Smart Buildings Industry Recap
In our Smarter Buildings through IoT, Cloud and SaaS Technology report we highlighted that buildings generate about 40% of all greenhouse gases (“GHG”) and waste approximately 30% of the energy they consume. We also shared that Software-as-a-Service (“SaaS”), cloud, and Internet of Things (“IoT”) solutions that analyze and quantify building energy consumption, waste and Greenhouse Gas (“GHG”) emissions is an evolving industry worth hundreds of billions of dollars. This is likely why Amazon (NASDAQ:AMZN) announced this week that it is launching a $2 billion fund to invest in climate technologies. This report details Kontrol Energy (CSE:KNR, OTC:KNRLF), a Sophic Capital client and emerging leader in the Smart Buildings industry, an industry addressing a $100 billion annual market.
An Undiscovered Company Emerges as A Smart Buildings Leader
Kontrol Energy makes buildings smarter in real-time. Smarter buildings are more profitable, valuable, and sustainable. Led by a management team with 60 years of experience coupled with a previous exit and about 44% insider ownership, we believe that Kontrol Energy (“Kontrol” or “the Company”) will appeal to investors interested in SaaS, cloud, IoT and environmental, social, and governance (“ESG”) themes or value stocks with high growth expectations trading at a discount to its comps (Table 1).
Table Canadian SaaS and Software Company Valuations
Reasons to Invest Before Other Investors Discover Kontrol Energy
- Experienced management team that has had a prior exit
- Insiders own 44% of the common shares
- Low share count: only 29.8 million common shares issued and outstanding
- Targeting the Smart Buildings industry, a market forecasted to be worth hundreds of billions of dollars this decade
- High margin, recurring revenue (as per Table 1, stock valuation seems to ignore this)
- Major brands like Toyota Tsusho, Beyond Meats, Suncor, and Brookfield are customers
- MOU with European HVAC OEM is a $400 million market opportunity
- Kontrol Energy falls under on-trend investment themes: Software-as-a-Service (“SaaS”), cloud, Internet of Things (“IoT”) and environmental, social, and governance (“ESG”)
- Unknown to most investors.
Kontrol Energy Overview
Kontrol Energy improves building energy consumption, energy waste, and GHG emissions with technology. The Company is primarily a SaaS / cloud provider that makes buildings smarter in real-time in the management of energy and related emissions, resulting in more profitable, valuable, and sustainable buildings for Kontrol’s customers. The Company’s non-invasive solution collects and analyzes real-time data wirelessly from a building’s mechanical, electrical, utilities, and environmental systems to optimize operational efficiencies and reduce energy waste. The Company’s SmartMax Gateway and smart learning automation devices collect, analyze, and optimize building operations in real-time. Over the past 10 years, Kontrol has collected and analyzed over 30 billion data records across hundreds of buildings. Kontrol’s learning algorithms digest these data records, making Kontrol’s solutions smarter over time, a benefit to all customers since Kontrol’s software is cloud-based.
While Smart Building industry large caps have scale advantages, they generally lack a simple, unified platform that can quickly and easily bring a building on-line. As a small cap disruptor, Kontrol Energy has been able to out-compete many large competitors for important customer wins.
Kontrol Energy has a simple business model: design solutions that reduce its customers’ overall energy costs while providing a corresponding reduction in GHG emissions. Kontrol does this by aggregating data generated by IoT devices into its cloud-based management and analytics services. These IoT devices are non-invasive and operate wirelessly, an important consideration for markets such as New York City where physically modifying some buildings is regulated. The Company brings buildings on-line and creates real-time intelligence through smart learning algorithms. Increasing intelligence and automation in existing buildings represent opportunities to upgrade the energy performance of building assets, improve asset life, and lower costs.
The second part of Kontrol’s business model is to scale the business via a disciplined mergers and acquisition (“M&A”) strategy. To date, the strategy has proven successful, with the Company closing 5 accretive acquisitions over the last 4 years:
- CEMSI: Value added solutions for emissions and process monitoring applications across the U.S. and Canada.
- DiMAX: Re-branded as Kontrol SmartSite, and now the platform for Kontrol’s Toyota Smart Factory partnership. Kontrol SmartSite analyzes the management of complex heating, ventilation, and cooling systems for large residential, commercial, and mission critical real estate owners.
- Efficiency Engineering: Design and automation services for industrial, municipal, and commercial building owners across Canada.
- ORTECH: High quality GHG reporting, environmental permitting, air quality monitoring, emission and odour testing, gas analysis and renewable energy/power consulting services.
- Log One EMS: Rebranded as Kontrol SmartSuite. Occupancy-based, intelligent control systems for commercial, and multi-residential real estate.
As well, Kontrol is also working to close another acquisition on July 6, 2020. Although Kontrol has not named the company, management has disclosed that the targeted firm generated $3.7 million in revenue (about 40% recurring) in 2019 and $843,000 of net income.
High Margin Revenue Model
Kontrol Energy has three revenue streams: SaaS, Services, and Automation/Retrofit. Of the $14.5 million of revenue that Kontrol Energy reported for fiscal 2019, about $4 million was recurring, $7 million was repeat business, and $3 million was new projects that the Company didn’t have at the beginning of the year.
SaaS revenue is predictable, recurring and generally provides high margins. Each customer pays SaaS revenue regularly, and this revenue stream grows as Kontrol lands-and-expands its solutions across a client’s building portfolio. Kontrol’s SaaS solutions include:
- SmartSite® Cloud building energy software designed to assist in the operation and management of complex heating, ventilation, and cooling systems for factories, large multi-residential, commercial, and mission critical buildings;
- SmartSuite® Energy Management Building Automation and Controls. SmartSuite is a smart thermostat (like Google Nest) for the multi residential and commercial market. Kontrol recognizes SmartSuite as a building automation sale that includes upfront purchases of hardware and ongoing SaaS.
Service revenue is also recurring revenue. ORTECH, Kontrol’s emission compliance group, generates the majority of its revenue from regulatory activities. ORTECH’s revenues are recurring since industrial operators must fulfil mandatory reporting submissions to governments. CEMSI, Kontrol’s GHG emissions and process monitoring solutions provider, also provides ongoing services revenue following system implementations.
Automation/Retrofit revenue results from projects that upgrade building energy efficiency, decrease energy demand, and/or reduce GHGs. On automation retrofits, Kontrol defines a project and sometimes installs hardware and the software, typically targeting heating, ventilation, and air conditioning (“HVAC”) systems, gas, and water efficiency. Some projects include electricity generation at or near where it will be used versus sourcing power from a centralized utility power plant. Generation projects often utilize cogeneration (the production of electricity and thermal energy from a single source).
Kontrol Energy also has IoT hardware products that can be rapidly deployed within any building. These devices gather data related to heating, cooling and electricity and send that data to Kontrol’s cloud architecture for real-time analysis. Through comparison and analysis to over 30 billion data points spanning more than 200 buildings, Kontrol can quickly identify inefficiencies, savings, and mission critical risks. With an ongoing cycle of review, analysis, and adjustment, building owners and managers can optimize their energy demand, energy consumption and generate significant savings while having instant visibility to building performance. Automated alerts and notifications allow for the potential to address problems more quickly and efficiently. The entire process is enhanced through machine learning over time. Kontrol’s IoT products include:
- SmartMax® Energy Gateway is Kontrol’s third IoT product. It installs into building automation and HVAC systems (usually in less than 1 hour), providing access to energy data from these systems which is then securely exported to Kontrol’s SmartSite Cloud for analysis.
Factoring in these revenue streams, Kontrol Energy is targeting blended gross margins in the 50 to 55% range. Kontrol does not disclose the margins from its Recurring, Services, and Automation/Retrofit sales. Based upon our experience, we typically see SaaS companies generate margins from 75 to 80% over the long term. We also typically model Service-type revenues with margins between 50 to 60%, and hardware/design/retrofit businesses with margins that vary from 10 to 50%, depending upon the business. We cannot say what Kontrol’s Automation/Margins would be, but we would likely model in the 30 to 35% range.
One way to validate the solutions of smaller tech companies is to look at their customers. Major brands are difficult to sell to and often have long sales cycles. Getting a major brand to commit to using a small, and often unknown, company’s solution is a good indicator that the company has addressed a significant problem.
As the illustration to the right illustrates, Kontrol has a blue-chip customer base that includes several major brands. This partial customer list also shows the diversification of Kontrol’s solutions across numerous industries, thereby reducing company risk should an industry experience a systemic contraction.
Case Study – Toyota Tsusho Canada
Toyota Tsusho is the trading arm of the Toyota Group that operates a diverse set of businesses that span industrial, commercial, and consumer sectors. In March 2019, Kontrol signed an agreement with Toyota Tsusho’s Canadian subsidiary (“TTCI”) to implement Smart Factory technology solutions. Under the agreement, Kontrol and TTCI intend to establish a joint venture company to provide technology solutions and services to OEMs in the automotive sector to optimize production and manage energy in real-time. In September 2019, Kontrol received its first SmartFactory order from TTCI, and a second pilot commenced in October 2019.
The Toyota Tsusho joint venture has a large pipeline of 200 facilities. Each facility could be worth an average of $150,000 of recurring revenue annually, representing approximately a $30 million pipeline of recurring revenue for Kontrol in one geography – North America. To date, the joint venture has projects underway in 5 facilities and is targeting 100 facilities by 2023.
Case Study – Beyond Meat
Beyond Meat (NASDAQ:BYND), is a Los Angeles-based producer of plant-based meat substitutes. In January 2020, Kontrol Energy announced an initial US$150,000 order to provide Beyond Meat with a real-time analyzer and associated installation and monitoring services to assist in the rapid evaluation, measurement and validation of organic inputs. The purpose of the solution is to improve operations and lower operating costs. The Beyond Meat contract represented a new market vertical with one of the world leading companies in food processing industry.
Given that third parties are forecasting the Smart Buildings industry to be worth tens of billions of dollars in the next few years, Kontrol Energy has a great opportunity to scale. The Company does not disclose its total pipeline but plans to issue $40 million of proposals for 2020. Typical closure rates for proposals are about 40%; if management maintains this rate, it will increase confidence to its stated goal of growing top line revenue to $175 million by 2026, up from $14.5 million in 2019.
Kontrol Energy has 2 pipeline opportunities worth mentioning. One is Toyota Tsusho (discussed in detail in this report’s first case study) which represents a potential $30 million recurring revenue opportunity in North America. We remind investors that Toyota Tsusho is a global company, doing business in 120 countries and 1,000 group companies, with many of those companies having multiple locations. Toyota Tsuho is also diversified across 6 industries and has a unique division focused on Africa, lending to less revenue lumpiness during the business cycle. Kontrol’s “land-and-expand” strategy could see its Toyota Tsusho footprint grow well beyond the 200 facilities over the next decade. Each facility could generate on average $150,000 of annual recurring revenue, lending to a $30 million total addressable market of recurring revenues within Toyota Tsusho.
The second pipeline opportunity is with a global, European HVAC OEM that has the potential to penetrate 20,000 sites. Kontrol entered an MOU with the OEM to outfit 2 locations with Kontrol’s white label energy management and analytics platform. Under the MOU’s terms, the OEM will select pilot sites and providing access to local site equipment and applicable data (20,000 sites currently have the OEM’s systems) . The OEM has the option to select 2 additional pilot sites to bring the total number of pilot sites to 4. Each OEM site could generate $20,000 of revenue with most of that recurring revenue. Assuming a 40% closure rate, this OEM represents a $400 million opportunity for Kontrol Energy, and most of that recurring – from 1 customer. Yes, we had to read that twice too.
Kontrol Energy has a low share count that will be attractive to investors who want EPS to scale quickly, which typically lead to higher valuation multiples. Insiders own 44% of the issued and outstanding shares, meaning that management’s interests are aligned with investor interests. Many investors may not view Kontrol’s $11.2 million of debt favourably, but Sophic Capital believes this is wrong given management’s success in acquiring accretive businesses. Scarcity of shares matters when a management team executes and earnings scale, and tight equity capital structures like Kontrol Energy has typically reward patient equity investors. In 2019 the Company reported revenue of $14.5 million, with blended gross margins of 46%, and both positive Adjusted EBITDA and positive cash flow from operating activity, meaning Kontrol doesn’t need to raise cash, except perhaps for additional M&A activity.
Management is currently refinancing its debentures to support future growth, is first offering up to $5.8 million of non-convertible/non-redeemable/unsecured debentures to holders of its October 2020 paper. The non-brokered, private placement will see each $1,000 debenture pay 8% on the principal monthly and comes with 50 common shares. The new debentures will mature October 31, 2022. Management has proven they can manage their balance sheet and re-finance as required. Their ability to manage the debt markets and their capital structure reflects their financial discipline. Kontrol closed a $1.25 million first tranche of the convertible debenture offering of $1.25 million on June 23, 2020 and stated that the funds would be sufficient to close an upcoming acquisition, likely around July 6, 2020. Management also indicated that it had good visibility into closing the balance of the financing for a gross total of $2 million.
Combined, Kontrol Energy’s C-suite has over 60 years of industry experience and they have also had a prior exit. Insiders own 44% of the Company, and thus far, they have continued growing the business both organically and via accretive acquisitions.
Kontrol Energy (CSE:KNR, OTC:KNRLF), a Sophic Capital client, is an undiscovered microcap company led by an experienced owner/operator management team that has a solid record of acquiring accretive Smart Building solutions providers in a market worth ten of billions of dollars. Kontrol’s high margin, recurring revenues are attractive to investors seeking to capitalize on thematic SaaS, cloud, IoT, and ESG trends. And as Table 1 illustrates, Kontrol Energy trades at a discount to Canadian SaaS companies. The Company’s share structure is tightly controlled providing the potential for high earnings per share metrics and high multiples. For more information, please contact Sophic Capital.
The information and recommendations made available here through our emails, newsletters, website, press releases, collectively considered as (“Material”) by Sophic Capital Inc. (“Sophic” or “Company”) is for informational purposes only and shall not be used or construed as an offer to sell or be used as a solicitation of an offer to buy any services or securities. You hereby acknowledge that any reliance upon any Materials shall be at your sole risk. In particular, none of the information provided in our monthly newsletter and emails or any other Material should be viewed as an invite, and/or induce or encourage any person to make any kind of investment decision. The recommendations and information provided in our Material are not tailored to the needs of particular persons and may not be appropriate for you depending on your financial position or investment goals or needs. You should apply your own judgment in making any use of the information provided in the Company’s Material, especially as the basis for any investment decisions. Securities or other investments referred to in the Materials may not be suitable for you and you should not make any kind of investment decision in relation to them without first obtaining independent investment advice from a qualified and registered investment advisor. You further agree that neither Sophic, its employees, affiliates consultants, and/or clients will be liable for any losses or liabilities that may be occasioned as a result of the information provided in any of the Company’s Material. By accessing Sophic’s website and signing up to receive the Company’s monthly newsletter or any other Material, you accept and agree to be bound by and comply with the terms and conditions set out herein. If you do not accept and agree to the terms, you should not use the Company’s website or accept the terms and conditions associated to the newsletter signup. Sophic is not registered as an adviser under the securities legislation of any jurisdiction of Canada and provides Material on behalf of its clients pursuant to an exemption from the registration requirements that is available in respect of generic advice. In no event will Sophic be responsible or liable to you or any other party for any damages of any kind arising out of or relating to the use of, misuse of and/or inability to use the Company’s website or Material. The information is directed only at persons resident in Canada. The Company’s Material or the information provided in the Material shall not in any form constitute as an offer or solicitation to anyone in the United States of America or any jurisdiction where such offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation. If you choose to access Sophic’s website and/or have signed up to receive the Company’s monthly newsletter or any other Material, you acknowledge that the information in the Material is intended for use by persons resident in Canada only. Sophic is not an investment advisory, and Material provided by Sophic shall not be used to make investment decisions. Information provided in the Company’s Material is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. Sophic and/or its principals and employees may have positions in the stocks mentioned in the Company’s Material and may trade in the stocks mentioned in the Material. Do not consider buying or selling any stock without conducting your own due diligence and/or without obtaining independent investment advice from a qualified and registered investment advisor.