Description

Situation Overview

The market has once again forgotten that General Finance Corporation (“GFN”) is not an oil and gas company, leaving us with an opportunity to own a sector- and geography-diversified cash generator with extremely attractive unit economics, heavy insider ownership and a few potential near-term catalysts, with 2.3x upside from where it trades today.  GFN also offers a cash flow yield of over 30%.  

This opportunity exists for a couple of reasons including (i) because the company is relatively small, has debt, and is thinly traded, the market tends to focus heavily on its oil and gas exposure (less than 20% of business), (ii) GFN screens poorly due to its historically aggressive growth and acquisition strategy which has resulted in a low (at times)-appearing return on capital, and (iii) GFN’s historically complex capital structure.

GFN stock peaked above $15 / share in late 2018, about the same time that XOP peaked and since then both have declined over 60%.  Ignoring the company’s excellent unit economics, I think the major things the market is missing with GFN are:

(i) GFN has a strong and growing business outside of oil and gas.  In fact, despite trading at 8-11x EBITDA over the past several years, GFN today trades at less than 8x its non-oil and gas EBITDA ($81.6mm vs EV of $629).  If you value their oil and gas EBITDA at 3x, you immediately get another 25% on top of today’s stock price;

(ii) the capital structure has gotten simpler and lower-risk over the last few years, and this is likely to continue resulting in much more screen-friendliness; and

(iii) management has significantly tilted its fleet away from manufactured (i.e. mobile-home-like) units and toward the significantly more attractive (lower capex, longer life, higher demand) storage container and “ground level office” (basically an office unit inside a storage container) units;

A couple of other incremental positives include the fact that GFN can realize a public-to-private arbitrage by buying capital-constrained “mom-and-pop” competitors for 5-7x EBITDA, and also that the company is likely a good acquisition candidate given the propensity of large players in this space to look for consolidation.  Founder Ron Valenta holds over 20% of the stock and transitioned to Executive Chairman from CEO in 2017.  He has historically been irritated by the market’s undervaluing of his company and is likely an interested seller at the right price.

Company Overview

GFN provides mobile storage container and related leasing and sales services.  These are the containers you see sitting in the parking lot behind a retail store providing extra storage, at a construction site holding the electrician’s tools and supplies, etc.  The company’s fleet includes storage containers, freight containers, liquid containment tanks, office containers, mobile offices, and modular buildings.

Mobile storage containers represent about two thirds of the company’s fleet and the unit economics are excellent.  Paraphrasing their investor presentation: they buy a container for $2,500-$3,500 and rent it out at ~$100 / month.  In most cases, this is a price level where customers are not very price sensitive.  The operations don’t require much.  A small branch could theoretically be run by a single employee who manages orders and also drives the truck to pick up / deliver units.  Companywide GFN tends to earn about a 60% gross margin on its leasing business (in total, leasing is about 65% of consolidated revenue).  Consolidated EBITDA margin has been in the mid-20s.  Many rentals last multiple years, resulting in a more than full payback on the container for a single rental.  It is not unusual for customers to want to purchase these units as well, and purchases may run from $1,800 to upwards of $2,000 for a well-used unit.  Sales of lease inventory is a 25-30% gross margin business.  Part of the reason used units sell for such an attractive price is that these things don’t really age.  They last 20-30 years and a quick coat of paint can render a used unit almost indistinguishable from a new one, so maintenance costs are very low.  The final piece of the unit economics is that these containers recognize non-economic depreciation, so GFN doesn’t pay much in the way of taxes.

The Company was founded in 2005 as a spac for industry veteran Ron Valenta (referred to in a prior VIC writeup as a legend in the portable storage industry) to “have another go” after selling a prior mobile storage company that he founded.  The company purchased Asia-Pacific subsidiary Royal Wolf in 2007, North America’s Pac-Van in 2008, and has made a multitude of smaller acquisitions along the way.  Today GFN employs nearly a thousand people and has 50,000 customers including large and small entities, with no customer representing more than 5% of GFN’s revenue in that region, and the top 20 customers in each region representing less than 25% of revenue.

GFN’s capital structure include secured opco credit facilities for each of North America ($179mm due March 2022) and Asia-Pacific ($114mm due November 2023), $77mm of 8.125% Sr Notes due July 2021, and $8mm of equipment financing and other debt for total debt of $379mm less $12mm of balance sheet cash.  Also $40.7mm of preferreds, a $23mm Bison derivative liability discussed further below, and 31.5mm diluted shares at $6.26 for a market cap of $197mm.  Total enterprise value (including $0.5mm of minority interest) of $629mm.  Also about $100mm of federal + state NOLs that I’m ignoring.

Ron Valenta owns nearly 25% of the GFN’s stock, Gagnon Securities owns ~12%, and Ron Havner, former CEO of Public Storage (and friend and former coworker of Ron’s) owns ~18% of the shares.  All longtime holders.

The company’s four divisions are as follows:

Pac-Van: North America container leasing and sales in a variety of verticals (construction, oil & gas, industrial, retail, education, government, mining, commercial).  ~55% of revenue and ~58% of EBITDA.  59 branch locations in U.S. and Canada.  I estimate about 4% oil and gas.

Lone Star: Liquid containment tank leasing and related. ~10% of revenue and ~12% of EBITDA.  Two branch locations in Texas.  I treat as all oil and gas.

Southern Frac: Manufacture and sale of liquid containment tanks and other industrial products.  ~5% of revenue and ~1% of EBITDA.  I treat as all oil and gas so there’s some extra EBITDA here (a very small amount).

Royal Wolf: container leasing and sales in Australia and New Zealand.  23 branches in Australia and 14 in New Zealand.  GFN estimates it has a 35% market share in Australia and 50% share in New Zealand and is twice the size of its next largest competitor.  ~30% of revenue and EBITDA.  I treat as no oil and gas.  Possibly some in “other” segment.

Industry Overview

The mobile storage market is highly fragmented as one might guess, given the ease of renting a yard and buying some containers (these mom and pops tend to hit a capital raising ceiling, which is when GFN comes and buys them).  The North American market is between $5-6 billion, with 25-30% of that represented by GFN, Mobile Mini (“MINI”) and Willscot (in the process of merging), and McGrath.  I don’t have a granular industry forecast, but think of it as GDP-ish growth with a small kicker for continually increasing awareness/adoption of temporary storage.

Mobile Mini has historically been the best comp to GFN’s North American storage business.  My customer and competitor calls have indicated that despite being larger, MINI isn’t known for particularly excellent service and tends to have higher prices and a willingness to lead pricing, allowing GFN to follow behind.  There is also however something of a “local franchise” element to the industry, where customers’ relatively lower price sensitivity means they’re most likely to call up the person they enjoy dealing with rather than trying to squeeze $4 / month off their bill.

That said, I don’t come across a lot of angst about cutthroat competition.  The high level of fragmentation allows GFN to pursue a multipronged growth strategy including acquisitions, fleet purchases, and greenfield branch development, in areas where they expect attractive competitive dynamics.

The Asia-Pacific region is much smaller – backing out GFN’s stated market share numbers, you get a total TAM of a few hundred million combined between Australia and New Zealand.  However the company cites a $1.1 billion opportunity in portable container buildings (frequently used at mining/drilling sites where workers live on-site).

Point 1.  Punished for oil and gas acquisitions and tied to commodity price.  Core business obscured

In April 2014, with WTI over $100 / barrel, GFN purchased Texas-based Lone Star who differentiated itself by providing a higher level of service than other than frac tank rental providers.  The purchase price was just over $100 million and Lone Star generated $20 million of EBITDA for GFN in the year ended June 2015.  However as activity slowed over the next two fiscal years, Lone Star’s EBITDA dropped to $6 million.  Similarly, Southern Frac’s EBITDA declined from $5 million in FY15 to go negative in the next two fiscal years.  GFN’s stock went from above $9 to below $4.  Since then as noted above with respect to the late 2018 peak in both oil prices and GFN’s stock, the stock has responded very heavily to movements in oil prices.  On the upside, this provides an attractive entry point to investors who actually look at the industry exposures (included in every quarterly earnings presentation) and note that GFN generates at least $80 million of EBITDA outside of the oil and gas sector.

From FY15 to FY19, GFN’s non-oil and gas EBITDA grew at an annualized rate of 9.1%.  I have no clue what will happen with oil prices medium term.  A sharp recovery in activity could give investors $30-35 million of EBITDA (~$1 / share) of oil and gas EBITDA.  However in a scenario with prolonged oil weakness, I expect GFN’s continued stability and growth in its core business to become more apparent, and I expect the share of oil and gas-related EBITDA in GFN’s numbers to decrease even more.

Point 2.  Complex capitalization caused by aggressive expansion has been off-putting to investors

GFN’s capital structure has been a bit of a confusing mess over the years.  The absolute level of debt + pref (~$400mm currently) is high relative to many businesses but it is appropriate for the asset-heavy and cash-flowing nature of this business.  However, longtime investors have seen: an equity and debt deal with Bison Capital to fund the initial Royal Wolf acquisition, the subsequent IPOing of Royal Wolf so it was half held by GFN and half public in Australia, two different prefs, opco credit facilities, holdco notes, more holdco notes, a FILO expansion to one of the credit facilities, and another complex-ish Bison Capital deal to repurchase the other half of Royal Wolf.

Barring the Royal Wolf repurchase, which was a simplifying transaction, GFN for years presented a cobbled-together capital structure that appeared to be a reflection of Ron’s aggressive expansion plans.  To be clear I think Ron is right to expand quickly and probably knows the strength and resilience of this business better than anyone but for a small and thinly traded company, I think that makes it easy for people to put in the “why bother” pile (the answer is cash flow).  More recently, as Ron has gotten more frustrated with the public market valuation and has promoted (a more conservative, operations-focused) Jody Miller to CEO, I have seen more of an interest from GFN in simplifying the capital structure, which I believe should make it more obviously attractive to new investors.  This should involve refinancing the senior notes, eliminating the prefs, and eventually retiring the remaining obligation from the Bison/Royal Wolf deal.

It is worth giving some additional color on the Bison derivative liability.  When Bison funded GFN’s 2017 repurchase of the public Royal Wolf shares, they provided a $26mm convertible note on which GFN forced conversion in September 2018, converting the note into 3.06 million shares.  As part of the note indenture, Bison was guaranteed a 1.75x cumulative (sum of principal, interest, and share sale proceeds) return on the $26mm convertible note.  Bison received ~$3mm of interest on the note prior to conversion, leaving required proceeds of $42.5.  As a result, if Bison sells its shares at an average price of less than $13.89, GFN must make up the difference via a payment to Bison.  At the current stock price, this is a liability of ~$23mm.  Technically Bison could sell all of their shares now and demand a payment in this amount from GFN.  However having discussed this with management, they believe that this is extremely unlikely given Bison’s familiarity with and belief in GFN and the fact that Bison’s Doug Trussler sits on GFN’s board.

Point 3.  GFN’s financials should continue to improve as the company tilts its fleet toward its higher return-on-capital, lower maintenance container business.

Since FY2015, GFN has grown its storage container and office container fleets by 53% and 69%, respectively while in aggregate its freight container, liquid containment tank, mobile office, and modular building fleet has shrunk by ~2%.  The company frequently notes on its conference calls the high level of demand for its office containers, implying a favorable pricing outlook (GFN’s average lease rates for office containers have increased by 29% to $385/month since FY15.  Storage container lease rates are up ~3% to $117 over the same period).

Point 4.  In the current environment GFN is likely to shift significant cash flow to debt paydown, which could result in a significant rerating of the stock.

GFN has invested heavily in its fleet through acquisitions and equipment purchases.  While as a long-term holder I agree that prudent fleet expansions are likely the most value-accretive strategy, a meaningful debt reduction for a microcap could significantly reduce the apparent risk profile to microcap investors.

Valuation

~$81.5mm of TTM non-oil and gas EBITDA at 10x is an EV of $816mm (as stated above, GFN has historically traded at 8-11x EBITDA measured across all of its EBITDA including oil & gas.  MINI has traded at 12-15x EBITDA, though a higher multiple is merited for MINI as they have more high value leasing revenue relative to their sales revenue).  Subtract: net debt of $367.3mm, prefs of $40.7mm, minority interest of a half million.  Implied market cap of $408mm or $12.94 / share or 2.1x the current price without putting any value on oil and gas (also represents a 15% cash flow yield on current consolidated TTM cash flow).  This is my base case and the Bison derivative liability is immaterial at this level.  If you want to value the TTM oil and gas EBITDA of $17mm at 3x (I think valuing it at zero is overly conservative), that’s another $51mm or $1.61 / share (~25% of current value).  If the oil and gas EBITDA recovers to $30mm at 5x, that’s a total share price of over $17 or ~2.8x current level.

For reference, my cash flow calculation is $98.5mm of TTM consolidated EBITDA less $24mm of interest, $1.5mm of taxes, $7mm of maintenance capex, and $3.7mm of preferred dividends.

Risks

1: Leverage, covenants, maturities, economic sensitivity.  Despite the excellent underlying business fundamentals, GFN is still a thinly traded microcap with leverage of just under 4x TTM EBITDA.  While (a) this is the kind of asset that makes sense to leverage given the significant steady cash profile, (b) the company navigated the 08-09 financial crisis with a higher relative debt load and (c) the TTM cash generation of over ~$62mm provides a lot of breathing room, there is always a chance that a deep, protracted economic downturn could result in a covenant breach or an inability to refinance the $77 million of holdco notes that come due in a year.  This could obviously result in a significant impairment.  In the current environment, this is far and away the most important risk.

I’ve spoken with management since the beginning of the pandemic and they seem very focused on doing whatever is necessary to keep any issues very far away including prioritizing debt paydown in cash flow allocation, and reducing opex and G&A if necessary.  For what it’s worth (not much) they said they’d run numerous 2009-like scenarios and were comfortable with what they saw.

They also noted on their most recent conference call that the pandemic appeared to be creating some opportunities for storage and office needs in the retail, medical, and industrial sectors.  In addition, while they were not seeing a usual seasonal increase in construction activity, a number of their existing construction sector rentals were staying out on rent longer than expected due to projects being paused.  As expected, oil and gas related revenue was declining as of quarter end.  I will perhaps eat these words down the road but I don’t believe shale died this year so I think that the decline in GFN’s oil and gas revenue will be temporary, even if it lasts a while.

2: New larger competitor with Willscot / MINI deal.  While this combined company will be a couple times GFN’s size in North America and will benefit from some cost synergies, I don’t see it drastically changing the competitive landscape given the level of fragmentation in the industry beyond the top handful of players.  GFN has long been suggested as a potentially attractive acquisition candidate for one of the larger players, and I believe that still to be true.

3: In a normal environment I’d be more concerned about the risk of taking on a bad/poorly-time/overly large acquisition.  As activity returns and management feels that we are in a more “normal” environment this will be something to watch.  For now management is focused on protecting the enterprise in an uncertain environment.

Catalyst

Quarterly earnings showing relative stability through economic downturn and continued increase of business weighting toward steadier growing non-oil and gas sectors

Shift of capital allocation from significant fleet investments to debt paydown over coming quarters

Refinancing of $77mm Sr. Notes due July 2021 and further cleaning of up the capital structure with elimination of Bison liability and preferreds