Selecta - It ain't over 'till it's over.

All,

Please find our updated analysis of Selecta here.

Two quarters ago, management pronounced the machine culling program over. Last week, however, we were presented with yet a few thousand fewer Private machines than before. Until the company stops shrinking its fleet, KKR should struggle to apply a IVS-like 9x multiple to Selecta. So even though the recent bondholder ID request does not look like the coincidence IR claim it is, we think a refinancing next year would be more promising.

Investment Rationale:

- We are holding 2% and 4% of NAV in the 2LNs and the Prefs respectively on the thesis that the company will boom this year with Paris Olympics to come and following the end of its turnaround plan.

- On our math, the Prefs now trade at approx. 6.5x our 2024 EBITDA projection - if we assume KKR were ready to subordinate their piece in return for a refinancing. We have seen worse.

- We have, however, been disappointed that the company has not managed to continue to raise sales prices to catch up with recent inflation and as a result have had to drop our financial forecast for Selecta. We expect Selecta to refinance its SSNs and 2LNs at 5x next year with a near 1.5x FCCR if an 8% coupon is attainable, although a recent bondholder ID request suggests this may be happening sooner. We expect KKR to equitise their Prefs in return for SSN Prefs accepting some other attractive instrument. Meanwhile, we expect the newly tidied-up fleet to grow profitably - despite delays.

- Non-payment of the Prefs does not constitute default but rather triggers an automatic conversion into equity (need 30% of SSN Prefs to request) where the KKR portion receives economic but non-voting common shares. 

Q224:

- Management said the company was "feeling the pinch" from the drop in discretionary consumption when reporting a €10m softer than expected. But lower COGS made up for that, resulting in an on-target gross margin and EBITDA. The company continued to reduce its Private fleet, which had us a little disappointed. Management had proclaimed an end to machine reduction two quarters ago and the number is still falling. A question on the call did not explicitly confirm that the current number of 169k machines will be the bottom.

- SMDs have begun improving again. The company continues to cut private machines, but at a slower pace. 

- By pure arithmetic, the company is still missing €50m in gross margin based on its current sales. GM used to hover above 60% and only dropped to ~55% in 2021. Three years later GM is still low.

- FCF was lower than expected, however, due to significant CapEx. Management suggested the high CapEx was merely a matter of timing of renewals, but failed to assure us that the Q3 figure for instance would be correspondingly low. CapEx was merely expected to "normalise" in H224. The company used the remaining cash flow and some to pay down the RCF by €12m.

- Management further stated that the company needed only €25m to run smothly. We take that to mean "Cash in Bank" and add another €10m of cash in machines to our estimate of that requirement.

- The company has requested bondholder identities in mid-summer. IR has been going out of their way to insist that the request is mere routine. We are still struggling. The Euros and Olympics may have been going well and so we speculate this could be an opportune moment to reach out to friendly holders and gauge support for an A&E. 

- Lavazza's bid for IVS would theoretically value cover the structure - in particular if - one distant day perhaps - Selecta also stops shrinking its Private fleet...

Key Value Drivers:

- One-off costs seem to have come down, although management appear to have re-classed some capex related costs into the figure. Cash leakage between IAS 17 EBITDA and OCF has reduced to less than €10m, of which €7m are taxes and WC. In Q224, between the financials and the presentation, management's "one-off" and WC figures seem to overlap more than usually. 

- Gross Margin: with 55% GM, the company is still lagging its pre-crisis 60% by the equivalent of well over €50m p.a. However, the drop in margin occurred back in 2021 and we are now betting a little bit that it's only because of inflation that we haven't seen a faster re-build. We don't see a structural shift.

- Sports Events: Q324 should be good and could provide a moment for the company to approach creditors. "Coincidentally" says IR, Selecta have requested bondholders to identify themselves. 

- Operating expenses remain under tight control. 

- We understand that KKR have recently contacted a number of potential investors - including former owner Compass, Lavazza and Costa (Coca-Cola) - but that no sales process has officially taken place. 

- This company is in theory IPO-able. It has been public in the past. But it'll need a better story than cost cutting and telemetry to attract any investors from outside Switzerland.

- Recent transactions show encouraging valuations. The Lavazza's acquisition of IVS valued the latter at 9.4x EBITDA for instance or a 4% FCF yield. Note that Selecta can only achieve these valuations if it returns to profitable growth.

- Back to Working From Work. Selecta still suffer a vast drop in revenue from the WFH trend.

Key Risks:

- It ain't over 'till it's over. The culling of the Private fleet is still ongoing. While the Semi Private and Public fleets have steadied, management could not affirm that this is the bottom, two quarters after having declared the end of their machine reduction plan.

- Discretionary spend: Selecta is "feeling the pinch" of the contraction in consumer spending. Little treats during the day are especially discretionary. Selecta revenues can be volatile and pro-cyclical.

- Higher CapEx: Q224 surprised with a chunky CapEx outlay. We assume this has to do with readying the Public fleet for the Euros and the Olympics. Management said it had to do with timing of new contracts etc. - it could have been SBB. But if not, we don't know if that is perhaps the same thing. The figure is guided to "normalise" in H224, but we don't know if we will have more such surprises. 

- Tax Liability: In early 2023 a Dutch court ruled that Selecta still has to pay €27m in taxes for its Autobar acquisition. Contrary to management guidance, we have modelled those for 2024. 

- Option Value: Despite their high-profile involvement, KKR originally took over the company for only a €220m PIK Note investment, which was converted to equity. KKR have since been supportive throughout the years, but we arrive at less than €500m of funds invested of which just under €200m are sitting pari passu with the SSN Prefs. We are expecting a move from the sponsor in H225.

- Tail Risks: 1) Energy contracts seem diversified and under control so far, still contributing to YoY savings. 2) De-regulation of working hours in one of its main markets - Switzerland for instance - could see fast food, kiosks and QSRs enter into competition with Selecta's vending machines (in particular in the Public sector).

Here to discuss with you,

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk