Description
Founded in 1927, Mac-Gray Corp (TUC) is a $63 million market cap company headquartered in Cambridge, Massachusetts. The company’s main business is operating laundry routes primarily east of the Mississippi. The company provides and operates laundry facilities for the multi-housing industry, including apartments and college/university housing. This business provides recurring revenues and stable, positive cash flows. The two main drivers increasing profitability are an improving economy (decreasing apartment vacancy rates) and improving revenue generation and cost benefits from the rollout of card-operated machines. Mac-Gray was a family owned company until it came public in 1998 and is still closely held by the CEO and his family members, controlling approximately 40% of the company’s stock.
Recurring revenue stream: The laundry route business is characterized by stable recurring revenue streams, as individuals consistently wash their clothes on a regular basis, generally using the same facilities week after week. In 2002, TUC retained 97% of its route business contracts, signifying positive performance related to customer satisfaction. No customer represents more than 1% of sales. Contracts to run laundry facilities generally run 7- 10 years before renewal. Laundry represented 80% of 2002 revenues. Growth comes from a combination of housing vacancy rate improvements, price increases and expansion of its route business by new contract wins and acquired routes. Variations in revenues generally relate to sales of laundry equipment and microfridge products (discussed below).
Positive cash flows: For the nine months ended September 30, 2003, free cash flow (FCF) was $4.3 mil (defined as NI+D&A-Capex) versus $4.6 million for the same period in 2002 and EBITDA was 18.8 million versus 20.8 last year. In 2002, the company had free cash flow of $7.5 million. EBITDA for 2002 was $28.6 million. Capex relates to the buildout and retrofitting of laundry facilities, generally supplying the washer and dryers for the facilities. The table below highlights the sound cash flow characteristics of the company. Of Note, FCF for 1998 and 1999 reflects the impact of acquisitions.
Mac-Gray Summary Financials 2002 2001 2000 1999 1998
Revenue ( mil) $150 $152 $154 $149 $137
EBITDA ( mil) $29 $30 $34 $31 $30
FCF ( mil) $7 $10 $10 -$3 $1
EPS $0.23 $0.20 $0.30 ($0.04) $0.60
Valuations: Currently the stock is trading at 4.3x trailing EBITDA. In 2000, when investors valued the Company as more of a growth story, the stock was afforded EBITDA multiples above 13x. These valuations were reflective of private market valuations during the consolidation phase of the industry. I believe that as the economy improves and small price increases are implemented, revenues and earnings should accelerate to the point where an 8x trailing EBITDA multiple would be more appropriate for the stock.
Balance sheet is solid: Over the past couple of years the company has been paying down debt. Currently, the company has approximately $53 million of long-term debt, with a total credit line of $80 million. This is less that 2x EBITDA, and interest expense coverage is less than a third of FCF. Notably, the company just refinanced all its debt and should see interest expense savings going forward. Cash stands at $5 million.
Competition. There are three main players in the industry, namely TUC, Webb and Coinmach. Coinmach is a debt laden private equity backed former public rollup that has gone private. Interestingly, Webb, who I believe has a congenial relationship with Mac-Gray, purchased 9% of Mac-gray through open market transactions when TUC’S stock price was depressed. In addition, TUC competes with in-house operations of housing facilities.
Back in May of 2000, Coinmach was taken private for $187 million in cash plus almost $700 mil of debt. The company had approximately $527 million of revenues and $144 million of EBITDA. Therefore, the private equity firm that bought out Coinmach paid roughly 6x EBITDA back in mid 2000. This infers TUC is now trading below what a private equity firm would pay. I believe that an industry player would pay a premium to this multiple for a sound company such as Mac-Gray.
Growth: Due to the use of coin-operated machines it has been very difficulty for laundry route operators to institute annual price increases. First, the retrofitting of the coin slots on each machine was tedious and costly and second the increase was a factor of coins, generally being increased by $0.25 to reflect a quarter. Over the past few years, TUC has consciously implemented card-operated machines throughout its installed base of machines. Currently I believe almost 40% of TUC’s machines are card operated, which generate approximately 50% of the route revenue. This is either by magnetic-strip credit card like vehicles or through a smart card. Both “cards” provide efficiencies to both the customer and TUC. For the customer, it is convenient not have to carry coins and for TUC, the company can institute price increases to match or beat inflation. In addition, TUC’s collection and maintenance are now streamlined, requiring less manual labor. This is due to centralization of cash machines in a facility along with the replacement of coins with paper money.
A second growth opportunity is winning new business. New business is generally competed for by price. In the late 90’s, I believe Coinmach was very aggressive on pricing to win contracts. Contracts can include an upfront cash payment to the facility and some split of the revenue from the facility. I believe TUC adhered to its ROI hurdles with each contract up for bid, which made it difficult to win against Coinmach in the late 90’s. Now, with its stellar service record intact and sound industry pricing discipline in place, I believe TUC will start to win more contracts as they compete against Coinmach. I believe Coinmach has had to stretch resources given their aggressive pricing on contracts, while industry sources have noted that Coinmach’s service is not on par with Mac-Gray’s or Webb’s. Compounding this with Coinmach’s debt burden should make it difficult for Coinmach to compete effectively against TUC, thus providing increased growth for TUC.
Risks:
Why was the stock so depressed hitting a low of $2.60 during 2002? My research indicated Coinmach entered the market in the late 90’s and positioned itself as the low cost solution, often winning contracts by offering upfront payments versus more life of the contract revenue splits. Further, Coinmach aggressively acquired companies, paying double-digit EBITDA multiples for many players. I believe Mac-Gray was reluctant to pay such multiples and thus explored other avenues for growth at more reasonable prices. Specifically the company purchased a copier company and a small appliance company, MicroFirdge, anticipating leveraging its customer base. However, this growth avenue has not borne fruit, though I believe they are currently in the black.
This foray into new territory that leveraged an existing customer base was ill conceived. The Internet and related paperless environments has reduced the dependence on copiers, while the competition in the consumer small appliance market is intense. However I believe that management has learned not to be overly aggressive and will consequently focus on the core laundry route business. Over time, if a suitor is found, I believe the two non-core business lines could and should be divested.
By going public, TUC had presented investors with a growth opportunity through consolidating the industry. Coinmach ruined Mac - Gray’s strategy with their aggressive, somewhat irrational pricing and forced TUC to seek other avenues for growth to uphold what they promised investors. In the end, they failed to deliver the promised growth and thus institutional shareholders abandoned the stock. Further, given the weak economy and related occupancy rates, internal growth was weak. The declining stock market and lack of institutional interest has left the stock depressed with low daily volume. So far in 2003, as the route business has begun to rebound, competitive pricing factors have abated, and the stock market has shown strength, Mac-Gray’s stock has nearly doubled from its 2002 lows. I still see the potential for the stock to double from here with little risk from operations!
I believe management runs a tight ship from an expense perspective. Offices are sparse and headcount is minimal at corporate levels. Stuart MacDonald, Chairman and CEO, and his family still own approximately 40% of the company. As such, his strategic plan is as focused on preserving the value of the company, as it is to growing it. Thus after the diversification debacle of the late 90’s mentioned above, I believe management will stick to its core business of laundry and continue to grow.
Institutional investors may shun this stock given its limited float and trading. However, for those looking for smaller companies, this stock trades enough to build a position over time. The risk is more from liquidity than the business. Of note, one major shareholder (who is not an insider) has recently filed that he sold some of his position.
Catalyst
Catalysts:
Longer term I see positive events for shareholders. First, it’s hard to fathom why this company stays public. If management so desires, it would be rather easy to purchase the Company and take it private with or without a private equity backer.
The company generates enough cash flow to fund growth without tapping the equity markets, especially at today’s stock price. It could use the excess cash flow to issue a dividend or repurchase shares. It has a small repurchase plan in operation and has bought back about 130,000 shares since 2002.
Another scenario is merging with Webb; I believe the two companies share the same culture and have little overlap in their existing routes. Webb’s has 9% of TUC’s stock, but due to management’s high ownership percentage it would have to be a friendly deal.
Operationally, I expect the company to continue to efficiently operate its existing routes, while adding new ones through acquisition and contract wins. I view Micro-fridge and the Copico business as non-core. Thus if a viable suitor presents an attractive offer to TUC, I believe they would be divested.
In the end, TUC is a cash-flow machine that has been profitably operated since inception. As investors recognize this gem, I believe the stock should double to $10, which would only be a 6x EV multiple based on my estimate for 2004 EBITDA of $30 million.