Description

General Finance (GFN)

We are resubmitting for your consideration shares of General Finance Corp (NASDAQ: GFN), which we last wrote up in August 2011when its shares changed hands at $2.66 and the market cap was $59m.  Patient investors who bought in to the sum of the parts thesis back then enjoyed a spectacular run, as GFN shares would go on to reach an all-time high of $10.15 on Dec 29th, 2014.  However, the stock price has suffered since then for several reasons including:

 1. GFN’s acquisition of Lone Star Tank Rental (frack container leasing) in April 2014 which helped propel the stock towards $10 as it outperformed expectations in 2014 but has been hit hard this year due to its exposure to the oil and gas industry

2. An ill-timed and subsequently cancelled follow-on equity offering

3. Indiscriminate selling by index funds as GFN was removed from the Russell index this summer

4. Overall small-cap/micro-cap weakness

GFN is a misunderstood free cash flow machine due to the very low maintenance capex nature of the long-lived storage containers it rents.  We believe that even at cyclical low levels of EBITDA for its Lone Star business that GFN can generate close to $1 per share in free cash flow today and closer to $1.50 per share in a reasonable recovery scenario.  At a 10% FCF yield, that translates to a $10-15 stock price as compared to the current price in the $4 range.  You can do the math on even lower yields….

GFN is led by Ron Valenta, a pioneer in the portable storage industry, who owns roughly 8.4 million shares or 32% of the company (including several trusts for the benefit of his family).  Mr. Valenta founded Mobile Storage Group which was acquired in 2008 by Mobile Mini (the only pure play comp to GFN which has traded at a 10-15x multiple of EBITDA for years).  His former protégé, Ron Haver (now Chairman and CEO of $42 billion market cap Public Storage (NYSE:PSA)) owns 10% and the rest of his management team owns 7%.  Interests are aligned. 

Our prior write-up resulted in a 4x bagger for those who timed it right.  We believe we have the unique opportunity to repeat that success all over again.  Moreover, as Mr. Valenta founded GFN in 2007 as he had “sellers remorse” after he sold Mobile Storage (which he founded in 1988), we believe a strategic sale may be likely to occur in the next several years as Mr. Valenta is frustrated with the public markets and poor trading of his stock.  What might a strategic buyer pay for a top 3 North American player and #1 player in Australia/New Zealand?  Weak companies in this industry sell for 8x EBITDA.  Mobile Mini trades at 13-15x EBITDA.  Let’s just say GFN sells out for 12x EBITDA on a $90 million level of EBITDA (assumes reasonably recover for Lone Star; GFN was doing more than $100mm EBITDA before the business softened).  That translates to a roughly a $21 share price.  Sounds like a dream but it’s more than possible.

From purely a stock market perspective, the combination of a lack of liquidity in the small/microcap space, the selloff in commodities, the misperception that GFN is entirely levered to oil prices, a limited public float, the declining Australian Dollar and tax loss selling have created the opportunity to buy shares cheaply today.  At their current levels, we believe that the shares once again offer exciting potential for price appreciation along with strong downside protection in the form of industry consolidation buyout multiples and the many NOL vehicles seeking strong cash flowing assets. 

Capital Structure

As a reminder, GFN is comprised of two distinct businesses; each with its own capitalization.  The US business is comprised of three subsidiaries: Pac-Van Inc., Lone Star Tank Rental, and Southern Frac.  The Asia-Pacific business is comprised of Royal Wolf Holdings Limited.  Royal Wolf is listed on the Australian Stock Exchange (ASX) under the ticker RWH: AU

Here is a summary of the capital structure today:

Here is more detail on the debt:

History

A good deal of the background on the Company can be found in our original write-up.  We will save you the hassle of going to get it by reproducing the summary below and filling in what has happened since then.  GFN also has an excellent investor presentation available on their website in the investor relations section – http://bit.ly/21Sb5D5

GFN is a player in the portable storage industry.  The portable storage industry entails the leasing (and sometimes sale) of storage container products, modular buildings and mobile offices.  Portable storage pundits like to highlight the cost, security, and feature advantages of portable storage units over warehouse or permanent office space.  End markets include retail, construction, industrial, commercial, governmental, and homeowner usage.  Storage container rental is a tremendous free cash flow generator characterized by high non-economic depreciation resulting in little or no cash taxes and lease rates that typically entail rapid payback periods (2-3 years) on equipment purchases.  The recurring revenue from the lease stream is predictable and the assets themselves tend to have long useful lives.

GFN went public in April 2006 at $8.00 raising $69mm with Ron Valenta (the founder of Mobile Storage Group and a renowned leader in the portable storage industry) as its CEO.  Valenta is considered a "legend" in the portable storage industry with a significant track record of building value for himself and investors alike.  From 1985 to 1989, Mr. Valenta was a Senior Vice President of publicly traded Public Storage, Inc. ($42b market cap). From 2003 to 2006 he was a director of the National Portable Storage Association and from 1988 to 2003, Valenta served as the President and Chief Executive Officer of Mobile Storage, Inc., a portable storage company he founded with a lease fleet of over 103,000 units and 78 branch locations throughout the United States and the United Kingdom.

We estimate Mr. Valenta has invested ~$35m of his own capital in GFN in addition to personally guaranteeing $10mm of the GFN's US credit facility including a personal backstop of GFN through some of the recent difficulties it encountered during the financial crisis.

In September 2007, GFN acquired an 86% interest in Royal Wolf, a leading portable storage company based in Australia for ~$84 million.  Valenta and his affiliates (Olowalu and Kaiser in SEC filings) bought around $12mm of GFN stock at $8.00 in conjunction with the transaction.  In addition, when the SEC caused an unexpected delay in its review of GFN's proxy statement which resulted in the seller of Royal Wolf threatening to cancel the transaction, Mr. Valenta personally backstopped the entire transaction in the event that it was not completed by a certain date or it did not receive shareholder approval.  The transaction closed in September 2007 and GFN stock subsequently traded in excess of $10 per share.

In October 2008, GFN entered the US market through its acquisition of Pac-Van, a 26 branch portable storage, modular buildings and mobile office company based in Indianapolis  (but with offices in 17 states) for ~$20mm cash, 4mm shares and the assumption of debt which, all in, totaled $158m in consideration.  Boasting more than 7,000 customers, Pac-Van had achieved a 26% CAGR in EBITDA from 2003 until the time of its purchase. Pac-Van was particularly hard hit post Lehman with EBITDA declining from in excess of $20mm to roughly $10mm.  However, the business today began to stabilize and became well positioned to grow and acquire weakened smaller competitors.

Other key dates

Oct 2012 – GFN acquires 90% of Southern Frac, a domestic manufacturer of portable liquid storage tank containers

May 2013 – GFN completes public offering of 350,000 shares of 9.00% Series C Cumulative Redeemable Perpetual Preferred Stock

March 2014 – GFN acquires LoneStar

GFN made a (now) mistimed acquisition of a portable liquid storage container company called Lone Star Tank Rental/KHM Rentals LLC.  Lone Star leases portable liquid storage tank containers and containment products, as well as provides certain fluid management services, to the oil and gas industry in the Permian and Eagle Ford basins of Texas through a fleet of more than 1,200 units. Unaudited revenues for Lone Star for the year ended December 31, 2013 were $45 million.

GFN paid $95m for the Lone Star or around 5.8 times Lone Star's adjusted 2013 EBITDA.  Of the total purchase consideration, the sellers received $75 million in cash, $10 million in shares of GFN’s common stock, and some non-compete/indemnity holdbacks.

March 2 2015 – GFN announces 4.4m share offering

March 12 2015 – GFN postpones the offering due to unfavorable market conditions as Mr. Valenta refused to price the follow on at less than $8 per share.

GFN Today

THE US BUSINESS

Pac-Van (around 40-45% of Total EBITDA)

Pac-Van is the Company’s core portable storage business and a leading provider of portable storage container rentals and sales. It also rents and sells mobile offices and modular buildings, as well as rents liquid containment tanks. The primary competitor in Pac-Van’s market is Mobile Mini, which trades for ~13x ttm EBITDA.  Pac-Van operates 31 branch locations in the U.S. and the western provinces of Canada. Non-residential construction is Pac-Van’s largest vertical, representing about one-third of its end-market mix.

Lone Star (around 10-20% of EBITDA)

Lone Star is a leading provider of liquid containment tank rentals and related services in the Permian Basin of West Texas and the Eagle Ford Shale in South Texas. It differentiates itself by contracting directly with major exploration & production companies, as opposed to relying upon oil field equipment and service companies as middle-men, which helps fortify long-term customer relationships.  Lone Star generated around $16mm of EBITDA at the time of its purchase by GFN and was on track to produce in excess of $30mm of EBITDA prior to the collapse in oil prices.

Southern Frac

Southern Frac is a domestic manufacturer of portable containment tanks in Texas.  The Company sells tanks to GFN’s subsidiaries Lone Star and Pac-Van, as well as to third-parties, which are primarily oil and gas exploration & production companies. It can also serve customers in markets such as chemicals, industrial, and waste management.  It recently announced the development of several new product lines in response to the slowdown in the fracking business.

THE ASIA-PACIFIC BUSINESS

Royal Wolf (around 40-45% of EBITDA)

Royal Wolf leases and sells portable storage containers, portable container buildings and freight containers. Royal Wolf currently operates 28 customer service centers located in Australia and seven in New Zealand. Royal Wolf is the only portable container lease and sales company represented in all major business centers in Australia, and is the only company with a nationally integrated infrastructure and work force. It serves both small to mid-size retail customers and large corporate customers across a broad array of end markets.

 Source of the business unit descriptions: OPCO report + our own original comments

A word on the business

In both the US and abroad, GFN operates in highly fragmented market that adds up to over $5b across all segments.  A top 5 recognized provider on a national, regional and local level, GFN has 43 branches in the United States, presence in 35 of top 50 MSAs and a total lease fleet of over 74,000 units.  Abroad, they have 35% market share in Australia and New Zealand and it is the only container leasing and sales company with a nationally integrated infrastructure and workforce with over 41,000 units.  The Company has over 35,000 customers and no one customer accounts for more than 4% of revenues.

Leasing portable storage containers is a high return on capital business.

The typical cost of a unit is $2,000-$2,500.  It features little to no maintenance capex, a long economic life, attractive tax attributes and high incremental EBITDA margins.  GFN has averaged $30m/yr in free cash flow before net fleet activity and acquisitions over the last several years.

The current state of affairs

GFN has long been a rollup story given easy access to financing, the market’s willingness to lend to these types of assets, and the experience of the management team in the industry.  Even as utilizations stayed relatively flat, the Company was able to show incremental growth.  The story has now changed.  The slowdown in the US oil & gas sector and the Asia-Pacific resource sector has clearly shown up in GFN’s results.  Starting in February of this year, lowered fiscal 2015 revenue guidance to $310-325 million (previously $320-335 million), factoring in a stronger U.S. dollar relative to Australian currency and some adjustments for Lone Star.  Royal Wolf has seen its shares fall almost 30% this year.  Just before summer the Company reported both average fleet utilization and lease revenue/container declines.  Management reduced its 2015 EBITDA guidance to be 'marginally behind FY14’.  Small/microcap land tends to draw investors looking for sales and EBITDA growth.  GFN played to that strength to take its stock from the $2’s to over $10 over the last few years.  It now finds itself back in the doghouse with its growth prospects challenging and its stock likely screening as an over leveraged industrial with the word “oil” in one of its business descriptions.

A key to understanding what happens in the current environment concerns the company’s capex.  DA Davidson summarized this nicely in a recent October 2015 report:

“A substantial portion of capital expenditures in prior years has been purchases of lease fleet assets.  These purchases are mostly discretionary with no major contractual arrangements with suppliers; and significant related investment in recent years has been to support growth.  FCF (including PP&E investment but before lease fleet purchases) has been in a range of $20-$44 million in the last 3 years (we estimate this figure will be $20 million in fiscal 2016).  In addition, GFN regularly generates in excess of $20 million per year in lease fleet sales which is additive to the aforementioned free cash figures.  Lastly, GFN’s credit lending facilities include no major maintenance covenants.”

GFN is something of a walking LBO in its current state.  We illustrate this below:

VALUATION

Based on our research, conversations with Management, and publicly available guidance and estimates, we think that GFN trades for a low single digit multiple of free cash flow.

In an environment where Lone Star’s EBITDA recovers to a more normalized $20m, the numbers look like this:

Current messaging from Management indicates that acquisitions and fleet building are not the current focus of the Company in this environment.  If this is coupled with stability in the most troubled areas of the business, investors should get the benefit of stable to high free cash flow to the equity which can be used to reduce debt and thus increase equity value.

CEO Valenta commented on Lone Star’s stabilization on the last conference call:

“We are seeing good activity in the Permian where it looks like there's more of the players are coming into because of their cost structure is so low. Eagle Ford has stabilized but the Permian seems to show some signs of life or certainly more than Eagle Ford. With our focus on our safety and our systems and our service levels which we haven't cut, we’re beginning to pick up market share in the Permian relative to our prior competitors for those that are still there.”

CFO Barrantes added this color as well:

“It has moved up sequentially primarily because as Ron had mentioned the pricing at Lone Star has seemed to level off compared to Q4, obviously Q4 we had significant rate adjustments which were on a retroactive basis and that sort of thing. Their rental rates generally across the board have gone up from Q4”

SUMMARY

As was the case when we first wrote this up years ago, this idea is not for everybody, as many may be put off by either the lack of volume in GFN shares (average is ~65k per day), the idea of owning a piece of an Australian company via a US listed 'stub', or playing for a turnaround in the EBITDA of a US storage company.  However, where else can you find a company that:

·         - Trades at north of a 25% FCF yield

·         - Is led by a stellar management team with >40% insider ownership

·         - Maintains leading market positions in its industry in two continents

·         - Invests on long-lived, low maintenance capex, non-economic depreciating assets not subject to technological obsolescence

·         - Pays little to no current income taxes due to depreciation shield

·         - Could be acquired for 5 times the current price in a strategic transaction

- We strongly believe that patient investors will be handsomely rewarded and that now is the time to re-establish a position in GFN.

RISKS

1.  The recovery in US Oil & Gas is muted, or takes longer than expected, thus suppressing any EBITDA lift.

2.  The market fails to add up the sum of the parts and/or continues to assign GFN a holding company discount.

3.  The Company continues to do acquisitions and ends up with buying something they cannot integrate well/justify.

Catalyst

1.       Improved results as stabilization takes hold across all segments.

2.       Company demonstrated discretionary nature of their capex, low levels of maintenance capex, and ability to pay down debt.

3.       GFN is sold to a strategic acquirer.