Rebuttal To Spruce Point’s short report on Envirostar

Rebuttal To Spruce Point’s short report on Envirostar

I own shares in EVI in our family office. Unfortunately I am not at liberty to disclose which one but we are based in Hong Kong. I and/or my firm are long shares of EVI

Below is a write-up to directly counter Spruce Point’s short report on Envirostar, which I believe is a poorly researched piece.

Spruce Point Capital’s widely publicized short on Envirostar can be found here:

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I encourage you to read the long thesis first - a great summary can be found here: Note that this presentation is not a substitute for your own due diligence; reading the filings and speaking with management are key for understanding EVI.

Shorts can be useful and I largely respect a well-researched piece; this is not that. Let's begin point by point:

Envirostar Just Another Poor Roll-Up, Close To Covenant Breach

Spruce Point claims "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."

Is Envirostar just another poor roll-up? Well let's look at the things that matter for a period of 3 years - a fair amount of time.

Envirostar has consistently generated >35% ROE during this period while ROIC stood above 50%. This is a business generating consistently stable cash flows with no reinvestment requirements. It has paid consistently high dividends with a special dividend in FY14 and >80% payout ratio for FY15-16 - the cash is there.

Spruce Point claims margins and cash flow are contracting post-WSD acquisition. I believe that's incorrect. They fail to mention that this is a lumpy business model dependent on contract work - there are no annual trends to go by because it's based on idiosyncratic and local demand. Prior to WSD, 1Q16 had EBIT margins of 4% while it jumped to 6% 1Q17...should we attribute that to massive operational improvements then? Margins vary widely depending on whether it's a new installation or recurring sale. Aside from that, WSD and Martin-Ray one-off transaction costs were $559,000 which results in a 0.6% EBIT margin delta for FY17. Also, is it that surprising that newly acquired subsidiaries are impacting the cost profile? That's standard M&A.

Spruce Point also notes ominously that "EVI must maintain quarterly profitability or risk a covenant breach. Q4 earnings of just $0.5m put it in jeopardy of a breach". Bringing up the covenant is disingenuous, EVI and its subsidiaries have been profitable for a very very long time.

Terrible Industry Headwinds and New Tech Disruption

EVI's business is a laundry equipment distributor, how do you technologically disrupt laundry? Spruce Point presents EVI's customer set as an industry in secular decline, mainly by omitting half of their customer types. While EVI's customers do INCLUDE "independent and franchise dry cleaning stores and chains, and coin laundromat stores and distributors" they also INCLUDE hotels, government institutions, nursery homes, cruises etc. Indeed, in FY17 sales to a government agency accounted for 22%. The very same centralized laundry operators they cite as disruptors are also customers of EVI. More broadly, how do you disrupt the need for laundry? Spruce Point cites without sources that the laundromat industry declined 20% since 2005. Yet as Peter Kaye notes in the comments of a well-written short article by Matt Horvath (, EVI sales actually grew at 5% CAGR between 2004 - 2012.

With this straw man backdrop, Spruce Point claims "Not surprisingly, we believe this is why Envirostar is finding deals because experienced equipment operators see more problems ahead and want to sell". Experienced laundry operators are not selling out and retiring. Every subsidiary EVI has acquired, the management team must stay on and continue to run the business while sharing in an option scheme.

Questionable Management, Governance and Auditor

Spruce Point attacks the CEO, Henry Nahmad, as an inexperienced operator. Sure, Henry Nahmad had no experience in laundry when he first purchase his stake in EVI; however, he had experience in roll-ups and M&A at Watsco. According to the previous CFO Venerando Indelicato, during this time Henry took the time to learn the industry - after acquiring his stake in early 2015 we must note that nothing happened until October 2016. Spruce Point also cites that Henry has recently formed a new entity called Hammer Times LLC in an attempt to paint Henry as an unfocused executive. For one, Henry Nahmad can have whatever hobbies he wants. Secondly, EVI is a business that runs itself - Henry's main role is seeking out operators to roll-up. I believe his 24 year option scheme is a far stronger incentive than his hobby in rap music.

The short report also notes that the COO Michael Steiner dumped some shares post WSD. What is not mentioned is that Michael also retains 500,000 shares while his brother Robert Steiner keeps 100,000. As part of the founding family, the Steiners have owned shares in the sub-$5 range for decades - is it surprising he chose to get rich by unloading some shares?

Finally, Spruce Point injects some old fashioned accounting red flags by noting their auditor EisnerAmper has been linked to three frauds in the past. This is a pointless assertion - they are a mid-size global accounting firm. Frauds impact accounting firms of all sizes; should I raise a red flag when we see Ernst & Young (Lehman, Sino Forest) or PwC (Tyco) or any of the big 4 accounting firms?

Significant Overvaluation With No Room For Error

The report cites that EVI has paid 0.5x sales for their acquisitions - I believe this is the wrong way to look at it. Every acquisition thus far has been profitable and they aim for ~5x EBIT. Since the economics do not range widely within laundry distribution, it's simple to figure out the incremental profits.

Nor is there any issue in investors paying "5x" sales right now. In a roll-up strategy, it's basic sense to use an "overvalued" currency (ie. shares) to buy companies at lower multiples because it's a cheap form of financing. Conversely, using undervalued shares to conduct M&A tends to be a terrible idea. Basic Warren Buffett financial engineering.

The multiple is expensive, I do not dispute that; however, it's actually an advantage to EVI's mid-term strategy while they are still rolling up. Meanwhile, as I discussed above there are no real operational strains. Small deal sizes are a given, there's over 100 peers across America because they operate in hyper fragmented local markets. Finally, where is the competition from strategic buyers? No one else is rolling up laundry distributors, most players are family-owned operations - even if they were, they cannot afford to outpay EVI because they aren't listed and can't use shares as a currency.

Capital Structure and Valuation

Spruce Point cites some high multiples and again warns on operational risks. While he is largely correct here that the valuation is high; as I discussed already, this is part of the buy-and-build process and the high multiple works to EVI's advantage when acquiring with shares.

Valuation matters in any investment thesis - however in this case it's difficult to gauge what EVI should be worth because the size of these deals vary greatly. For example, WSD alone doubled EVI's revenues ($60m) while Martin-Ray only added $11.5m in sales. The implication here is that the next 2 deals could drastically change the valuation picture.

Meanwhile, as I detailed above there is no margin erosion, fundamental pressure nor risk of covenant breach. If you decide to short it on valuation, go for it - just do not make up imaginary difficulties for the business.

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