Spruce Point Issues "Strong Sell" On Envirostar
Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving Envirostar, Inc. (NYSE/MKT: EVI or "the Company"), a distributor of commercial and industrial laundry and dry cleaning equipment. With its shares up >600% since 2016, it has become one of the most overvalued microcaps in the stock market as index funds blindly pile in. Investors are ascribing nonsensical multiples to its recent acquisition roll-up strategy and ignoring signs of an impending covenant breach.
Spruce Point has a very successful track record of identifying over-promoted and poorly executed roll-up stories. As a result, we have a "Strong Sell" opinion and a long-term price target of approximately $5.60 - $16.80 cents per share, or approximately 40% to 80% downside risk.
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Envirostar Is The Worst Roll-Up Strategy Spruce Point Has Ever Seen
Spruce Point has been a dogged proponent against investing in roll-up strategies, which are often just financially engineered plays designed to game index funds into overpaying for stocks, with little focus or incentive for management to create organic growth or value creation through operational improvement.
We made early and successful calls identifying problematic roll-ups across many industrial sectors, notably AMETEK (test equipment), Greif (packaging), CECO Environmental (pollution control), and Echo Global (ECHO).
We view Envirostar as one of the worst and most speculative roll-up stories we’ve seen. Already three quarters post closing its biggest deal of Western State (Oct 2016) and EVI’s margins, profits, and cash flow are contracting. 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
Terrible Industry Headwinds and New Technology Disruption
Envirostar’s customers include independent and franchise dry cleaning stores and chains, and coin laundromat stores and distributors. Recent industry data shows a 20% decline in laundry facilities since 2005. Industry margins have compressed as a result of urbanization and new housing offering in place wash/dryers, while rents, utilities and other fixed cost increases have squeezed operators.
Meanwhile, technology and phone apps are making it easier to outsource laundry needs. This trend is causing technology intermediaries to partner with centralized laundry operators or a select few partners. We expect this consolidation trend to place further pressure on the industry. Not surprisingly, we believe this is why Envirostar is finding deals because experienced equipment operators see more problems ahead and want to sell
Questionable Management, Governance Structure and Auditor
Envirostar is headed by a relatively new and inexperienced CEO who has no experience in the laundry industry, yet bought into the Company in 2015. While he does own a lot of stock and appears aligned with investors, he has weak Board oversight with Directors that receive little cash pay and own no stock. For example, the CEO recently formed a new business entity (undisclosed) called Hammer Times LLC after Q2’17 – is he getting into the rap music industry? Former CEO (now COO) Steiner also recently formed an (undisclosed) business entity and quickly dumped stock after closing the Western deal
Management is not transparent, doesn’t hold conference calls, and gives limited MD&A discussion about drivers of its business in its SEC filings. EVI intends to acquire companies and allow them to operate independently. The management teams acquired appear old, and looking for a way to cash out by receiving EVI stock, making the success of the strategy dependent on keeping EVI’s stock inflated
Envirostar’s auditor traces its roots to Berkovits & Co, a Florida based firm tied to at least three companies charged with fraud including: 1) the $100m INYX fraud pursued by the Dept. of Justice (Berkovits), 2) VOIP, charged by the SEC for fraudulent overstatement of profits, and 3) PrimEdge whose CEO was accused of bilking investors out of $20m (Berkovits)
Significant Overvaluation With No Room For Error
Envirostar is the most expensive and financially weakest roll-up stories we’ve ever evaluated. Be careful, Envirostar has paid an average of just 0.5x sales for recent deals, yet public investors are overpaying now by 5x
At the current enterprise value of $320m, the market is ascribing a value of 2.2x, 32x, 61x to our estimates for CY2018 sale/EBITDA/EPS results. Blue chip industrial distribution peers with significantly higher margins trade at 1x, 11x and 21x
At the current valuation, investors are discounting near perfection execution of another $175m+ of deals, which will be a struggle to achieve given organizational strains, small deal sizes needed to push the needle, and competition from other strategic buyers. We see 40% - 80% downside risk once investors realize they own a bag of dirty laundry.