Bursting my balloon
I’ve tried to get a better understanding of Fluence’s current situation, but I just can’t seem to know it well enough to assess the risks properly. This is the link to their latest investor presentation:
My biggest concern is that it is still — at heart — a China story. China seems to account for a significant portion of its recurring revenue and Smart Product Solution (SPS). I don’t know enough about Fluence’s manufacturing process, but I suspect there is disproportionate exposure to China — at least somewhere in their supply chain — there also.
To me all this sovereign risk presents an asymmetrical bet in the wrong direction. Given the current geo-politics, new contracts in Taiwan and Korea provide me with with little comfort and don’t present the diversification I would need to stay. This is now firmly in my too hard basket.
I just don’t get it. I don’t understand spy balloons. They seem terrifyingly low-tech. Their crudeness, randomness, and sheer brazenness just serves to remind me how arbitrarily my capital — however tiny of a percentage of Fluence it composes — can be treated at the hands of an autocratic government.
At the time of writing the US Air Force has now beaten me thrice in pulling a trigger [1] [2] [3]. I’m trying to get out before there is a fourth or beyond. Fluence is a sell for me now. Hard pass.
I’m still holding Fluence out of complete inertia. I haven’t looked at it properly for some time — during which there have been some seismic geopolitical changes. This is particularly significant because much of my thesis was based on a China growth narrative. I’ll look into it more over the coming weeks, but there are a lot of moving parts. Just a classic Frogurt case as Strawman might say.
My perception is that: the sovereign risk for western capital has intensified (that’s bad); China’s need for innovative clean water has likely increased (that’s ‘good’ — only in the sense of this investment obviously); COVID-19 happened (that’s bad); it’s now 2022 (that’s…good?); China’s domestic growth is possibly imploding (that’s bad)…et cetera, et cetera, et cetera.
If I can’t get my head around it this is looking like a sell for me and a cutting of my losses. Maybe I can go now.
Less than a kilometre from the Eiffel Tower lies one of Paris’ lesser known sights: the Paris Sewer Museum. The word ‘museum’ lends an elegance to this experience that it barely deserves. It is essentially a walk along a grated metal gangway which is suspended above one of the world’s oldest and still functioning combined sewers. Storm-water mixes with raw sewage well within breathing distance as you dry-reach and try to read the laminated placards about Victor Hugo’s 1862 ‘Les Misérables’, not daring to wipe away the fine film that has settled upon them. More enjoyment is to be found once you’re back above ground and watching the relieved and laughing glances of other couples emerging from the stairwell and the even more hilarious looks on the faces of school children who have just experienced the world’s worst excursion. But neither climbing the bell tower of the Notre Dame nor the passage of time will allow your wife to forget that part of her birthday in Paris was spent in that godforsaken place.
The 2,500 kilometres of tunnels flowing towards centralized treatment facilities using over a billion litres of water per day is an engineering marvel of yesteryear, but the business case for efficiencies writes itself. For the rapidly industrialising provincial towns of China the opportunity exists to ‘leapfrog’ the less efficient aspects of wastewater management.
Fluence’s own investor material cites its claim on some of the US $15 billion dollars set aside by the Chinese government for rural waste water treatment. However, one of Fluence’s most recent contracts was for municipal wastewater in Beijing (ASX announcement 3/05/2018). Adding yet another locality and partner to its impressively broad relationship base.
Fluence may in fact be uniquely positioned to continue to reap rewards from an ongoing Chinese government commitment to a number of forms of modernisation of it’s sewerage system. This broader trend has been documented even outside of 5 year plan announcements (Link). The range of ‘plug and play’ product’s from Fluence’s waste water solutions side of the business have proven to be adaptable, scalable and capable of value-adding at various points of the sewage treatment cycle.
It’s perhaps now the least glamorous of my investment positions, but Fluence’s answer to an ancient problem is more sophisticated than a particular Parisian landmark.
If both utilities are owned, pay the owner 10 X…
The boardgame Monopoly never really sold us on Water Works. You couldn’t build hotels on it, and even if you got the two utilities they were on opposite sides of the board which kept business lumpy. Whilst I think the Parker Brothers understated their value – I personally think this Water Works will be a game changer…or is at least worth more than $150 – there may be some truth in how hard it is to squeeze money out of the water business.
In the case of Fluence, a couple of recent ASX announcements post capital raise have highlighted both these issues for me. They mainly relate to the NIROBOX wing of the business which I have written less about. The first, on 28/11/2018, was about a new finance facility for the Build, Own, Operate & Transfer (BOOT) model. At first glance, the optics of a company taking on debt so close to a capital raise are not ideal. However, this is not a company leveraging long-term debt to fund hopeful and uncertain future growth. Rather, it appears to be a sensible risk mitigation strategy for a somewhat undercapitalized business trying to keep up with growing orders. It is probably better to think of this finance facility as similar to a ‘revolving credit’ or ‘line of credit’ to help Fluence smooth out it’s inherently lumpy cash flow.
The second announcement on 04/12/2018 relates to a NIROBOX contract win in Peru. The contract is to create a 5 NIROBOX unit facility (but may expand to 10) for an industrial client. The 10 year agreement is a BOO (there being no ‘T’ransfer of the plant, as Fluence will operate it). The investment will cost Fluence an initial US $8.4 million. The annual revenue is expected to be US $1.7 million. Whilst there are no details in the announcement about the margins for this revenue Fluence is negotiating with other industrial customers to supply water which could increase the annual revenue to as much as US $5 million. Surely a money-maker even if at low margin?!
This has the appearance of an exciting new revenue stream that has the potential to scale well, in much the same way as the Aspiral units may in China. These announcements and others, such as that of 18/10/2018 for NIROBOX units to Northern Egypt, allay many of my concerns about the recent capital raise. Fluence’s use of capital seems purposive and expedient. I’ll only become wary if the company fails to meet – or revises – its profit guidance for 2019.
Knowing where the bodies (of water) are buried…
Fluence investors may experience frustration trying to work out where its announcements fit in the greater scheme of things. Part of the problem is that many of them can be scarce on immediately interpretable financial detail.
For example, yesterday’s ASX announcement [20/12/2018] related to new more specific contract details about a broader partnership with the ITEST corporation in China announced by FLC on 12/10/2018. Then, the 3 year partnership was said to be worth an estimated US $45 million. I interpret this as being US $45 million in sales/revenue, or approximately US $15 million revenue per year.
Of course, even this data remains fairly meaningless without details of Fluence’s expenses. I have recently found this analyst’s report – albeit one with an inherent bias being commissioned by FLC itself – from Sep 2018. It contains numbers…but more importantly it contains pictures and pie charts (see below).
And speaking of Pi, who doesn’t love a good formula? Mine is not as accurate as 3.14 etc. Less Archimedes and more like your uncle teaching you how to count how many Kms away that lightning strike was [1]. Now I’m no financial expert, but I’m also guessing your uncle was neither a meteorologist nor a physicist, and that if you’re reading this it probably means you didn’t get struck in a thunderstorm.
So, this is Uncle Pablo’s Two-Part-Somewhat-Recklessly-Bullish-Rule-of-4:
Firstly, my favorite, the Qualitative. Each contract you read about will be in the vein of one or more of the following 4 broad themes:
- Living standards improving in the developing world (ASPIRAL units in places like China);
- Environmental standards of industrial water use improving worldwide;
- Water scarcity caused by geo-political circumstances (MABR in Israel; Egypt’s need for water due to Ethiopia claiming a larger share of the River Nile [2]); and
- Water scarcity issues when developing isolated areas (NIROBOX units for resorts in the South Pacific and the Caribbean).
Each of these 4 trends is a tailwind for Fluence and, unfortunately, for its competitors.
Secondly, (yawn), the Quantitative. As a general (massively so) rule, divide any sales or revenue figure by 4 to get Fluence’s gross profit (the margins presently hovering around 25% mark, although the ASPIRAL units are trending higher). That is, if a contract is said to be worth $80 million…read approximately $20 million in gross profit.
