BQE Water: Write-Up Preview
BQE Water is a high-quality, capital-light Canadian microcap that offers a potential multi-bagger investment opportunity over the next 20 years.
Thesis Summary
Business Description
BQE Water (“BQE”) (CVE:BQE) is a Canadian microcap company that trades on the TSX Venture Exchange. BQE’s current market capitalisation at the time of writing is $77.62 million.
BQE is a professional services firm that provides technical consulting services to the mining and metallurgical industry concerning the treatment of mining and metallurgical wastewater streams. As BQE’s management likes to say, the company’s main product is clean water.
BQE’s business consists of two distinct segments.
The technical services segment involves providing technical consulting services to mining companies with mines in the development and permitting stage for the planning and design of water treatment plants. Specific services include feasibility and assessment studies, toxicity investigations, process engineering design, treatment plant commission and plant optimisation. This segment produces non-recurring revenues in the form of consulting fees.
The operating services segment involves operating water treatment plants for mining companies with mines that are either operating, are in the process of being closed, or have closed down. This segment produces long-term recurring revenues in the form of either “water treatment fees”, which are tolling fees charged per cubic metre of clean water treated and discharged subject to specific water quality criteria; monthly fees, hourly fees, or a combination of both; “support fees”, which are linked to the achievement of operational targets and delivered through supervisory and ongoing operational support services; or in the case of joint ventures, by sharing in the value of metals recovered from treating wastewater.
BQE’s technical services segment essentially acts as a funnel for the far more lucrative operating services segment of the business. Work that originates in the technical services segment is slowly (but not always) converted into work for the operating services segment once the mine and water treatment plant become operational. As we will see, this conversion of work from one segment to the other results in higher-margin, long-term recurring revenues that can last decades.
Business Strategy
BQE’s corporate strategy is to monetise the value of its intellectual property by providing services to mine owners and operators throughout the entire lifecycle of a mine with an emphasis on earning water treatment fees through the operation of water treatment plants during the mine’s operational phase.
Financial Characteristics
BQE’s business has many unique, highly-attractive financial characteristics, including:
A capital-light business model in which the cost of capital intensive activities are borne BQE’s clients;
High returns on invested capital;
High-margin free cash flows with very low capital expenditures;
A strong financial position with very little interest bearing debt and excess cash on the balance sheet;
High-margin, scalable, long-term recurring revenues from operating water treatment plants;
Non-cyclical revenues;
Expanding operating margins;
A durable competitive advantage in the form of intellectual property;
A lack of competitors and a focus on seeking out projects with weak competition;
An informational feedback loop that drives further innovation and the development of IP;
A very large addressable market that is expanding due to societal tailwinds;
A management team that is highly competent, focused, and aligned with shareholders; and
Organic long-term catalysts.
Durable Competitive Advantage
BQE has a durable competitive advantage over its competitors due to its significant intellectual property that primarily consists of its technical know-how concerning the water treatment process itself, which has the potential for a perpetual protection period.
Additionally, BQE has a unique competitive advantage in the treatment of water contaminated by selenium and cyanide. BQE currently offers the only non-biological treatment solution for selenium contamination, which is protected by patent until April 2035. Furthermore, one of BQE’s directors is the original inventor of the treatment process for water contaminated by cyanide.
Lack of Competitors
In addition to possessing durable competitive advantages, BQE also actively pursues projects where there is weak competition. BQE is typically either the sole bidder for a project or bids against the mining company itself.
Competent, Focused, Shareholder-Oriented Management
BQE’s management is highly competent due to their technical expertise and experience; is focused on pursuing the business’s core competencies and projects where BQE water has an advantage and can differentiate itself based on its services; and is shareholder-oriented, as demonstrated by the insider ownership among management and previous value accretive share repurchases.
Catalysts
There are three catalysts that could significantly increase the value of BQE’s business in the near and long-term future. These include the market opportunity for BQE to treat water contaminated by selenium, organic growth through BQE’s gradual addition of new mining projects, and significant projects that management have alluded to as being “company maker projects”.
Valuation
I estimate the value of BQE’s business in 20 years time on a discounted cash flows basis, factoring in the current value of the business and the additional value of the catalysts, to be in the range of $849,904,338.14 or $666.35 per share to $1,729,048,074.57 or $1,355.63 per share.
This represents a multiple on the current $69,387,573 enterprise value in the range of 12.24x to 24.91x.
Introduction
A theme has unwittingly begun to emerge on this blog. All three of the businesses that I have written about thus far - Cipher Pharmaceuticals, Moberg Pharma AB, and now, BQE Water - are “capital-light compounders”. In other words, they are businesses that employ relatively little tangible capital within their businesses that also have the ability to earn increasing and potentially unlimited returns on invested capital by increasing their earnings with very little or no need for incremental reinvestment of capital.
To understand what makes this type of business so special, let us recall that the objective of investing is to give up consumption now to be able to consume more later (the notion of “consumption” takes into account the reality of inflation).
Typically, when you make an investment in a business, you are giving up some portion of your capacity for consumption now because the capital you invest is no longer available to you for spending. Furthermore, in the case of most businesses, in order to further increase your ability to consume later on, you must continue to give up some of your capacity for consumption now by making additional reinvestments of capital, whether this is done by you personally or by management on your behalf through reinvestment of the business’s earnings. So, for the ordinary business, in order to continue to increase your future capacity for consumption, you must continually give up consumption now through reinvestments of capital.
By contrast, in the case of the capital-light compounder business, after you have made your initial investment, the business no longer requires you to continue foregoing consumption now by making incremental reinvestments of capital. This is because the business is able to increase its earnings and your future capacity for consumption without additional reinvestments of capital. That being the case, management (provided they are competent) begins to return the cash being thrown off by the business to you via share buy-backs or dividends, thereby increasing your capacity for consumption both now (through the returns of capital) and in the future (through the business’s increasing earnings). That is what makes this type of business so special - you are wealthier (in terms of your capacity for consumption) both now and in the future.
The archetype of this business model is a royalty. The owner of a royalty typically makes a single upfront investment, after which time they reap very high margin, potentially increasing cash flows without the need to make incremental reinvestments of capital, which are made (if needed) by the licensee. That is why Cipher and Moberg fit the capital-light compounder business model so well - part of their earnings are derived from royalties that have the potential to grow without Cipher or Moberg needing to make additional reinvestments of capital.
The only downside of these businesses is that they typically do not offer the opportunity to redeploy additional capital at the same high rates of return, which is why the capital is returned to shareholders. But then again, you can’t have it all (most of the time).
BQE is a business that also fits this profile to some degree, although BQE’s business model does not include earnings from royalties. Rather, BQE is able to grow its high-margin free cash flows with very small reinvestments of capital due to its operation of water treatment plants, which earn a “tolling fee” based on the amount and quality of clean water that is discharged by the plant.
The only capital constraint on BQE’s ability to operate additional water treatment plants is the human capital required to operate them. According to management, a plant producing up to $1.5 million in revenue per year only requires five people to operate it, so the reinvestment of capital required to operate an additional plant is very small in proportion to the economic value produced. This is also because the cost of constructing the water treatment plant is borne by BQE’s clients. Furthermore, the tolling fees provide operating leverage because an increase in the output of the water treatment plant does not require a corresponding increase in the number of employees manning the plant.
So, BQE fits the profile of the capital-light compounder business model because it can increase its earnings significantly by operating additional water treatment, the opening of which only require very small reinvestments of capital on BQE’s part in the form of human capital.
With that conceptual framework in mind, let’s proceed to a more detailed examination of BQE Water’s business. All figures are in CAD unless otherwise specified. As always, this write-up is not a recommendation to buy or financial advice. You must do your own due diligence and satisfy yourself of the facts presented here. All investment decisions are your own. Thank you for reading and happy hunting.