Description

This write up is to highlight an under-appreciated business and management team within the industrial space, and to update on COVID impact and on the potential for value creation in a sizeable acquisition. Post-COVID, the market’s initial distaste for cyclicality and financial leverage was followed by a shorter-tem mindset regarding the pandemic impact. We believe these combined to obfuscate an otherwise compelling medium-term opportunity, as a management team with a stellar execution track record announced in March 2020 the purchase of a competitor and leader of an adjacent space, Mobile Mini (MINI).

While this is an asset heavy company, it has the right combination of factors that make it a solid investment as such: a stellar moat with pricing and contracting power, combined with a long runway of high ROIC reinvestment opportunities (industry consolidation and asset investment).

This is a deleveraging transaction and creates a powerhouse company in a fragmented industry, leading to extensive synergies and pricing power. Although COVID and recessionary effects may impact near-term numbers, WSC has idiosyncratic drivers to keep earnings growing through any economic environment ($50mm of synergies and ~$100mm of rental rate growth over the next 3 years). Our industry checks have been extremely positive around the combination of WSC + MINI and their ability to win in the marketplace. We believe this $15 stock should be ~$20 in the near-term, as the merger closes, and as high as $30 as the company executes on its integration and growth plan over a 3yr period resulting in a ~25-30% IRR. 

Business Description and History

Willscot (WSC) is a modular space and portable storage provider in North America, which came public via a SPAC in late 2017. The Company leases standardized metal “boxes” that have been converted to serve as offices, classrooms, or storage units. The modular space is used in a variety of end markets, including construction, manufacturing, education, retail, and energy. Space is put out to start on single year leases, however the average customer usage of a box is almost three years. WSC has substantial pricing power to raise rates by 10-20% in year two, since its offerings often represents a fraction of the overall cost of a project (~50 bps), but are completely vital to the project. WSC and its competitors also receive fees for both the delivery and removal of their product. These costs, along with considerable inconvenience, act as a deterrent to switching providers. Management describes their offerings as the first piece of equipment on a job site, and the last thing off.

The SPAC that acquired WSC took advantage of the financial distress of its former parent, Algeco Group. While Algeco operated a similar business in Europe, the North American arm was easily carved out and sold to pay down debt. Under Algeco ownership, its Willscot arm exhibited some classic dynamics we often see and love with traditional spin-offs: capital starvation and lack of strategy and focus. This was immediately remedied as WSC became a newly public company and management embarked on a substantial transformation strategy. In two years, the company has doubled revenue through acquisitions and caught up on growth capex. EBITDA has grown even faster, via deal synergies and increased rental rates. 

Business Strategy

WSC’s share price has been volatile since coming public, despite its underlying results being very steady. The market has tended to sell off WSC when there are macro concerns around cyclical and levered companies. However WSC’s results and execution have been very steady.

Results have been growing as WSC has allocated capital to two strategies:

• Industry Consolidation: In 2018, WSC purchased its largest competitor (ModSpace) along with two smaller acquisitions, which collectively took its market share from ~20% to 40% in a single year. Management has proven extremely capable in integrating acquisitions. After purchasing ~$135mm in EBITDA in 2018, WSC has nearly achieved an incremental $71mm of EBITDA on that base over the past 2 years. This includes headcount, logistics, and real estate consolidation.
  
  Despite this consolidation, the industry remains substantially fragmented with the next 7 companies smaller than WSC making up only ~25% market share (primarily “mom-and-pop” operators). Scale matters in this industry, and WSC is the only company in the industry with standardized operations and scale. In March 2020, the company announced the all-stock purchase of Mobile Mini, which takes their total market share in both office and storage boxes to over 50%. We go through that in detail below.
  
  

• Value Added Products and Services (“VAPS”): In addition to acquisitions, WSC has come up with a unique market strategy called VAPS. WSC markets VAPS as space that is “Ready to Work”. It outfits boxes with basic necessities such as furniture, fixtures, and internet connectivity, and then leases the boxes at higher rates. Customers are happy to pay for the fixtures rather than do it themselves, and WSC is able to optimize spend by having pre-set configurations and purchases. For an investment of $2,400 to add VAPS to one box, WSC generates 40%+ unlevered IRRs by charging $100 or more per month relative to a basic box rental. In total, WSC estimates a $128mm remaining revenue opportunity (80% flow through to EBITDA = $102mm of EBITDA) from VAPS at a slow and steady pace over the next three years as it outfits boxes after they come off lease. Additional high-margin revenue should come from VAPS offerings to MINI’s customer base. 

Both prongs of this strategy have very impactful EBITDA drivers, and offer substantial visibility to continue growing EBITDA at double digit rates for years (~10% per year). An additional, but less visible driver is the potential for pricing improvement resulting from a more consolidated industry. The ModSpace deal closed only 14 months ago, so these benefits should continue to show up over the next 2-3 years as leases come up for renewal.

Mobile Mini Purchase

On March 2nd, WSC announced the transformative purchase of Mobile Mini (MINI). While WSC is the purchasing entity, the transaction is more of merger of equals with WSC shareholders owning 53% of the pro forma entity, and MINI shareholders owning 47%.  

WSC’s thesis, along with our industry checks both confirm the same thing: This combination makes perfect commercial sense. MINI is a business that focuses on portable storage containers. WSC has a small portable storage business adjacent to its modular space business, and the dynamics and customer base of the two industries are very similar. Our conversations highlighted a few key points on the overlap:

• Purchasing managers clearly prefer “one invoice” on construction or retail/office/education sites - they want to be able to buy the box, the furnishings, and the storage all in one. The alternative is that a purchaser will have to lease things separately, have legal involved on multiple contracts, and coordinate delivery to make sure everything is operational all at once so they can then get started on construction of the actual project

• Storage boxes and office boxes are stored, delivered, installed and serviced in the same way, giving WSC an opportunity for substantial real estate, headcount, and logistics optimization

• This combination increases geographic scale, which helps WSC win both local and national customers since speed to delivery are factors in purchasing. In addition, this industry often responds to natural disasters, and speed to delivery helps in winning these opportunities 

• WSC will be able to better control supply (and scrap boxes if needed) and therefore be a price setter in the market

As one former WSC employee told us, this combination is really a monopoly and the only reason regulators don’t see it that way is because one sells office boxes and one sells storage boxes - despite the base boxes being exactly the same. 

As part of this complementary transaction, WSC expects $50mm of merger synergies to be achieved, 80% of which will be completed within 24 months. The synergies here are achievable - back office and corporate spend optimization, along with optimizing the branch infrastructure where there are geographic overlaps. As mentioned above, WSC already has a track record of achieving $70mm of synergies ahead of plan over the last two years. 

COVID and Downside Protection

COVID is currently having a mixed impact on WSC - and while we don’t know where things will ultimately shake out, we applaud management for clearly laying out the scenarios. Broadly speaking, WSC and MINI are recession resilient as far as FCF. In an economic slowdown, volumes on rent will go down. However, the business model is resilient in two ways:

1. The average lease term for WSC is more than 30 months, and very rarely do boxes get cancelled on active job sites (our conversations confirmed - of the people we talked to covering hundreds of projects, no one has cancelled large scale projects thus far due to COVID). So volume and price impacts are blunted by and depend on whatever rolls off leases, combined with how long the downturn lasts
   
   

2. The majority of WSC’s $100-200mm in yearly capex is discretionary and can be “shut off” within 90 days, while additional cash would likely flow in from asset sales. WSC has already reduced capex spending by $50mm in response to the pandemic

Looking at history, prior to the last recession from 2004 to 2007, WSC averaged $195mm of EBITDA and $120mm of capex per year. As the boom of the housing and construction cycle reversed, WSC reduced spending 79% from $120mm per year down to $25mm per year in 2008-2011. Although EBITDA averaged 8% lower ($180mm in 2008-2011), EBITDA less Capex was higher by more than double. As growth started to return, WSC slowly increased Capex commensurate with the EBITDA levels they were seeing at the time. In total, the Company generated a healthy $1.3bn of EBITDA minus Capex over a 14-year period through 2017 (for comparison, WSC’s 2017 purchase by the SPAC was for $1.1bn).


Currently, management has laid out the impact from COVID, along with clear scenarios around further downside in their model. Capex has also been adjusted accordingly. At a base case 25% demand shock in Q2, and an overall 10% revenue reduction for the year, WSC EBITDA is still growing at ~5% YoY due to price increases, VAPS penetration, and previous merger synergies. A further downside having a 30% reduction in demand through Q4 leaves WSC with $357mm of EBITDA, versus their base case of $412mm (-13%). On top of these ranges we would add MINI’s EBITDA (at similar ranges) as well as deal synergies once the deal closes. . In total, this provides significant support to see growth in earnings even in a major downturn scenario. 

Valuation

We look at valuation/returns for WSC in a few ways:

• On an extremely simplified basis, WSC has guided for the combined company to generate $500mm in Free Cash Flow, in ~3 years after merger close and after all synergies are implemented. This is off a pro forma baseline combined FCF of $290mm, or a 72% increase. We believe a business like WSC should garner at least a 10-15x FCF multiple, yielding a share price of $22-32 per share - or a 16-36% IRR over ~2.5 years.
  
  For reference, on pre-COVID estimates, MINI is trading at a ~7.5% forward FCF yield, and WSC at a ~7% forward FCF yield. As mentioned above, FCF should increase or stay the same in a downturn as the company flexes down capex. The above valuation also does not take into account any FCF generation in the interim time period, which should be an additional $2 per share per year after integration costs are spent.
  
  

• Using a more traditional EBITDA based valuation, we would value shares at least at 10x EV/EBITDA - a discount to MINI’s 11-12x typical trading range over the past 5 years and similar to the blended average of MINI + WSC’s trading range. Our estimates also take into account COVID guidance from management for 2020E, and grow from there - materially better profit numbers are possible depending on the shape of the current recovery. Our target price in this scenario continues to be in the $20-30 range, or a 21-28% IRR return.
  
  
  In the near-term, we believe pricing this stock on the combined, 2021E numbers (which will be easier to do, once the merger is closed and COVID impacts subside), the stock should be in the low $20s, or a +45% return. After that, as growth and synergies roll up, we see a share price approaching $30 per share.
  
  

Additional upside from these numbers come from better/faster integration synergies, ability to flex substantial pricing power, and any additional cross sell and product expansion opportunities. With 80% incremental margins, additional revenue is substantially accretive and we would not be surprised if there is a $50 or $100mm opportunity for incremental revenue, leaving $40-80mm of incremental EBITDA to be had.

• As noted in the scenario analysis, we can flex WSC’s EBITDA down on a sustained economic downturn for 2020E and then a modest recovery, combined with a slower ramp of synergies - at an 8x multiple, we get to a ~$10 share price or -31% downside.
  

Risks:

• Integration risks - MINI is the largest acquisition WSC has done to date. Past acquisitions have gone well, but nothing has been of this size

• Further COVID impacts - COVID is having a mixed/uncertain impact to demand - increases in healthcare, additional space for offices, offset by decreases in construction starts and retail. Education markets may also be impacted if students don’t go back to school. Ultimately, if the industry is left oversupplied due to lack of demand, pressure will weigh on rental rates

Catalyst

• Closing of MINI transaction and updated near and long-term guidance on the combination
• Earnings report being better than expected despite COVID