Description

When former Chemistry teacher Walter White looked to launder his ill-gotten gains, by what means did he originally choose to do so?  A carwash. 

Why a carwash?  Skyler mentioned carwashes are a “cash” rich business and at only 19 cars per-hour x the number of hours in the day they can actually create a reliable and substantial revenue stream (via which one could launder money).  While Skyler was right that carwashes can be very good businesses what she underestimated how good a business and she over-estimated how cash reliant they are (they are heavily plastic reliant in order to maximize throughput).  If you are wondering why we opted for a trip down Breaking Bad memory lane it is because the company in question owns the very carwash that Walter and Skyler bought in Albuquerque. 

I do want to post another image of the newer Mister Carwashes just to show you while the Albuquerque location does hold some appeal (beyond acting as a narrative-crutch) it is by no means representative of the overall store base which is far fresher and more streamlined looking (see below).

Mister Car Wash (“MCW”) operates 360 carwashes in 18 states and has little to no presence in 41 of the 50 most densely populated MSAs.  MCW IPO’d in June 2021 at $15/share (when MCW had ~340 locations).  MCW was originally started in 1969 in Houston Texas.  In 1996 Car Wash Partners was formed to create a leading conveyor carwash company with the goal of creating a national brand.  Over the next 7 years they acquired 38 locations.  In 2003 MCW introduced the Unlimited Wash Club (a membership model with a monthly price of $19.99 that offers subscribers unlimited washes across any locations – MCW has not raised prices on its monthly membership since it was introduced in 2003).  In 2007 MCW was purchased by ONCAP and added 21 new locations becoming the second largest carwash in the United States.  In 2013 John Lai (current CEO) was appointed as CEO (he was originally the son-in-law of MCW’s prior CEO where they both worked at Ecolab before starting Car Wash Partners).  In 2014 MCW was purchased by Leonard Green Partners.  In 2016 MCW reached 200 stores (adding 90 stores since 2014).  MCW operates carwashes that can be completed as fast as 3-5 minutes with north of 200 cars processed per hour (eat your heart out Skyler & Walt!).  In 2021 after achieving a 20x on their investment in just 7 quick years Leonard Green Partners decided to IPO MCW.  LGP still owns mid-70s of MCW today and actually sold a very small amount of stock at the IPO (37.5M shares were sold at IPO @ $15/share with only 6.25M shares being sold by LGP).  LGP then broke the lock in August 2021 to sell an incremental 12M shares @ $19.57/share.  So all told LGP has only sold 18.25M shares and still holds some 215M shares or 72% of the shares outstanding.  This overhang has kept many away but I think it is a red-herring.  First LGP has long proven to have extreme patience with their portfolio companies (especially ones as successful as MCW, which is likely the most successful investment LGP has made in the last 20 years) – heck the still hold TCS shares which IPO’d in 2013 and now trades healthily below its IPO price of $18.  Second, LGP clearly could have sold more at IPO or even more in the secondary – neither were particularly large offerings.  This signals to me they are fine letting this management team do what they are best at …. compounding capital.

At IPO, MCW had a stated goal of getting to 1,000 locations; ~3x their footprint at the time of the IPO.  This was going to be done via a mix of greenfield (stated goal of 16-18 greenfield openings per year) and brownfield (50 over 5 years).  It is worth mentioning on the brownfield goal, in the three quarters of being public MCW has done 10 brownfields already.   New units target an AUV of $1.2M in the first year with four-wall EBITDA margins of 25%, growing AUV to $1.7M in year three with >40% four-wall EBITDA margins.  By using a sale-leaseback on properties MCW is able to create payback periods on greenfield units of ~3 years.  Further, MCW lifts EBITDA at acquired units by on average 60% showing the power of the MCW network (and by extension UWC, more on that later).  In 2019 AUV was $2.6M (fell to $1.7M in 2020 due to COVID).  Historically MCW grew more via brownfield but as money (private equity and otherwise) flooded the space carwash valuations levitated from 6-8x to now 12x-16x EBITDA and we have heard some rumors of a few platforms trying to sell for mid-teens on a net-lease basis, they are now putting emphasis on greenfield over brownfield.  The management team clearly cut their teeth with brownfield acquisitions and in the past they have made 50 acquisitions in one year let alone the 50 over five years that was guided.  Being the only player with public currency in a fractured market likely gives them an edge over others – especially once bonus depreciation expires and makes it less of a tax boondoggle for folks (looking at you Mr. David Bonderman – via his family office Wildcat Capital Management they own Express Wash Concepts which has ~45 units in Ohio). 

The carwash industry is a $11B annual revenue space growing 3%-4% annually.  MCW has only 2% of all conveyor tunnel locations but captures ~5% of industry revenue. 75%+ of the market is dominated by mom & pop operators that only have 1-2 locations.  The top 10 operators combined only account for 7% of all units (and this is after 5+ years of private equity money flooding into the space and pushing up valuations). There is a strong preference for DIFM over DIY as exhibited in the growth of conveyor tunnels vs self-service spray washes that dominated gas stations over the past 30+ years.  There are 18,000 tunnel wash units in the US.  Of these 18,000 units 20%-25% of the market uses no technology (i.e. they are older full-service locations) and last year 700 units were added (4%-unit growth) and this year it will be 500-600 units and 2022 will look like 2021 in new unit adds.  In speaking with industry experts they believe the market can easily double or triple before hitting market saturation – broadly the industry is still dominated by DIY options and full-service locations and in-bay locations which are both vestiges of the past.  Individual carwashes will average between $1M-$1.5M in sales with top performers at $2M-$3M range and best run units will have EBITDA margin of 50%-60% (as was shown above MCW units tend to be top performers from an AUV perspective but corporate EBITDA margins are a bit lower and we will get into later why that is the case).

Carwashes are in that category of sneaky good businesses that people don’t realize until they study the industry.  Prior to COVID MCW achieved 39 consecutive quarters of positive SSS averaging a +9% gain from FY10-FY19.  SSS in 2020 was -9.5% and this year we are on track for north of +35%.  MCW has ~1.6M UWC members (paying monthly members).  UWC represented 66% of total washes in Q3’21 and is around 62% of overall revenue.  UWC was a gift to MCW and the industry writ large.  It created a moat in an industry that had none via local market densification.  In the carwash business the cost stack looks as follows: labor, water, and chemicals (just about in that order).  The incremental cost of a carwash is about $2 so if someone is paying ~$20 per month for a UWC membership and washing every day you will lose money but at around 3x-4x per month you are making good money with 8x-10x per month being your break even.  Normally people get their cars washed around 2x per year and spend something like $20 (just under) to do it.  But with a membership model the frequency goes way up (margin per wash goes down) and customers become more loyal to a certain brand based on how densified their locations are within their geos.  If 60% of customers are on a $20/month subscription you should be at a 50% EBITDA margin and if they increase their wash count from 4x per month to 5x per month EBITDA margins would only drop to 40%.  Conversion rates on the UWC product is around 8%-12%.  But churn is naturally high as with any consumer product (4% to 5% monthly) with an average lifetime of 12-15 months.  But it is worth mentioning MCW is extremely conservative in churn math in that if a customer pauses a membership say for the winter or travel they count them as a churned customer.

MCW has EBITDA margins in the mid-30s compared with 40s-60s for certain locations.  The reason MCW’s EBITDA margins are comparable and lower than other operators in the space is because MCW is willing to operate with lower utilization in certain geographies in order to dominate local markets via densification.  There are two potential ways one can win a local market in the carwash business:

1)      Lower prices – this risks a price war and is generally unattractive.  There has been two instances of larger scale price wars in the carwash industry both were in Chicago and done by PE-backed firms with illogical footprints and both ended poorly (e.g. bankruptcy) sending a strong signal to the entire industry which hasn’t since repeated this mistake.

2)      Lower utilization – this is a different form of price cut that only works with UWC since you are willing to operate with lower utilization but by densifying a market and using subscription you make it so other competitors are at a blatant disadvantage given your convenience advantage with a subscription product.   

MCW is also willing to operate with slightly lower margins because they pay their people so well.  The pay significantly above market and offer a number of perks (401k, tuition reimbursement, stock options to all managers, and mental/financial wellness programs).  They do this in order to reduce churn and a recognition that their front-line people are their sales force and represent the brand.  This is why MCW has a higher NPS (55) than Trader Joe’s (41), Chick-Fil-A (26), etc.  MCW is customer obsessed and carwash obsessed.  They are also the only company in the space that has vertically integrated chemicals and have employed scientists and water specialists to make sure their cleaning agents and the pH balance of the water they use is optimized - no other car was does this.  Listen to any conference call or meeting and the first thing CEO John Lai talks about is culture and how important it is.  He is stealing a page from Home Depot’s playbook and making sure customers always win by focusing on a fanatical employee base.  This is also why MCW gets a lot of free marketing from various celebrities who are MCW members (Shaquille O’Neal, Cardi-B, etc.). MCW itself spends almost nothing on marketing for example in 2019 and 2020 they spent $3.9M and $3.2M in total.  This compares with MCW’s only other public quasi-competitor DRVN which spent $69.8M in 2019 and $61.9M in 2020 in advertising. 

MCW has long-term targets of:

·       Annual unit growth: HSD

·       Acquired locations: 50 over 5 years

·       SSS: MSD growth

·       Revenue growth: HSD growth

·       Adj EBITDA growth: LDD growth

The one bugaboo is this is not priced like they are giving away the business.  MCW currently trades at ~25x NTM EV/EBITDA.  While this is completely reasonable for fast growing niche concepts (FND comes to mind which trades at 27x fwd and this business maps incredibly similar to that so its not surprising the multiples are in the same neighborhood) – should MCW growth slow or car washes prove to be low moat businesses with vastly more competition clearly this would fall in the over valued category.  Some would argue MCW should trade more like DRVN (the only other publicly traded car wash owner which trades at 20x fwd).  To be clear I do think MCW’s valuation will compress towards DRVN but I do think MCW is a vastly superior operator – this can be seen on both SSS metrics and margins but more importantly via field work where DRVN unanimously comes back as one of the worst operators in the space vs MCW as one of the best.   

I think we have safely killed the inferior business risk above, what other business can consistently grow SSS for 39 consecutive quarters and earn 30%+ EBITDA margins (especially when mature stores and private competitor are all in the 50% EBITDA range?  At maturity it would not surprise me if this business did low 40s EBITDA margins and at those margins / ROICs its hard for anyone to rationally make the argument this is a bad business.  

This leaves us with the question of growth.  MCW management is guiding to topline growth of HSD and Adj EBITDA growth of LDD.  While perfectly fine levels those doesn’t merit a 20x+ multiple.  I would offer that I think this management team is being wildly conservative in an effort to start a beat & raise culture (which they have done every single quarter since being public).  In speaking with former employees and prior owners (ONCAP & LGP) MCW consistently beat and exceeded expectations during their respective ownership and management proved extremely conservative and capable.  In looking at what management has guided vs what they have historically achieved there is a wide gap. 

I think as it sits MCW offers a compelling IRR with a free option on a phenomenal IRR.  I think management is being conservative and likely will grow at LDD as greenfield + brownfield will be greater than expected (heck they have tripled their greenfield team in the last year and completely vertically integrated a number of build out functions so unless they will be wildly less productive with all those extra hands I have a strong feeling 16-18 greenfield openings per year will be a faction of what they actually achieve).  If you get LDD topline you will get 15%-25% type EBITDA compounding and as the occurs you quickly get numbers well above street and the spooky 25x fwd EBITDA multiple quickly collapses.  Assuming multiple compression to 20x EBITDA (to be inline with DRVN and a discount to premium operators like FND) and then further below in out years – you can easily underwrite 15% IRRs at current prices over the next 5+ years (likely much longer than that). MCW trades at 16x my FY23 and 13x my FY25 EV/EBITDA estimates. I just have cash building and paying down debt - they will be massively under-levered very quickly. I also assume no large brownfield deals and fairly-conservative greenfield. I expect the company will do better than my projections.

Then we have our free option.  Should MCW use its public currency and acquire a platform deal (a large carwash chain of 50+ units) it would do a number of things:

1)      It would likely be instantly accretive provided this management team isn’t drinking stupid juice

2)      It would give them much more scale and would further their geographic footprint opening up more spots for greenfield openings to backfill markets for years to come

3)      Depending on size it could solve the LGP overhang that is spooking some people out of the stock

If they do a transformative platform deal the IRR stream changes dramatically and likely moves in the 20% range.  But I don’t underwrite to this as I lack imagination and hope the management team can achieve what I don’t feel comfortable underwriting.  What is clear is if they do not do deals, MCW will be dramatically under-levered very quickly. When MCW was owned by LGP they ran around 7x debt/EBITDA presently they are at 2.4x debt/EBITDA and management’s targeted leverage range is 2x-3x. Next year MCW will likely be on the extreme low end of its targeted debt range.  I would hope management employs excess capital towards more greenfield and brownfield openings but if they ease its very easy to see them engage in a robust buyback plan given the large and growing FCF the business spits out.   One of two things will happen share count will rapidly start shrinking or growth will be better than anticipated. 

MCW has all the qualities one looks for in a good investment:

• High quality management team with aligned interests
• Attractive unit economics with a moat to protect them
• Sensible balance sheet with ample cash coming in the door
• Long-runway of future growth
• Company is in control of their own destiny with little to no terminal value risk

I will end on this note.  The most powerful observation in speaking with CEOs and owners of private car washes is unanimously they all bought MCW in their PAs.  What does that say when your private competitors think so much of you that they willingly buy your stock at IPO when given the chance.  It is like the inverse of Buffett’s silver bullet test (phew was worried I wouldn’t be able to slip a Buffett reference into this write-up and barely made it).    

Hopefully in the next 3-5 years our anti-hero Walter White will personify an investment in MCW the best:

Catalyst

• Continued beat & raise
• Accelerated greenfield openings
• A large brownfield deal totally changing everyone's estimates