Description

Summary

Founded in 1878, Angelica Corporation is comprised of two divisions: life uniform and textile services. Life Uniform is a specialty retailer selling healthcare apparel primarily through 237 retail outlets located primarily in malls and strip shopping centers. Textile Services is the largest operator of commercial laundry facilities servicing healthcare institutions in the U.S. The Company is in the late stages of a restructuring in which they have sold their uniform manufacturing business to Cintas and Medline (2002), repaid almost all of their debt, and announced their intention to divest their life uniform division (2003). The remaining textile services business generates strong, recurring cash flow, has a diverse customer base, and barriers to entry. In addition, the shares are cheap, trading at 1.3x tangible book value (which I believe is understated as the company owns virtually all its real estate), 5.5x EBITDA and a 10% free cash flow yield (Adjusted for $20 million cash value of life insurance policies being liquidated and $20 million valuation for textile services - more on this below). The Company’s former CEO recently retired and was replaced by Steve O’hara, who was an AGL Board member and was formerly the CEO of Rawlings, which he sold to K2. I believe he is inclined to try to sell the company and the shares present an attractive risk/reward at current levels.

Business

The Life Uniform division sells apparel to the healthcare industry (scrubs, lab coats, etc) through 237 stores, a catalog and website. This division generates north of $80 million in sales and is EBITDA and cash flow positive. This business is in the process of being marketed by Morgan Joseph and I believe will generate $20 million+ in proceeds (tax basis is higher), which approximates net book value. The stores currently have approximately $15 million in inventory, which provides downside value in a liquidation if no buyers show up during the sale process.

Textile Services operates 27 laundry plants (typically 50-70,000 square feet employing up to 150 employees each) near various major metro areas in the US, and provides textile rental and linen management services primarily to healthcare institutions (there are some hotels, motels and restaurants in their mix). Notably, 25 of these facilities are owned by the company. Angelica has attempted to transform its customer relationships from commodity oriented laundry service to a more value-added linen management service. The company has three different types of relationships with its customers:

Stage 1 Customer owned goods, This is a true commodity business where margins are lowest. It is often a way for Angelica to get their foot-in-the-door.
Stage 2 Providing rental goods where Angelica owns the linens and is in effect a “banker” to the customer. In these relationships, AGL installs their AngelLink software and helps the healthcare facilities track linen usage by department and assists in cart make-up. This is the majority of the business.
Stage 3 Cart exchange. In these relationships, which are 20% of the business, AGL has full management responsibility for linen management at a given institution.

Angelica is well positioned as healthcare facilities increasingly are looking to out-source various non-core functions, including laundry. In certain cases, Angelica will purchase the on-premise laundry at a hospital in exchange for a long-term supply agreement. The business has historically grown about 5% organically (1-2% price, 3-4% new customers) although recent plant divestitures have masked this somewhat.

This is a reasonably good business for the following reasons:

Long term contracts - Most are 3 years + with cpi escalators.
Diversified customer base - there is large customer diversification. Only significant customer is Tenet which is less than 10% of business.
Barriers to Entry - AGL’s presence in a market is itself a barrier as building a new laundry facility is non-economic without significant and guaranteed utilization. In addition, the clustering of facilities have to be geographically proximate to the customers given the timely nature of the service.
Consolidation opportunities - AGL has the opportunity to acquire competing facilities at well under 6x cash flow. Typically, they can squeeze 2-3% out of the cost structure by adjusting their route delivery system and through purchasing synergies (natural gas, etc). In addition, they take capacity out of the market in such deals which ultimately helps their pricing.
Operating Leverage - AGL’s current capacity utilization is approximately 80%. Given the fixed-cost nature of the business, there should be significant operating leverage as they fill these plants up.
Growth - AGL should participate in (I) increased healthcare demand predicted by demographic trends (aging of baby boomers, new treatments, etc) and (ii) outsourcing by hospitals.

Market / Competition

Angelica serves approximately 45% of the healthcare market. The company sizes the U.S. healthcare linen market at $5.3 billion, which breaks down as $1.8 bn in hospitals (AGL has 27% share), $1.1 billion in long-term care (AGL has 1% share) and $2.4 billion in clinics (AGL has 3% share)

AGL’s biggest competitor in their markets are on premise laundries (OPLs) operated by hospitals which have a 24% share. The industry is quite fragmented with only two national competitors (Crothall Services owned by UK-based Compass and Sodexho Laundry Services) with healthcare volume of approximately one-half of AGL’s volume. In addition, there are approximately 13 mid-sized regional competitors doing between $20-100 million in volume. Aramark, Cintas and G&K are often mentioned as competitors. However, Aramark focuses more on janitorial and Cintas and G&K are primarily industrial launderers.

Financials

Given the discontinued operations, restructuring activities (plant divestitures, etc,) and re-financing, it is somewhat difficult to construct apples-to-apples comparisons with historical financials. However, the company provided additional detail on 9-month-to-date numbers in an 8K dated December 4, 2003. The business is not seasonal so these financials can be annualized.

Textile services is currently generating 8% EBIT segment margins and 11% EBITDA segment margins. Management believes there is room for a couple hundred basis points of improvement through (I) operating leverage from increased capacity utilization and (ii) capes spending in excess of depreciation for machinery and equipment that will lead to both labor and energy cost savings in future years.

Textile services is on track to generate $31 Mn in segment EBITDA and $21 Mn in segment EBIT. Corporate overhead has been running approximately $6-7 million to support three decentralized divisions. Management is actively reducing this and should be able to bring it down to $5 Mn. Importantly, the textile division has its own management team in Atlanta and so a prospective buyer of Angelica would be underwriting segment EBITDA, not consolidated EBITDA. The company recently spent $16 million building two facilities (Phoenix, AZ and Columbia, SC). I estimate these will generate an incremental $2 million in EBITDA. Thus, I estimate the shares are currently trading at 5.5x Adjusted EV/EBITDA, 8x Adjusted EV/EBIT and 10x FCF. In addition, there is a margin of safety as the company has as debt-free balance sheet and owns virtually all of its real estate. I believe there is roughly $10 of upside and perhaps a few points of downside.

Misc. Issues
Natural gas is a significant cost to the company. However, Angelica buys forward approximately 50% of its next twelve months natural gas needs and actively passes-along cost increases to its customers via surcharges. In addition, close to half of Angelica’s sales are in California where workman’s compensation costs have negatively effected earnings. However, given that one has to be geographically proximate to compete for business, Angelica’s competitors face the same issues.

Catalyst

Sale of Life Uniform division will complete restructuring. CEO seems inclined to judiciously use debt free balance sheet to grow the business and ultimately sell the company (perhaps to Compass or Sodexho). Possible pressure by large shareholders, including Steel Partners (7.6%), Cannell Capital (8.0%) and First Pacific (9.7%).