Description

Select Interior Concepts has been written up a handful of times, but a recent deal to sell its Residential Design Services segment (RDS) to Interior Logic (a Platinum Equity portfolio co) for $215mm (11x LTM EBITDA) merits a revisit.

In short, the remaining segment (Architectural Surfaces Group) is a building material distributor specializing in the fragmented countertops and tiles verticals.

Pro forma for the transaction, the RemainCo will be in a net cash position. Following the announcement, management guided to FY2021 EBITDA of $31-33mm on a pro forma basis. Taking guidance at face value, that implies a sub-8x multiple excluding any cash generated by RDS during 1H21.

Standalone ASG expects to do mid/high-20% gross margins and mid-teens EBITDA margins, with a similar fixed/variable split (~85%/15%). From a business mix standpoint, the R&R exposure improves from 25% status quo to ~55-60% pro forma, though I'd argue there's a difference between kitchen renovation R&R and, say, re-roofing. Customer concentration appaers to be thinning out, with the top 10 accounting for < 10% of sales (vs sporadic years in which the top customer exceeded 10%).

Why does it trade at a substantial discount to ostensible comps like BLD (13x), IBP (13x), FERG (14x), SITE (25x), and HDS (acquired for 15x pre-synergy)? Probably a few reasons. The most obvious is that it's a microcap special situation without much sell-side coverage. Prior notes have touched on the rudderless strategic direction, the limited float and shareholder turnover--and the changes put in place to shore up the management team and refocus the company on profitable growth.

Aside from that, historical returns on capital have also been mediocre for the combined business (LSD-MSD ROIC). That will improve as the company doubles down on the distribution business, where they have a wide open runway for greenfield expansion. Specifically, greenfield locations require ~$1mm in capex and ~$1.5mm in WC, and take 9-12 months to get to a positive EBITDA run-rate. Like other building product distributors, a branch seasons over 3-4 years to a ~$10mm top-line with mid-teens EBITDA margins. Historically greenfields have yielded a ~30% ROIC in this segment.

Tuck-ins are less exciting, with your typical mom & pop going for MSD/HSD multiples, with cost synergies coming from procurement and corporate overhead. We're not likely looking at multiple turns of synergies unless we think about cross-selling (i.e. loading countertop SKUs where a target primarily sells tiles and vice versa).

Aside from growth spend and broad-based sector strength, there are some other opportunities for organic growth. Firstly, the segment hasn't historically done a lot of sales into the national homebuilders, but management has noted this segment as an attractive and underpenetrated target market. Interior Logic, who is acquiring the RDS segment, is focused on these customers, and is explicitly focused on expanding its cabinet and countertop business within this segment. To my knowledge the company hasn't announced a sales agreement with INTGLR, but it would seem to align with both companies' strategies.

In my opinion, SIC is undervalued on LTM and 2021 numbers. In the next few quarters, investors should get more clarity on (i) pro forma historicals (though Ks and Qs have always had decent segment level detail), (ii) pro forma cash taxes and other modeling considerations, and (iii) the streamlined growth strategy, including any sales agreement with Interior Logic.

Catalyst

• As the pending transaction progresses, more granularity is provided on the streamlined distribution business
• Clean balance sheet allows for accelerated greenfield growth or opportunistic bolt-ons
• Continued strength in the broader building sector, with countertops and tiles typically lagging structural products
• Potential sales agreement with Interior Logic, who is acquiring the RDS segment, and whose focus on homebuilders would be strategic to RemainCo