Trellidor listed on the JSE in October 2015. As an aside, I have a general rule of not investing in IPOs, knowing that they are usually priced for perfection. The only beneficiaries usually are the sellers and their investment bankers (a tribe, I must admit, that I once belonged to). Unsurprisingly, the stock quickly sold off 30% from its listed price during the year. The underlying business, however, did not escape my ‘value’ radar.

It was in the difficult markets that I was able to buy a wonderful business at an attractive price. Trellidor is a world-class business that will have customers in South Africa for years to come. One must remember that derivatives of its product have been used for defences since man entered the iron age. In tough economic times, crime usually rises and so does demand for security products. Trellidor is the market leader with 30% market share and the only one with a national footprint. It has a few key factors that tantalise any value investor’s taste buds: 1) great management 2) an agency distribution model 3) requires little capital to grow 4) attractive and growing competitive advantages.

Trellidor sells a custom-manufactured gating product nationwide through a network of franchisees to end-users. The ‘franchise’ model can be a wonderful business model for investors as shareholders obtain many of the benefits of a large distribution channel without paying for them – capitalism’s equivalent of social benefits. In Franchise systems, the business’s distribution channel is financed by owner-operators who want to ‘live the dream’ of working for themselves. The owner-operators will stump up a large portion of initial capital to employ staff, pay rent and offer unpaid ‘sweat’ equity with full responsibility for the operating risks of the business. It is a model that consistently yields far better performance than employee-led businesses. The franchisor’s (Trellidor) job is to build a brand and sell product to their franchisees. Trellidor uses its scale to advertise nationally (building their customer captivity) and makes money on the goods sold to franchisees at 50% gross margins. In this case, the Franchisees operate as agents of Trellidor’s manufactured product.

The agency business model offers a cocktail of strong forces that create wonderful returns on invested capital. First, there needs to be a seemingly ‘independent’ intermediary who buys on behalf of the end-user. Second, there needs to be a product that is complex or difficult for the end-user to determine the perceived cost vs the actual cost. Lastly, add a twist of common-interest incentives between the seller and the intermediary. If the seller sells at a higher price, the price of the product is not of a key concern to the intermediary as they simply charge the end-user more. The intermediary is more concerned about the quality and the ease of installation of the product – rather than the price. This model is often well-hidden, but can be found in insurance, plumbing, financial advisors and your even your local dentist – does your dentist ever phone around for three quotes to get the best price for your dentures?

Trellidor does suffer with one immediate challenge. It’s producing more cash than it needs for internal operations. We’re highly conscious that the CEO’s primary role is the allocation of capital. Much of the future returns of a company are determined by this very important role. I was pleased that during the year Trellidor purchased Taylor Blinds at a 5.7x historic PE and at a reasonable premium to book value – an example of good capital allocation. From discussions with management, it is likely to be very complementary to the Trellidor’s ‘made to fit’ home product offering with upside from distribution though their nationwide network of franchisees.

It is these factors: 1) the manufactured custom-fitted products 2) franchise distribution system and 3) well-established national Trellidor brand, that Trellidor has tantalising high returns on invested capital and is very cash-generative. We’re excited for what value the business will develop in the future.

A video that will give a feel for the product

Ps. forgive the poor video recording, we hope to improve in this area.