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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Tuesday, October 3, 2017

On obfuscation and the cynicism of investor stupidity ($EVI)

A short seller's presentation on $EVI was published yesterday. It is a long read. IMHO readers would be better off reading EVI's just published 10-K for 2017 and for 2015 as well. Go straight to the source.

But time is short and relative. "Should I read this or that?" The report's author hacks this concept of constrained time - as do many other media - to tell us an abbreviated version of things from their perspective.

It succeeded in serving its purpose, as it often does in the info/business/complex, but failed to adequately inform, as as it also often does in the info/business/complex. We the audience should expect more lest we fall to the level of stupidity expected in its consumption.

This was a valuation / technical short dressed up as fundamental analysis with absurd allegations, self serving drivel and a misunderstanding of the industry served. It reflects a cynicism about investors' intelligence, assuming people will believe it since it comes from a source that's been reinforced by the authority shaping mechanism of the info/business/media. I don't buy it.

For example, of a main allegation, that the company is "teetering on a covenant breach":

"Per the terms of its credit agreement, EVI must maintain quarterly profitability or risk a covenant breach. Q4'17 earnings of just $0.5m means that EVI is already teetering on a covenant breach"

The record shows that in the last 5-years quarterly and 15 years annually the company has never reported a loss. The report should include that information if it considers a quarterly loss a risk.

One can argue valuation until they're blue in the face. I'll frame up the short case a bit more simply quoting my backgammon opponent of last night, himself a former aerospace analyst: "Paying 20x pro forma EBITDA for a cyclical company is insane. We're mid-cycle for godsakes! When the cycle turns, you're going to get creamed. You should sell! You're buying into the cult of personality with this CEO!"

That's the short case: Valuation on a cyclical company.

Don't believe what anyone says about laundry being non-cyclical; capital goods are cyclical. EVI is cyclical. But, the record indicates that EVI is a late cycle play, that additional exposure to maintenance CAPEX mitigates some of the extremes of the cyclicality as does current and future geographic + product diversity.

Which gets to the bigger point on why I and others are bulls despite the nose-bleed NTM valuation. Investing is a business of probabilities. I see a high probability that EVI can continue to expand its growth, within and beyond the traditional capital laundry equipment into water reuse, remediation, perhaps even chemicals (the CEO's former business) and into add'l areas serving a client base that now stretches across the US and into Mexico, Central America and the Caribbean. (PS: All those wiped out resorts will need new equipment soon).

The point is, what's important is simply the company's effectiveness at  continuing to achieve it's "buy and build" expansion in the future.

So if you believe (as I do) that this company will report $16M or $24M in EBITDA in the future, than arbitrarily narrowing the opportunity set for that growth to a 12-month time horizon "b/c that's how we value things" is meaningless.

I also believe that the CEO is a rare and unusual talent and as I commented elsewhere, shorting this thing b/c 4Q17 margins are weak is like shorting Doc Gooden in '84 after he lost two games in a row, in August.

Obviously, one should only expand their comfort zone when using knowledge and information as a guide. Unfortunately, the short report contained neither. I actually expected more.

There's no harm in waiting for another pitch elsewhere. For me, I think EVI solves the problem of allocating capital b/c it allows me to buy a well run business that should grow significantly / materially over time. When the law of larger numbers starts to catch up, that's when the multiple will shrink, but at that point I suspect this will be a more expensive stock.

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ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS. I MAY OWN POSITIONS IN THE COMPANIES MENTIONED HERE.

8 comments:

  1. Can you explain this statement? "But, the record indicates that EVI is a late cycle play, that additional exposure to maintenance CAPEX mitigates some of the extremes of the cyclicality.."

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  2. What leads you to believe "CEO is a rare and unusual talent?" I have read upon him regarding his family relationship, his stint at WSO, etc. Obviously, high personal stake. Anything else?

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    1. late cycle play = impact of '08 recession didn't flow through inc statement until '10. there's a logic to the reason this would occur.

      maintenance capex = parts replacement cycles tend to be less volatile than capital equipment replacement cycles.

      rare and unusual talent = conversations with former colleagues + my general impression. i once asked his impression of an unrelated distribution business and his answer indicated that he's a student of business (as we all should be).

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  3. I read both the 10k, short report, and your previous posts. My thoughts:

    You're paying >30x EBITDA for a business that doesn't show organic growth or synergies from M&A. Unlike EVI, Watsco did show both. Additionally Watsco provides immediate need parts so it makes sense to use the distributor (who wants to be sitting in a hot building during work). I would hardly classify laundry equipment as immediate need.

    Going back to your first posts on EVI, it looks like you've been high on your EBITDA estimates for the company and are not keeping an honest perspective.

    A good roll-up shows synergies and produces cash flow which it can then put into new deals. This roll up isn't doing either. Instead management sells stock, which works when the price is appreciating. However, if sentiment turns and it begins to depreciate a stock issuance will only drive the price even lower. So now you're stuck.

    I don't see how the current price is justified by today's business or how EVI gets to your target ebitda without more share issuance which dilutes everyone and could cause the price to drop meaningfully.

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    1. I was previously skeptical of EVI, but have recently bought it.

      I am not sure why you say there are no synergies. Synergies don't always present themselves as cost savings in terms of head count. As with any distributor, as EVI grows in size, they will be able to charge higher commission % from the laundry part manufacturers. They can also cross-sell the items across their acquired companies.

      I am also not sure why end users of laundry equipment won't use a distributor and instead go directly to manufacturer. Customers use distributors across industries because they can buy large range of items at one place - it doesn't have to be an urgent buy item.

      I do agree that the valuation is too high. It won't seem high in long run if EVI can keep using their high stock price to "buy and build". When would this not work? If small distributors are no longer willing to sell. But this less likely because there's enough proof from first 4 acquisitions made money for the sellers and provided them an "exit" option that they otherwise won't have.

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    2. Another case where "buy and build" won't work is if the stock price crashes. This is when shareholders no longer buy the story of "buy and build". But in the past year, they've shown that "Buy and build" works via good execution. And there's a captive shareholder base that's unlikely to sell in short term, with the CEO + his friends/family fund holding ~50% of the shares.

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    3. thanks for your feedback MediumWill and Pheonix.

      "high on EBITDA estimates ... not keeping an honest perspective". i don't think i've ever provided any estimates for any companies i've written, since I don't know the future. maybe you're talking about the presumed $9M proforma EBITDA in the table from that deal? that was penciled in to give a rough gauge on valuation.

      similarly, it looks like they're doing PF $150M in sales @ 8% EBITDA margins that would be $12M in EBITDA. i don't think that's a forecast or estimate just a benchmark of where they could be in terms of valuing things. i try to be an open book and i'm certainly not seeking accuracy on something i know nothing about.

      as for synergies at last year's annual meeting mgmt was pretty emphatic about not seeking synergies but running these businesses independently. the thing to keep in mind is that these distributors for large commercial equipment are regional duopolies. go to a commercial laundry and ask them how they choose their distributors and report back. I think they'll say, "i choose the equipment and then i buy from that distributor".

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  4. ... and by the way, over an extended period both the longs and the shorts can be right. maybe the shorts make money in the next week / month / quarter but i think people who buy and hold have a reasonable probability of making +money over the next 3 years.

    and I think reasonable people who read what I write understand that's my mentality and aren't focused (as they shouldn't be) on false precision in some unknowable future

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