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Echelon analyst Ralph Garcea bets on Universal mCloud’s “unfair advantage”

Last updated: 01:24 29 Mar 2018 AEDT, First published: 23:24 27 Mar 2018 AEDT

1522172113_Echelon's-Ralph-Garcea-for-Proactive
Ralph Garcea -- Technology, Gaming & Diversified Industries Analyst at Echelon Wealth

Universal mCloud Corp. (CVE:MCLD) gained research coverage for the first time on January 29 of this year when Echelon Wealth Partners analyst Ralph Garcea initiated on the company with a Speculative Buy target of $1.25.

Garcea is bullish on the sectors Universal mCloud operates in and sees three acquisitions made by the company over the past year yielding numerous synergies thanks to the strategic acumen and ability to execute of the mCloud management team, led by President and Chief Executive Officer Russ McMeekin.

Proactive Investors visited Echelon’s Toronto head office recently for a discussion with Garcea about Artificial Intelligence (AI) and other business sectors in which mCloud enjoys, as Garcea puts it, an “unfair advantage” over its competitors.

In Echelon’s research report on Universal mCloud, you reference a third-party forecast suggesting global IoT (Internet of Things) spending will grow at a 17% compound average rate over the next five years.  What is your outlook for IoT based both on your analysis and discussions with money managers?

On the IoT side, it is really any device that is going into a manufacturing plant, into an office building, in an industrial complex – everything from a sawmill to an air conditioning system has the capability to send data.  All you need is the IP (Internet Protocol) address of the device and you can collect data from it.

The money is going to be made on the analysis of that data.  Any company that has a Big Data capability or an AI capability to mine that data for trends and preventative maintenance – anything on the analytics side is where the value is going to be built.  It’s not on the hardware side.

I’d also point out that users of this technology have choices.  If you are a large multinational and you are married to General Electric (NYSE:GE) equipment in your factory then you’ll probably go with GE Predix.  If you’re of the belief that nobody gets fired for hiring IBM (NYSE:IBM) then you’ll go with IBM Watson and spend millions of dollars on IBM Global Services to try to get your answer.

If you are in a specific niche and not married to either of those huge multinationals, then you’ll hire a company such as Universal mCloud to give you that data.

That is how we assess the industry and we try to avoid companies that would go head to head with a GE or IBM.  If you can grow in a $500 million niche inside this multibillion dollar market, those are the kinds of companies we focus on.

How prominent is Echelon’s presence in the IoT space and how strong is the institutional investor appetite for good companies in the sector?

I’ve been covering technology for over 20 years and have a pretty strong rapport with the larger cap companies, so we get good colour on where technology is going.  And we see five or six companies on the technology side each week.  I’d say we have developed a strong practice on IoT, Big Data and AI.

Echelon has been my home for over a year now and we’ve developed a good following from both corporate and institutional perspectives.  Arinder Mahal has joined on the banking side – he is an electrical engineer, former management consultant with Deloitte, and had his own technology advisory firm.  I think we’ve done a great job building the franchise.

As for the institutions, they make it clear that they are not into concept stocks.  They like companies at an inflection point with a great installed base in place and that are ready to leverage the recurring revenue from their opportunity.  If you have a SAAS (Software as a Service) model already and are collecting data and can get $100 or $1,000 a device per month to analyze data for a client, that is what the institutions look for.

Some institutions want to take 10% or 15% positions in companies, so you have to be at a $50 million or $100 million market capitalization and be generating some recurring revenue.  The large caps in my space, they are all trading at 7x or 8x revenue, but you would not necessarily go after something like that because growth has slowed on the top end, though it is 90% to 95% recurring revenue for any of those names, and that is what institutions are paying for.  And if that stock is liquid and they can move in and out when they want, that is what they seek.

Let’s shift our focus to Universal mCloud.  You defined three segments within the IoT space for them: HVAC (heating, ventilation and air conditioning), wind turbines and electrical transformers.  You have a line pointing to a $6 billion annual recurring revenue addressable market.  How much can mCloud win of a market that size, and what edge does the company have over competitors?

I think they have a good chance of getting to at least 10% of that number over time.  Russ McMeekin talks about the need to have an unfair advantage, which is something he learned during his tenure at Honeywell (NYSE:HON).  And he does have unfair advantages in each of those three verticals.

In HVAC, the Field Diagnostics Services, Inc. (FDSI) acquisition has 3,000+ Bank of America (NYSE:BAC) branches, and that is largely managed by Jones Lang LaSalle (NYSE:JLL).  In other words, you are working with the property operator managing those branches.  You move into a Starbucks (NASDAQ:SBUX) and get headquarters in Seattle to buy in, and then start with a couple of hundred stores in California and roll it out across the US.

In Canada, mCloud is working with the TELUS (TSE:T) enterprise sales force to sell its HVAC and smart building opportunity.  And they have set up a $50 million fund in Canada with Commercial Finance Group (CFG).  If you are a Tim Hortons franchisee who owns 50 stores, you might have to upgrade your stores with smart thermostats and lighting.  You work with CFG to get the loan and a three-year deal with them does not cost you anything.   Most commercial buildings will benefit 10% to 15% savings on your electricity bills. Buildings that are typical for the mCloud-TELUS partnership usually use no less than 200,000 kWh per year. There are over 440,000 buildings of this profile in Canada alone. This can equate to $300-400 per month of cash savings.  When you are in retail and it is a 2% margin business, your biggest variable cost is electricity.

So, they will leverage partners in the US and TELUS and CFG in Canada.

In wind, the NGRAIN acquisition gives them the unfair advantage.  NGRAIN has been working with Lockheed Martin (NYSE:LMT) on a million dollar per year contract doing F-22 and F-35 airframe analysis.  These are stealth fighters and when they come in from a sortie you take an image scan and make sure there is no compromise to the stealth profile of the aircraft.

mCloud now applies that technology to wind turbines.  A company that has a 20-year Power Purchase Agreement but after seven years experiences a costly increase to post-warranty maintenance service or much higher insurance premiums for its turbines, can tackle these with the mCloud solution.

Before, if you got some anomalous electrical generation off the wind farm you shut down two or three turbines for a week and sent a four-man crew out with a crane to see what was wrong.  With NGRAIN, you send the drone up, take a scan of the three turbine blades and send the data to the cloud.  mCloud knows the baseline signature of that turbine and can tell whether to shut it down. The AI algorithms do all the analysis.

The last bucket is electrical transformers, and the acquisition of CSA delivers the unfair advantage there.  CSA does 3D laser scans of concrete stacks for all the nuclear plant owners in the US to make sure there are no cracks.  That gives them relationships with Duke Energy (NYSE:DUK), Constellation, PG&E (NYSE:PGE), etc.  Obviously, to get the energy from the nuclear station to the city you have electrical transformers along the way.  The unfair advantage is that you turn back to the utilities, where you are a trusted partner, and let them know you can manage the transformers for them.

Universal mCloud is going to have north of 95% recurring revenue, which is one of the better models I have on the SaaS side.  A lot of institutions were weary when they marketed in the summer.  Now that the three acquisitions are done, they see what the pieces are, who Russ is, a board of directors that looks like it belongs to a billion dollar company.  I think they can get to a $500 million market cap over time with just those three buckets.

It sounds like a lot of hardware is involved in gathering data.  What challenges to adoption does that present?

Remember again that most HVACS, transformers and other electrical equipment these days come with sensors so all you need is the IP addresses to begin collecting data within the hour.  Tell mCloud the temperature and relative humidity you want to maintain, and they will save you 10% to 15% in energy costs.

With a wind farm, if you can keep a 100% run rate on a wind turbine, the payback period is usually less than a year.

With an electrical transformer, the full repair is in the tens of thousands of dollars.  Avoid one or two of them blowing up and that is the ROI (Return on Investment) story.

It would have been different if you had to send guys out to put a device in the equipment to collect the data, but now it all comes with the device pre-installed.

Looking at the acquisitions – FDSI (HVAC and building analytics), NGRAIN (AI and 3D Augmented Reality for analysis) and CSA (3D laser scanning) – how do all of these fit together effectively under one roof?  Does one plus one plus one equal four or five in this case?

If Russ and Tino Lanza and Mike Allman were not there to integrate these assets, it would have been one plus one plus one equals, maybe, three.  You need someone to integrate all this leading-edge technology and put it in one cloud platform and show the leverage across that customer base.

All the technology has been proven.  What other proof do you need than Lockheed F-35s and scanning technology that checks nuclear stacks.  And now you are not only integrating that technology into one cloud platform, but you’re leveraging the customer bases across those three segments.

And Russ has done this before.  He ran most of the skunkworks advanced analytical software development initiatives for Honeywell.  He was with them in Asia for four years in the early to mid-90s when China was about to explode.  He took defense industry tracking and analytical technologies into the gaming industry as well.  I see it already – the AI algorithms FDSI developed are being used across all three buckets.  You put the right data in and the analysis produces results that the unique few can produce. All highly patent protected.

I think one plus one plus one is probably equal to five, given what Russ has paid for these technologies and what he will be able to deliver.

You mentioned earlier that mCloud has an agreement with TELUS and a related $50 million fund to help ease acceptance by potential users.  Is this a common structure and what do you think the prospects are for that relationship?

It is common on the industry side to reach out to funds.  With this particular pool of capital they have removed the last barrier to acceptance from a Tim Hortons franchisee with a 2% margin.

“I don’t have $10,000 or $50,000 to invest to upgrade my thermostats and lighting.”

“Don’t worry about it – here you go.”

And it is not exclusive to TELUS but the relationship is very tight.  Ideally, in the US I’d like to see players like Jones Lang LaSalle and a fund 10 times the size of this one go after the restaurant chains, retail stores and supermarkets.

You’ve been out on the road with Russ McMeekin seeing some of your clients.   What has been the reaction to the mCloud story?

The first question you get from some of the larger funds is how you can compete against GE Predix and IBM Watson.  It is easy to answer.  There is no way those big guys can go very deep analytically in mCloud’s three asset types and really compete.  I think in the end one of them – or players like Honeywell, Oracle (NYSE:ORCL), SAP (NYSE:SAP) or Salesforce.com (NYSE:CRM) – acquires mCloud.

Everyone now gets what Russ’s vision is with the three acquisitions – the leverage across the Big Data play, a cloud solution from the start and the AI capability.  And if the TELUS rep brings me 30 stores tomorrow I am up and running that afternoon.

I think they want to see an example from each of those buckets.  Mash the three acquisitions together and you have a run rate of $4.7 million exiting 2017.  Give me a press release with TELUS and 30 Tim Hortons stores, one of your wind farm operators, and a Toronto Hydro or Duke Energy contract on the transformer side, and this stock is on its way to $2.00 in a heartbeat.

The institutions understand mCloud’s assets, the $6 billion opportunity in AI, and the potential to get 95% recurring revenue.  A lot of them don’t mind buying the stock at $1.00 if it has proven itself and you get a press release in each of these buckets.  The company is on a lot of radar screens and I think they are waiting for proof points.

You have the company doing just over $25 million in revenue in 2019 and EPS turning positive at 2 cents per share.  In subsequent years EPS is modeled to grow very quickly.  What does it take with a company such as mCloud for the market to sit up and take notice and get behind it with conviction?

Q1 will be a stub quarter because deals did not close until the end of March.  Q2 will see more people sit up and take notice.  But you are really going to need a large order from at least one of wind turbines, the utilities or TELUS.  I think Q3 will be the catalyst quarter.

They can grow this business adding minimal bodies now.  I am modeling doubles in revenue growth over the next two years, and that is what the institutions are looking for.  A lot of funds will pay 5x or 6x revenue if you are doing doubles on the revenue line.  I have pretty good confidence they are going to deliver given the relationships.

Of course, with companies of any size it is management that investors are really putting their belief in.  Existing talent and that being added through acquisitions seems quite top-tier at this company.

Institutions also remark on that.  They can’t believe this management and board for a $30 million market cap company.  That is the first thing we look at, too.  I see five or six business plans a week.  You can see in a moment if the top executives have done it before and if they have the team behind them to deliver.  We can tell relatively quickly who we want to back.

At mCloud, the entire management team is seasoned veterans from billion dollar companies.  The team is here for a $500 million market cap opportunity, not a $50 million market cap.

Any closing thoughts on mCloud or the industry in general?

Focus on these unfair advantages in each of those three segments.  You can have a great product and all these PHDs developing amazing algorithms, but if you can’t get deep into these verticals through relationships you can put whatever forecast you want out there and they’ll never reach it.  And again, we look for doubles, doubles, doubles in revenue growth.  These guys have the relationships to deliver them.

Please use the following to read Echelon Wealth Partners’ Research Disclosures: https://research.echelonpartners.com/research/disclosures.php

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