Description

No stranger to the VIC, IESC otherwise continues to grow in obscurity, with no earnings calls, no analyst coverage, no glossy annual reports, IR personnel, and a even a Chairman who hates having his picture taken.  Hence we can buy this nearly (net) debt-free company whose LTM revenues grew 20% yoy organically, (25% inorganically) and whose LTM EBIT/share grew ~44% at under 11x FY17E fcf/share (ends 9/30/17).  Business quality is above average, and mgmt. is probably better than that.

In a nutshell, IESC is like a PATK 2.0.  PATK has been a hugely successful rollup masterminded by Jeffrey Gendell.  Like PATK, IESC is one of the names he hung on to after winding down his hedge fund.  Roughly two years ago Gendell turned his attention in earnest to IESC, of which he is Chairman and majority owner.  I’m not expecting quite the same level of success, given that IESC doesn’t have the benefit of the depressed multiples coming out of the financial crisis.  But it does have over $400M in NOLs and unlike PATK, Gendell can steer this ship indefinitely.

Alcideholder wrote this up last September, and you should definitely check that out if any of this seems appealing.  Which begs the question, what compels me to update the story so soon?  The answer is, um, that I have an idea due to this site.  But in my defense, I’m going to make this as additive as possible, repeating just enough of the story to make this (just barely) coherent.

Brief history:

IESC began life as a public company in 1997.  Like many financial creatures of the go-go late ‘90s, IESC delivered sexy too-good-to-be-true numbers, and eventually the chickens came home to roost.  This was a rollup done wrong, and in the early 2000s it became apparent that mgmt. never really had a handle on the business.  A long series of restructurings led by a parade of CEOs left shareholders with enormous fatigue.  Eventually, Gendell became a shareholder through one of those restructurings by way of buying the company’s distressed debt.

It wasn’t until FY11 that the company finally got operations under control.  That year, Gendell appointed one of his lieutenants from Tontine – James Lindstrom – as CEO.  The company stopped pursuing revenue in geographies and niches where it didn’t belong.  Headcount and expenses were cut significantly.  Managers were given more autonomy and better incentives.  Etc.

And it wasn’t until FY15 that the company really got the acquisition machine rolling.  Since the June 2015 quarter, IESC has done 6 acquisitions and one disposal – a deal a month thus far.  They’ve all been of the bolt-on variety and that’s likely to continue, as it fits with their strategy (more on M&A below).

The company today:

Communications – this was the original business line.  Does electrical work for data centers, high-tech manufacturing, AV & security systems … basically all stuff that is driven by the rapid growth of data in our lives (i.e. the cloud and so forth).  No surprise then that organic growth has been high – with LTM revenues up 34% year over year.  It’s a nice business, with lots of blue-chip clients (e.g. Amazon, Google).  Operating ROA has averaged 22.5% from FY09 onwards (roughly the time during which Gendell has been in control).  (I use EBIT/assets since the company’s NOLs shield them from nearly all taxes.)  Needs almost no capital to grow.

Residential – does electrical work for single and multi-family homes, plus a bit of solar and cable installation as well.  Geographically focused on the some of the best housing markets – basically southern U.S. with a concentration in Texas.  (Interestingly, Texas housing has been holding up well despite the oil slump, plus IESC has taken some market share).  Revenue has been growing (organically) around the low double-digits, which I’m guessing is mostly just a function of the housing cycle.  But if you look at a chart of starts and permits in their regions (I’ll get you a chart in a moment), I think you’ll see why I say they’re probably around mid-cycle now, or at least not over-earning.

This too is a good business, with operating ROA of 3%, 5%, 14%, 26%, 41% over FY12-16.  Note that about 1/3 of COGS is copper wire, meaning they do have some exposure to commodity fluctuations, but the work turns over so quickly that it hasn’t been a big issue – even back around 2004, if you recall those days.  IESC is the largest player in this market and thus has become a preferred provider to most/all the big U.S. home builders

While IESC hasn’t done any M&A in this segment in a long time, there are apparently tons of mom & pop businesses that could be acquired at good prices.

Commercial & Industrial – does wiring for commercial buildings (e.g. hospitals, factories, universities, office buildings, etc.).  Historically, this has been the big problem child, and is far smaller today than it was in the past.  Mgmt has increasingly focused on the little niches of commercial construction where they excel, and thus revenues have not grown much despite the rebound in non-residential construction.  Operating ROA, however, has improved significantly to around 15%.  Interestingly, this might just be the segment with the most optionality, as they do the stuff you hear about in discussions Trump infrastructure stimulus – e.g. smart (electrical) grid, smart highways, etc.

Infrastructure – this is the newest segment, created with the FY13 acquisition of MISCOR.  This is a collection of both product and service businesses, doing stuff like electric motor repair, HVAC work, manufacturing specialized electrical engines, etc.  It’s also the segment seeing the most M&A activity.  Operating ROA is a lousy mid-single digit number, but that’s largely a function of MISCOR (more on this below).  All the new acquisitions seem to have much better economics, and seem to have come at very reasonable prices.

M&A

In a recent press release, the company states the following:

“Our long-term investment horizon at IES and flexibility of transaction structures allows us to provide a more attractive alternative than private equity for owners who want to retain an equity position in their business. Sellers can benefit from IES's substantial balance sheet and liquidity to grow their business, and can monetize their retained interest in a mutually agreed upon time frame.”

Sounds a little like that guy in Omaha, right?  The approach is very similar, but on a much smaller scale.  Synergies come from operational improvements, rather than from just firing people.  Acquisitions have been small relative to the whole as IESC is purposely trying to find deals that fly under the radar of private equity, and consequently don’t get bid up in price.  The typical seller is a mom & pop looking to do some estate planning while leaving their baby in good hands.

While net debt today is minimal, management is comfortable levering up to 1.5x EBITDA, with 1.0x being their idea of a normalized debt level.  I’m expecting about 41.5M in FY17 EBITDA, FYI.  Plus, free cash flow conversion has been very good, so just as with PATK, this company should be able to pay for much of their M&A program with cash on hand.

Finally, I’ll do my best to come up with a criticism here.  While I admire Gendell quite a bit, I loathe writeups that just fawn all over management.  So here goes: the MISCOR acquisition appears to have been a real stinker.  As best I can tell, earnings have been around breakeven and revenues declined 15% in FY16.  The deal cost about $23.4M, but half of that was paid for with 2.8M shares, which were trading at $4.24 at the time.  And Gendell owned just under half of MISCOR before selling it to IESC.

Now I can’t point to any other acquisition that has performed as poorly, nor can I find another one paid for with any equity.  But there it is.

Notes:

The most recent acquisition (Freeman Enclosure Systems) not included in any figures as no financials or cost have been disclosed yet.

Cash tax rate works out to 7-11%, due to the AMT, certain weird state tax rules, and other annoyances.

Catalyst

More M&A

Somebody pays attention

Street coverage?