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Select Interior Concepts: Overlooked And Mispriced, With An Activist Catalyst


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By Buckley Capital Management :

Introduction

Select Interior Concepts ( SIC ) was formed via a merger of two Trive Capital assets in 2017 - Architectural Surfaces Group ("ASG") and Residential Design Services ("RDS"). At today's share price of ~$11.00, I believe investors are offered the most asymmetric risk-reward opportunity available in the market today. The company recently announced a strategic alternatives process after a push from an activist (ADW Capital) - which should unlock enormous value for shareholders in the coming months. The announcement can be found here .

Architectural Surfaces Group

Select Interior Concepts' most important/valuable asset is ASG , the company's stone distribution business. ASG is an importer and distributor of natural and engineered stones, primarily serving repair-and-remodel ("R&R") clients nationwide. The majority of ASG's clients are interior designers, architectural firms and fabricators.

ASG is one of the highest quality distribution businesses I have ever come across. This is a high-moat business with attractive unit economics and a large runway for M&A with enormous cost/revenue synergies. After ~1 year of technology/systems deployment, ASG is now the only M&A-ready asset to take advantage of the massive consolidation opportunity in the stone distribution industry.

Today, ASG enjoys the many benefits of scale in the logistically complex stone distribution industry:

  • Global supply chain allowing flexibility on sourcing/pricing.
  • Marketing & merchandising leverage.
  • Exclusive quarries/sourcing relationships enabling a vast assemblage of high-margin, exquisite, rare and in-demand stones that are unavailable to other distributors.
  • National network of distribution and showroom centers to manage logistics, inventory, and distribution for its clients.
  • Hub-and-spoke distribution model maximizing freight efficiency.

ASG's end-market fundamentals are extremely attractive. Contrary to popular belief, repair and remodeling is noncyclical. Home improvement spending was down only 18.8% peak-to-trough through the great recession with total projects count down less than 1%. Over the last 10 years, total repair-and-remodel spending has increased ~7% annually, led by strong kitchen and bathroom spending (benefiting ASG). It should be noted that stone does not go obsolete and stone distributors usually work-down inventory through weak macro conditions to provide a cash buffer and remain profitable throughout a downturn.

Today, ASG is running at a rate of ~$270m in sales through its network of 23 distribution centers and wholesaling of its private-label brand collection. At the distribution center level, I believe ASG is running with close to 20% EBITDA margins. As seen below, before bulking up its corporate infrastructure to support the roll-up strategy, ASG was doing in excess of 19% margins (pre-scale/synergies).

http://arcsurfacesgroup.com/images/slider/map.png

Source: Select Interior Concepts May 2019 Investor Presentation

Over the last 3 years, ASG was able to ~4x its revenues through a mix of acquisitions and greenfields. On average, ASG has been acquiring high-quality assets for ~4-6x EBITDA pre-synergies or ~1x sales. While the M&A story is attractive, the returns they have achieved on the greenfield initiatives have been equally compelling:

  • Average fixed investment of only ~$1m
  • <12 months EBITDA break-even period
  • Average run-rate EBITDA of $1m at 15 months
  • ~$1.5-2m EBITDA fully ramped up

With a strategic alternatives process in place and an established corporate infrastructure/management team at the segment level, I believe the most logical way of looking at ASG is by backing out SIC-level G&A. With continued ramping of its 3 latest greenfield locations, and assuming minimal SSS growth (I believe ASG has been growing SSS 10-15% over the last few years), I believe ASG can achieve ~$50m of pre-corporate EBITDA this year excluding any additional acquisitions.

Looking at the universe of publicly traded noncyclical distribution businesses with ~20% location level EBITDA margins and a large runway for M&A with cost/revenue synergies - none of these businesses trade for less than 16x EBITDA. While there are no direct comparables to ASG, I believe this asset should be valued in line with SiteOne ( SITE ), Pool Corp. ( POOL ) or Floor & D├ęcor ( FND ). Given ASG is the sole consolidator of scale in the stone business and enjoys attractive unit economics/clear benefits of scale, I believe that any sponsor can afford to pay 12-15x EBITDA for ASG - and that would be conservative. At 12x pre-corporate EBITDA, ASG would be worth $600m or over $23 per share (100%+ premium to SIC's last closing price).

Residential Design Services

At today's share price of ~$11.00, I believe investors are getting the Residential Design Services ("RDS") business at a negative value.

Over the last 30+ years, end-to-end homebuilding has become extremely logistically complex and too complicated for homebuilders to complete internally. Indeed, by partnering with installers of scale (IBP, BLD, RDS) and leveraging their craftsmen, manufacturer relationships and footprint, homebuilders have been able to provide better on-time deliveries and higher-quality finishes to their homebuyers.

SIC's homebuilder services business, RDS, operates a network of one-stop shop "design centers" that work closely with homebuilders looking to outsource the end-to-end interior building process of their homes. Over the last 30+ years, homebuilders have enjoyed leveraging RDS' scale and high-quality service to provide a bespoke finish for their homebuyers. In essence, homebuilders route their homebuyers to strategically located RDS design centers to work closely with an in-house team of professional interior designers to select their "dream interior layout". RDS' team of craftsmen and installers then complete the end-to-end construction of the selected interior.

RDS is a unique business with attractive ROIC and an enormous consolidation opportunity. Due to the strong relationships the company has built with homebuilders over the last 30 years, RDS has become the critical link between homebuyers and homebuilders - which drives recurring-like business year-after-year.

Over the last few years, RDS has been successful at leveraging its brand and strong homebuilder relationships to create a unique M&A machine:

  • Acquire mom and pop shops for 4-5x EBITDA pre-synergies.
  • Plug-in manufacturer relationships to expand product selection at the new location.
  • Plug-in homebuilder relationships to drive SSS growth and create enormous revenue synergies.
  • Leverage footprint to bolster installation capabilities.

Source: Select Interior Concepts May 2019 Investor Presentation

While RDS has historically acquired assets for 4-5x EBITDA, I believe that as they ramp up new locations and plug-in manufacturer relationships, the "post synergy" multiple in year 4 or 5 is less than 2.5x EBITDA. Moreover, SIC enjoys a highly variable cost structure and it is important to note that it remained profitable every month throughout the great recession.

Source: Select Interior Concepts May 2019 Investor Presentation

Excluding any additional acquisitions and without crediting any organic growth for the remainder of the year, I believe RDS can achieve ~$40m of EBITDA this year. RDS' most comparable publicly traded peers are insulation installers Installed Building Products ( IBP ) and TopBuild ( BLD ). Indeed, both those businesses employ the same model as RDS, enjoy similar unit economics and are active consolidators - yet those businesses trade for ~12x EBITDA. I have also heard that Interior Logic Group ("ILG"), RDS' closest peer, is working on completing an IPO this summer that would yield a similar valuation to IBP and BLD.

While I believe RDS is a higher quality business than IBP or BLD, applying the same multiple yields $440m in value for this business or ~$17 per share incrementally or another ~$10.25 per share including SIC net debt of ~$6.75 per share.

Given RDS' attractive free cash flow profile, its multi-billion dollar total addressable dominated by small/regional players and its proven M&A model - I believe any sponsor/strategic will find this asset extremely compelling. I also believe that IBP or BLD may be interested in acquiring this asset to diversify away from insulation and enter the higher margin home interior installation space. There is also the likelihood of interest from ILG, which may be looking to acquire RDS to remove any pushback on its IPO multiple and benefit from enormous cost/revenue synergies (Based on estimated FY19 EBITDA of ~$72m, SIC currently trades for under 6x EBITDA and ILG is looking to IPO at ~11x).

Why does this opportunity exist?

  • Underfollowed : SIC is a somewhat illiquid $300m market cap with no "real" research coverage.
    • The company has done a poor job communicating the value of its assets, particularly with ASG and the massive consolidation opportunity/scale benefits in that business.
    • CEO Tyrone Johnson has no public market experience.
  • Frustrated shareholder base : As ADW noted in its public letters, the "legacy shareholders" of the company (144a investors that purchased their shares at $12 in December 2017) have generated negative IRR and their frustration has translated into enormous pressure/selling of the stock since the direct listing of SIC shares in August 2018. ADW's public letters can be found at:

ADW Capital Partners L.P. Seeks Sale of Select Interior Concepts, Inc. to Maximize Value for Shareholders

ADW Capital Demands Public Strategic Alternatives Process, Announces Its Own Public Investor Meeting to Discuss the Mismanagement of Select Interior Concepts and Encourages All Investors to Refrain from Voting Their Shares at the Annual Meeting to Deny Quorum

ADW Capital Announces Timing of Its Own Public Investor Meeting to Discuss the Mismanagement of Select Interior Concepts, Encourage All Investors to Refrain from Voting Their Shares and Communicate Shareholder Concerns Directly to the Board and Management of the Company

ADW Capital Issues Significant Update on Select Interior Concepts' Board of Directors and Management Team's Intransigence / Failure to Create Shareholder Value

ADW Capital Updates Shareholders On Its "No Vote" Campaign Based On The Company's Recent Announced Strategic Review Process

Catalysts

  • Monetization of ASG and RDS:
    • The company can unlock enormous value (150-250% return) if it is successful at selling both assets separately.
    • On the other hand, I believe that any sponsor can acquire both assets at a significant premium and still walk away with a great deal with two enormously valuable platforms that they can IPO at much higher valuations once both businesses reach scale.
  • Continued execution:
    • While management has done a poor job communicating the value of both assets, all capital allocation decisions have been sound and both businesses are flawlessly executing on their playbook.
    • Activist on watch: ADW can easily win a proxy vote and swap out the current management team/Board of Directors should the strategic alternatives process bear no fruit.

See also MSC Industrial Direct Raised The Dividend 19% And The Forward Yield Is Over 4% on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.





This article appears in: Investing , Stocks
Referenced Symbols: SIC , SITE , POOL , FND



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