2010 EVI writeup

8/8/2019 2010 EVI writeup

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Shaun Noll, [email protected]

Cell: 707-495-8353

EVI: Envirorstar

Current Price: $1.06Price Target: $1.90+

EVI primarily distributes commercial and industrial laundry and dry cleaning equipment including aproprietary line of dry cleaning machines (98% of revenue) with a focus on environmentally friendly drycleaning methods and equipment. There is even a green angle here for environmentalists!

Overall prospects for this business are not great but not terrible. Much of their dry cleaning products salesgoes into hotels, hospitals etc, which is obviously very weak. They do have some good growth intointernational and Latin America though, which is ~20% of their sales and growing. Not exactly the mostsexy industry but any investment is interesting at the right price.

EVI has a market cap of $8.2m, yet has $6.94m in cash, $1.75m in inventory, $1m in AR, with no debt

and less than $3m in AP and customer deposits. This would make sense if this company was burningcash but it is free cash flow positive, insiders own >60% of shares, and company has had respectableROE, ROIC and EPS growth over last few years.

I believe valuation for this company is ridiculous given ROE, ROIC, cash flow and balance sheet and thatthere are some clear catalysts that could unlock value in the next two years with minimal risk ofpermanent loss of capital. The only way EVI is fairly valued at current price is if extended cash burnoccurs and I think that is very unlikely.

The company used to pay out 50-100% of cash flow in dividend but cut the dividend when the economyreally started coming unwound to be conservative. As a result they have been building cash on the balance

sheet. Considering they were cash flow positive even in 2009 and cash flow approximates earnings theyreally don't need much, if any, cash on the balance sheet considering the $2.2m revolver they have (thathas to be renewed annually in October).

Note that cash + inventory + AR (at balance sheet value) exceeds current market cap. When discussingthe large cash balance with the CFO, he justified their cash levels by saying they are looking out foracquisitions. However, he also says they are not interested in most acquisitions because it is hard to findquality companies in this industry at this size with reliable accounting. It seems clear given past actionsthat they have other plans for the company however.

Market cap minus cash adjusted for customer deposits is $1.15m. Assuming mild rebound in end marketsin 2011 gets 2011 net income of $640k meaning the core company trades for a P/E of approximately 2x.Even if you adjust for customer deposits of $1.38m you still get a core P/E of less than 4x This is despitelow teens ROIC, strong cash flow and high ROE while growing eps by ~10% a year since 2001. Notethat even in the depths of the collapse they were free cash flow positive and kept ROE and ROIC atrespectable levels with decent profit margins. Liquidation value is approximately $7.5m so downside isprotected.

I think there are a few likely outcomes and catalysts:

1. Management takes the company private.


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Cell: 707-495-8353It makes no sense to me for a company this small to even be public and management agrees since theyattempted to take the company private last year (at an absurd price). The costs of being public faroutweigh the benefits and since insiders own 60% of shares, the float is ridiculously small. If they do takethe company private, I would imagine they pay out at least half the cash on the balance sheet sometimelater this year in a one time dividend, giving us >$0.50 in cash in the process. Management could then use

this cash they now have as equity in a very low leverage LBO that could largely be done with their line ofcredit and their own capital. Valuing the core company at 11x 2012 earnings (well below historicalvaluation) I get approximately $1.25 for the company. Add back the $0.50 we got in cash from thedividend, and this scenario gives us a total return of $1.75. From today's prices that is ~50% upside andmakes a lot of sense from managements perspective with relatively low risk for shareholders.

In this outcome, management could give themselves millions of dollars, take complete ownership of thecompany at low valuation on trough earnings, and save at least $350k annually (per CFO) in cost forbeing public and hassle. Note that for a company with


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Cell: 707-495-8353

Risks. The Steiner family owns an enormous amount of EVI shares. The Steiners lowball takeoutattempt last year worries me that they aren't the most shareholder friendly. This company also rentsproperty from the Steiners with guaranteed increases. The cost is not huge but they get 3% guaranteedincreases which obviously don't make sense in the current real estate market. The history on this though

is that EVI rented this property from the Steiners (the founders) before the company went public and itjust didnt make sense to change this relationship given that the rents are not excessive

However, management salary is high but they don't pay themselves a truly ridiculous salary, which theycould. EVI has no plans or arrangements with any officers which provide for the payment of retirementbenefits, or benefits that would be paid primarily following retirement, other than the Companys 401kwhich is a deferred compensation plan under which the company matches employee contributions up to2% of an eligible employees yearly compensation. Note that EVI also used to pay out a dividend asindication that they are somewhat shareholder friendly.

Also, the company has no arrangements that pay any company executive following or in connection with

resignation, other termination of employment or change in control of the company. The companys fivedirectors each receive a modest fee of $5,000 per annum. The chairman receives $10,000 per annum andis an independent officer.

If not for the huge inside ownership in these shares I would be less bullish on this stock. The real estatedeal bothers me but given other signs of management honesty, I think there is low risk of managementdoing something shady or destructive for shareholders. Some insider dealings are pretty common inmicro cap land so this is not as unusual as you might expect.

Another potential risk is the volatility of a stock this small and illiquid. If we get another market meltdown this stock could easily fall 50% for no fundamental reason. Investors should only own this stock if

they are comfortable with that and can afford to have at least a 2 year time frame. The way I think aboutthis is would I be comfortable buying this company if it was private and I could not sell for 2-3 years?For me, if someone proposed selling me a growing free cash flow positive company with no debt for lessthan the value of inventory and cash on hand that came with motivated management team, I would findthat extremely attractive.

Summary: So you essentially have 25% downside and 70%+ upside using relatively conservativeestimates, for a 2.5x return/risk ratio with very little risk of permanent loss of capital. It is impossible toknow exactly what could happen but it seems under almost any scenario the company is under valued.Stock could do anything in the short term but over the next two years I have a hard time coming up withany scenario that has less than a 50% return. Given market environment and limited downside this looks

pretty compelling to me. I am a buyer at anything

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2010 EVI writeup