“Royalty” - the term touches on the right of kings, as well as a legal claim on revenues or profits. It can also be a great business model, as shown by Franco-Nevada over the past several years.
And Franco-Nevada has indeed been royalty in the mining space through a period of shareholder value destruction. The stock has returned more than 110% in the past five years in a time of cratering commodity prices and plummeting share values.
We at CEO.CA are keen to follow the money, and that means looking for investment ideas beyond our focus on the commodity space … to financials, technology, food and beyond.
The non-mining royalty business seemed like a good place to start. And outside of mining royalty companies, Calgary-based Alaris Royalty Corp. (AD-T) is one that came into focus. It’s a “dividend aristocrat” that has hiked its payout several times and seen its business model validated by the recent emergence of other non-resource royalty upstarts.
Interestingly, Alaris emerged out of resource money. It was founded in 2003 and seed-funded by Alberta oilpatch billionaire Clayton Riddell, who was also a 10% shareholder up until 2013.
Alaris CEO Steve King and Stephen Reid (who is no long with the company) cofounded Alaris and added their first partner, LifeMark Health, the following year.
The idea was to fill a financing niche by providing non-equity investment to private North American growth companies with entrepreneurial management teams. The owners keep control of the business and get access to Alaris’s capital to strategically grow and expand operations - a contrast to the sale-driven objectives of private equity investors. Partner firms can also use Alaris capital for estate planning - a valuable tool for the aging boomer demographic - or to buy out minority or majority shareholders.
That initial LifeMark Health investment worked out alright for Alaris, and it’s also an example of how the company benefits when there is M&A activity with a portfolio partner. Alaris has contributed a total of $74 million, in seven tranches to LifeMark, one of Canada’s largest private health care service providers with a focus on physiotherapy and rehab clinics.
The company collects an annualized distribution of $4.2 million and has collected $95 million in cash from LifeMark’s new owner, Centric Health (CHH-T), as payment for partial redemption of Alaris’s preferred units in LifeMark. The remaining redemption value of Alaris’s LifeMark units is $36.9 million. Centric Health bought LifeMark in 2011.
An investment in Alaris is primarily a bet on the company’s management team and their ability to identify profitable royalty ideas, but they’re also a kind of bet on the underlying sector as well as offering exposure to a strong U.S. economy.
Alaris has 14 portfolio companies and a goal that no portfolio company makes up more than 10% of revenues (two of them currently do). The company’s diversified portfolio investments run from health and technology to infrastructure and retail. They have performed well, with a couple of exceptions.
Portfolio partners have included:
- a medical equipment company;
a Texas-based civil construction company;
a franchise of U.S. fitness clubs;
a manufacturer of wooden play centres for the residential market; and
a provider of products for first responders.
Alaris also has some exposure to the resource space through portfolio company SCR Mine Technologies. SCR provides surface and underground mining, construction, electrical and mechanical services to mining companies in northern Ontario.
Alaris has increased its dividend eight times since 2010 and currently pays out a monthly dividend of 14 cents, for a yield of about 7%. While the dividend has increased regularly, the stock has dropped 32% in the past year and trades at about $23, after reaching highs above $36 in late 2013 and 2014. Alaris pays out more than 90% of earnings as dividends.
Risks for the company, which is structured with U.S. and Netherlands subsidiaries, include an ongoing dispute with the Canada Revenue Agency. CRA denied the deduction of about $80 million in non-capital losses and reassessed Alaris for the taxation years 2009 through 2014, resulting in a charge of $24.5 million in taxes and interest.
Alaris is challenging the decision but had to pay 50% of the reassessed amount to CRA as a deposit. In its Q3 2015 financials, Alaris warned that $8.4 million in 2015 investment tax credits (as of Sept. 30) are also at risk if CRA prevails in the dispute, which Alaris anticipates “will take considerable time to resolve.” Subsequent to the quarter end, Alaris obtained a loan facility of $10 million “to assist with short-term working capital issues” and has drawn $4.5 million on it, according to a note in the financials.
The share price weakness is also a reflection that it hasn’t been all smooth sailing on the portfolio side. For example, portfolio company Sears Home Services (SHS) went bust in December 2013; Alaris had contributed $15 million as well as $2 million in loans. And in Q3 2015, Alaris took an impairment charge on its investment in KMH Limited Partnership, a company that runs imaging and diagnostic clinics in Canada and the U.S.
On Jan. 11, Alaris announced its latest deal, a US$13.3-million initial investment in MAHC - Mid-Atlantic Health Care, which runs post-hospital care facilities on the U.S. East Coast. Alaris has about $145 million in dry powder, consisting of $122.6 million on a credit facility and $22.4 million in working capital.
In a Jan. 12 research note, Haywood analyst James Reid called the MAHC investment positive and described recent weakness in the share price as “overblown.” He said it’s the result of a focus on a few problem partners rather than Alaris’s overall portfolio, which he said is performing well. The analyst values the company at a 13X multiple (reduced from 15X) of estimated 2016 EBITDA, compared to Alaris’s peers, which trade at 10.9X estimated 2016 EBITDA.
“We believe Alaris warrants a premium multiple given its established status in the space and proven history of earnings, cash flow and dividends,” Reid declared in the report. “We maintain our Buy rating and encourage accumulation at this price.” The lowering of the EBITDA multiple as well as dividend growth assumption to 4% (from 4.5%) prompted a $4.50 reduction in Haywood’s target price, to $33.50 a share. That represents upside of about 43% from current levels.
Alaris’s success in the royalty space has spawned new microcap entrants, which come with higher risks and the potential for higher returns. These include Diversified Royalty (DIV-T) - which emerged in 2014 out of environmental remediation firm Bennett Environmental - and Grenville Strategic Royalty (GRC-V). The latter also has a resource angle - it went public through an RTO with Troon Ventures, a Bruce McLeod shell company, and Bruce’s sister Catherine McLeod-Seltzer remains on the Grenville board.
Other players in the Canadian royalty space (non-resource) include Crown Capital Partners (CRN-T) - which is focused primarily on debt financing - and two income funds that derive cash flow from restaurant royalties: Boston Pizza Royalties Income Fund (BPF-T) and Keg Royalties Income Fund (KEG-T).
The newest player in the royalty space is AIM-listed Duke Royalty Limited (DUKE-L), which has Canadian roots and is bringing the diversified royalty business model to the U.K. Duke’s CEO and executive director is Neil Johnson, formerly of Canaccord and Difference Capital, and former Sandstorm Gold exec Justin Cochrane is on its investment team.
While the space is getting more crowded, Alaris stands out for its track record and experience - which has provided a valuable training ground for management in generating win-win deals and getting lots of looks at suitable private businesses.
Alaris Royalty Corp.
Shares outstanding: 36 million
Market cap: $833.4 million
Disclosure: Author owns shares of Grenville Strategic Royalty. This is not financial advice and all investors should do their own research and due diligence.