Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving Envirostar, Inc. (NYSE/MKT: EVI or “the Company”), a distributor of commercial and industrial laundry and dry cleaning equipment. With its shares up >600% since 2016, it has become one of the most overvalued microcaps in the stock market as index funds blindly pile in. Investors are ascribing nonsensical multiples to its recent acquisition roll-up strategy and ignoring signs of an impending covenant breach.
Spruce Point has a very successful track record of identifying over-promoted and poorly executed roll-up stories. As a result, we have a "Strong Sell" opinion and a long-term price target of approximately $5.60 - $16.80 cents per share, or approximately 40% to 80% downside risk.
Spruce Point “Strong Sell” Opinion On Envirostar (EVI), Sees 40% – 80% Downside
Envirostar (NYSE/MKT: EVI), formerly known as DRYCLEAN USA, is a distributor of commercial and industrial laundry and dry cleaning equipment. With its shares up >600% since 2016, it has become one of the most overvalued microcaps in the stock market as index funds blindly pile in. Investors are ascribing nonsensical multiples to its recent acquisitions, and failing to see a likely covenant breach.
Envirostar Just Another Poor Roll-Up, Close To Covenant Breach
Spruce Point has been a dogged proponent against investing in roll-up strategies, which are often just financially engineered plays designed to game index funds into overpaying for stocks, with little focus or incentive for management to create organic growth or value creation through operational improvement. We made early and successful calls identifying problematic roll-ups across many industrial sectors, AMETEK (test equipment), Greif (packaging), CECO Env’t (pollution control) and Echo Global (logistics). We view Envirostar as one of the worst + most speculative roll-up stories we’ve seen; already three quarters post closing its biggest deal of Western and EVI’s margins, profits, and cash flow are contracting.
EVI must maintain quarterly profitability or risk a covenant breach. Q4 earnings of just $0.5m put it in jeopardy of a breach
Terrible Industry Headwinds and New Tech Disruption
Envirostar’s customers include independent and franchise dry cleaning stores and chains, and coin laundromat stores and distributors. Recent industry data shows a 20% decline in laundry facilities since 2005. Industry margins have compressed as a result of urbanization and new housing offering in place wash/dryers, while rents, utilities and other fixed cost increases have squeezed operators. Meanwhile, technology and phone apps are making it easier to outsource laundry needs. This trend is causing technology intermediaries to partner with centralized laundry operators or a select few partners. We expect this consolidation trend to place further pressure on the industry. Not surprisingly, we believe this is why Envirostar is finding deals because experienced equipment operators see more problems ahead and want to sell
Questionable Management, Governance and Auditor
Envirostar is run by a relatively new CEO who has no experience in the laundry industry, yet bought into EVI in 2015. While he does own a lot of stock and appears aligned with investors, he has weak Board oversight with Directors that receive little cash pay and own no stock. For example, the CEO recently formed a new business entity called Hammer Times LLC after Q2’17 – is he getting into the rap music industry? COO Steiner also dumped shares quickly after the Western deal and formed an outside business entity. Management is not transparent, doesn’t hold conference calls, and gives limited MD&A discussion in its SEC filings. Envirostar’s auditor traces its roots to Berkovits & Co, a Florida based firm tied to at least three companies charged with fraud including: 1) $100m INYX fraud pursued by the Dept. of Justice, 2) VOIP, charged by the SEC for fraudulent overstatement of profits, and 3) PrimEdge whose CEO was accused of bilking investors out of $20m
Significant Overvaluation With No Room For Error
Envirostar is the most expensive and financially weakest roll-up stories we’ve ever evaluated. Be careful: Envirostar has paid an average of 0.5x sales for recent deals, yet public investors are overpaying now by 5x. At the current enterprise value of $320m, the market is ascribing a value of 2.2x, 32x, 61x to our estimates for CY2018 sale/EBITDA/EPS results. Blue chip industrial distribution peers with significantly higher margins trade at 1x, 11x and 21x, respectively. At the current valuation, investors are discounting near perfection execution of another $175m+ of deals, which will be a struggle to achieve given organizational strains, small deal sizes needed to push the needle, and competition from other strategic buyers. We see 40% - 80% downside risk once investors realize they own a bag of dirty laundry
Capital Structure and Valuation
Envirostar is currently trading at nearly 55x EBITDA and 101x P/E on its recent June fiscal year earnings.
Assuming its recent acquisition of Tri-State closes (there is a risk it doesn’t), the shares are still richly valued at 32x and 61x 2018 EBITDA and EPS. We will demonstrate that Envirostar’s recent acquisitions are covering up significant underlying margin erosion and fundamental pressures, while it teeters on a covenant breach.
Envirostar's Rapid Stock Appreciation Merits Scrutiny
Envirostar’s shares are up >600% since announcing three small acquisitions in 2016 and 2017. Its first acquisition of Western State Design, while transformational in size, is already showing signs of disappointment. Meanwhile, the Martin-Ray deal for $4m at one point resulted in a nonsensical +$130m in market value creation. Investor enthusiasm is running too far ahead of tangible earnings.
We believe blind index buying of shares has also distorted the intrinsic value of Envirostar’s shares.
Envirostar: Worst of Breed Roll-Up Story
Envirostar recently undertook a roll-up strategy. Its margin profile is significantly worse than recent industrial roll-up stories Spruce Point has exposed, and yet it carries an astronomical valuation. We don’t expect its margins to materially improve given EVI’s intention to keep each business functioning independently
Article by Spruce Point Management
See the full PDF below.