The elevator pitch for Otis

Otis Worldwide Corporation (NYSE:OTIS) is a leading developer of elevators and escalators that was spun off from American conglomerate United Technologies. Thomas Davies of VGI Partners explains the four factors which make the company attractive: 1) Its “razor blade” model of selling products upfront at low-cost, and then profiting from high-margin ongoing maintenance; 2) The company operates in an oligopoly; 3) Ongoing urbanisation, and 4) The recent spin-off from a broader conglomerate, which means a more focused business strategy. 

“United Technologies milked Otis for its cashflow and reinvested that in other parts of the business. Now you’ve got a management team who's very focused on Otis and optimising the outcome and earnings for Otis’ business."

In this short video, Davies expands on why this company is on its way up, including opportunities in reducing costs and boosting margins through digitisation.

Transcript

Otis was a spin-off from United Technologies, which is an industrial conglomerate in the US. The other business they own is Pratt & Whitney. So we've been following that business for a number of years because its components were such high quality. And so when this spin-off happened, we quickly decided to look at Otis. The reason we liked the elevators business, which is what Otis operates in, is that firstly, it's a razor blade model. So it operates the same as the razor blade industry, where you sell the elevator at very low margin and then you make all of your money on servicing and spare parts contracts.

What's important in servicing is having density within a city. So the more elevators you have within a city, or within a location, the cheaper it is to service an elevator and the quicker the technician can get there, if you have an outage. So what you see is that the incremental elevator sales in the industry go to the established players. Over many years, that's resulted in an oligopoly, so the top four players have 70% market share. We think that's a very good market share and it's a good business model that we like.

And the opportunity we think, in terms of the stock here today, is that it's been spun out from United Technologies (since you had a management team that weren't focused particularly on Otis itself, but were focused on the overall running of United Technologies). So they milked Otis for its cashflow, and then reinvested that in other parts of the business.

Now you've got a management team who's very focused on Otis and optimising the outcome and earnings for Otis' business. And we've seen this before where, when you get a spin-off, the individual business seems to operate a lot more efficiently and a lot better than when it's part of a conglomerate.

In addition, they're also digitising the monitoring systems. So as they move to a more digital monitoring system, there are massive cost efficiencies with servicing. So instead of sending an engineer out to check on an elevator, you can just pull it up on a dashboard on a PC and check that everything's fine and you don't need to service that elevator. So we think there are big margin opportunities on digital servicing and we also think that a focused management team will result in a much better outcome for shareholders.

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