food restaurant, benefitting all three divisions of the Group, specialist deep cleaning services are provided by REACT and Fidelis, with LaddersFree continuing to clean the windows and facades of the chain’s outlets2.
The acquisition of 24 hour Aquaflow is an example of strengthening this advantage; it will allow them to be able to do waterworks and flood cleaning services. There was a specialist cleaner who had similar capabilities to React previously, but none with a drainage business as well as nationwide coverage for all other services.
React’s goal is to be the one stop shop for outsourcing for facility management companies (companies hired by businesses to do all cleaning and upkeep of areas), as outsourcing is very common in facility management companies and react is becoming a better and better option for these companies to choose when it comes to specialist solutions, shown in the table below through the services react provides in comparison to other businesses.
Table 1: Different cleaning companies in the UK range of cleaning services provided
Their strategy (micro + macro level)
Covid exemplified their strategy, where from the ad-hoc work of emergency contamination they are able to get in contact with companies that require cleaning services and start up-selling them on the other services. From getting in contact, the sales team is able to offer all the other services the React group has and start doing contractual work for them. This has proven to be very effective, and has also worked from acquisitions where they cross sell (selling a previous client the new acquired companies services and a new client other company services).
On a macro level, they have a primary goal of 5 mm in fcf by FY27 (roughly doubling FCF from now). I believe this to be the inflection point, where the market will recognise react as a high quality business and give them the valuation they deserve. When they get to this point, whether they get acquired or keep growing is uncertain. One thing is for certain, shareholders will be well rewarded either way.
Valuation
It is worth mentioning that React usually gets paid for its services BEFORE it delivers them, greatly reducing working capital required and improving cash flow (money comes in before it comes out).
Owners earnings for FY24: A valuation method for a discounted cash flow (estimating future cash flows and discounting them to the present) which calculates the amount of money an owner could withdraw from the business and keep the business operating.
Owners earnings FY24 (000s)
287k is net income from comprehensive income statement, 1,643k is depreciation, 138k amortisation, 404k is maintenance capex and 640k is favourable working capital change as per 2024 annual report.
Equation 1: Owners earning for FY 2024
Based upon my DCF the spectrum of valuation range from this company is undervalued to this company is comically undervalued. In my best case scenario, I have them hitting their goal in year 5 (FY30, management’s goal is for FY27) and growing 10% after, justified through their average ROIC being 12.3% and having an above industry average value proposition. The base case for me is they hit their goal then grow at industry average after and the bear case for me is they just grow at industry average.
In all my valuations I include my 15% required rate of return, 3% terminal growth rate and 30% margin of safety
Bear case: £0.47 per share valuation
Base case: £1.02 per share valuation
Bull case: £1.14 per share valuation
To look at it from another perspective, 10x fcf is a reasonable multiple on a high quality, growing business, if they hit 5 mm in fcf and receive a 10x multiple, there is the 50 mm valuation which could be achieved in as little as 2.5 years.
Major risks and rebuttals
Management leaving
I have called Mark and spoken with him about this. Until that 2.5 year goal is reached, the key players (Mark, Shaun, Spencer) will be staying on board.
Significant shareholder dilution from acquisitions
An inflection point has been hit in regards to this, the 24 hour Aquaflow acquisition has been paid using primarily cash 4.5 mm and 0.5 mm from shares. This is far better than paying solely with equity as it both creates little shareholder dilution and aligns the incentive of Aquaflow’s managers with shareholders.
Bigger playing eating their lunch
This is a valid concern as far bigger companies such as ISS could easily purchase React group or make acquisitions that create a better offering than react’s. This probably will happen at the point of react hitting the 5mm in fcf, as already multiple private equity firms and bigger facility management companies have expressed interest, but will need to wait for a better macroeconomic environment in the UK to do so.
An important caveat is some of the most major shareholders such as Octopus (19% owner) and Harwood (12% ownership) have astute managers making decisions and want the best outcome for shareholders. They will not let the business sell at a price below the intrinsic value of the business.
Uncertainty about what happens post 5m FCF goal achieved
This is absurd to worry about. If the goal is achieved, shareholders will be rewarded, either from price appreciation, a buyout of the company or from the company doing dividends or buybacks. As Graham said, in the long term, the market is a weighing machine.
Acquisition risk
With acquisition comes changes, which when integrating an acquired company into the group could bring cultural clashes or system integration problems. Mark and Shaun have so far demonstrated an ability to select companies where the culture is aligned with REACTs.
Two things to note:
Do not know the exact details of the 4 mm debt used to purchase Aquaflow, nor the exact details of the contracts in terms of giving clients the ability to change cleaning intensity and regularity. Will follow these up with IR and update this post when I find out.
The content on this blog is for informational and entertainment purposes only and does not constitute financial advice. I am not a licensed financial advisor, and I do not own shares in any of the companies discussed unless otherwise stated. Always do your own research or consult a qualified professional before making any investment decisions. Markets move—and so should your skepticism.
Happy investing! Drop a comment if you have any questions.
Eli
Here is all my research