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1 Main Capital's Yaron Naymark talks Limbach's evolution $LMB (podcast #172)
Yaron Naymark, Founder of 1 Main Capital, is back for the third time on the Yet Another Value Podcast to discuss Limbach Holdings (NASDAQ: LMB), a mechanical systems solution engineering company that focuses on HVAC systems. Yaron talks about the evolution of the company since it went public via SPAC in 2016, transitioning towards the owner direct business and away from the older general contractor business, growth through acquisition strategy, equity raise in 2021 and why he finds $LMB interesting.
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Transcript begins below
Andrew Walker: All right. Hello and welcome to Yet Another Value podcast. I'm your host, Andrew Walker. If you like this podcast would mean a lot. If you could rate subscribe, review, and follow up, wherever you're watching or listening to it. With me today, I'm happy to have on for the third time, my friend, Yaron Naymark. Yaron, how's it going?
Yaron Naymark: Hey, I'm good. How are you?
Andrew: Doing great. Great to have you on Yaron. I should have said it. He's the founder of 1 Main Capital. Good friend. I think he's a super smart guy. Always happy to have him on. Just before we start talking around, let me just give everyone the disclaimer I give at the start of every podcast. Nothing on this podcast is investing advice. That's always true, but particularly true. Today we're going to be talking about Limbach, which is a sub-250 million market cap company. Obviously, at that size, at that scale, at that liquidity, a little bit of added risk. So everybody should just remember that and please keep in mind, not investment advice, do your own diligence, do your own work, all that type of stuff. But speaking of, do your own work, I know your own has done tons of work on this company. You followed these guys for four or five years, something like that. I can remember talking to you about them in 2020. You've gotten out, you've gotten them back in, but I we can talk about all that, but I'll pause there and just say, Limbach, LMB what is Limbach and why are they so interesting today?
Yaron: Yeah. I've actually been following them since they came public via SPAC. So like all the [crosstalk]
Andrew: I remember...
Yaron: I'll do your own diligence, non-investment advice, like later on. The fact that this came public via SPAC in 2016...
Andrew: I remember the early SPAC Mafia in 2016-2017 was all over Limbach and the Limbach Warrants and I remember those days.
Yaron: Yeah, by the way, those Warrants, they were down all the way through the 4th quarter, and with two minutes left in the fourth, they came back and went from being out of the well out of money and never going to have any value to now having value. So anyone who owned the Warrants has done really well. But yeah, I've followed it since 2016 from afar, they came public. They're a mechanical systems solution engineering company. They focus on HVAC systems, but they do some other mechanical stuff as well. They focus on the HVAC systems, mostly in commercial buildings. Historically, when they came public, they came public mostly sold new construction work through general contractors and the thesis was you can roll up this industry at very low valuations, call it four times EBITDA and grow this thing, get some geographic diversity, customer diversity and create a lot of value through acquisitive, accretive M&A. Selling work through general contractors is a pretty bad business, these are long lead time projects where you're installing HVAC systems and new construction projects.
You have to quote and bid on the work, then it could be a multi-year project where you're relying on other parts of the construction to be completed when they're expected to before you could start your part. In the meantime, you're like engineering it, prefabricating it in your facility, you're spending money, and you're not getting paid yet. So you're building up inventory, and receivables, basically. It's very working capital intensive. In the meantime, you could have cost inflation, but you already gave a fixed price so you could get underwater and the projects could have delays and overruns on, not only costs but also time, times money. So the variability in the margin profile of work through the general contractors is high variability. It's low margins, just a bad business. The company blew up a few times on guidance where they gave guidance, they missed guidance and had to guide down significantly because of this general contractor work and it wasn't a good SPAC roll-up. They weren't able to do acquisitions because obviously, they had capital issues due to these blowups.
Investors got frustrated and it became an orphan stock. I got involved for the first time as a special situation investment in 2020. When during COVID, obviously, HVAC systems became very important for hospitals, for lots of buildings because everyone was worried about COVID. They got some government work, they got a lot of hospital work. But the stock had traded down they had some debt. The stock had traded down to distress levels. I think it was sub $3 and the Warrants were in the pennies. It became very clear that they were not going to be distressed because this work was coming on and they were protecting margins. They were able to take some costs out of the business. So I got involved in 2020 as a special situation, did really well on it in 2020, and was planning on holding it for this transformation into what it is becoming today, which is selling less through general contractors and more directly to building owners, less new construction, more maintenance service work, small upgrades to your systems, right?
HVAC systems are probably the biggest source or the biggest use of electricity in buildings. So if you have an efficient HVAC system, you could save a lot on your electric bills. You become more ESG friendly and you could do work for building owners to help reduce their energy costs, make them more ESG friendly, and make their systems more reliable. Especially, if you have mission-critical infrastructure like data centers, hospitals, and biotech research facilities. You can't really have your HVAC system go out at 2:00 AM on a Saturday and wait until 9:00 AM on a Monday to get it fixed. So if you have mission-critical stuff and you're a trusted service provider, if Limbach could become a trusted service provider to these building owners with mission-critical infrastructure, they could start doing more service work which is not only much higher margin, it's less working capital intensive because shorter projects, you do the work, you get paid right away. You don't build up inventory and receivables and you don't get stuck with these cost overruns and just variability in margin.
It's higher margin, more predictable margin, lower capital intensity, and it's just a better business. While I made a lot of money on the trade, the special situation trade of this is not going bankrupt right now. It's a going concern. It got revalued. I still thought there was another huge opportunity of transitioning the business more towards owner-direct work and then continuing using the cash if the business is now throwing off because it's more predictable to roll up the industry at really attractive multiples, right? You could do acquisitions here at four to five times EBITDA which is really attractive for business with almost no cap. That's an attractive acquisition multiple. In the meantime, you're diversifying the business through acquisition, you're getting bigger, and a more diversified, larger business would be worthy of a higher multiple. So not only would you be making the business more predictable and growing earnings and free cash flow per share organically and the acquisition, but you would probably command to hire multiple in the future. This was trading really cheap still. I got a little frustrated with a few things that management did in particular and equity raises they did, which the way they did it and the amount they raised, I think they pissed off a lot of their shareholders, including me. I decided it wasn't an investment for me anymore. It was a trade that I did well on that I gave back some of the gains on, and I exited the position, but I kept following it on trades where you make a lot of money, especially if you have an affinity for the company and you want to see what goes on with them and you're curious. So I kept following the company.
They replaced the CEO earlier this year. I made it an investment. I think it became an investment once again for me, not just a trade. I've been in it since January and size and I think since they came public, they've taken their owner direct gross profit mix from a third. It used to be two-thirds general contractor, a third owner direct and today it's the opposite. It's two-thirds owner direct, a third general contractor so the mix has improved. Their EBITDA margins have doubled from like 3.5% when they came public to about 7% today. I think over time the opportunity is to take it to a low-teen EBITDA margin as they continue mixing the business and doing some M&A. So I think there's lots of room for the margins to continue to expand. The stock is still very cheap relative to comps, trades at a single-digit free cash flow, and multiple six times EBITDA net cash balance sheet, so they're going to be able to do a lot of M&A. It's getting added into the Russell now, so there's going to be some passive buying. There's just a lot of great angles here. It's becoming a better business, a larger business, and excited to talk to you about it today.
Andrew: Well, look, I think you just said everything about it. We can probably wrap the podcast up here, but I'll try and earn my keep. I guess the first thing, so I look at this business and as you said, they've got the old general contractor business, which they're trying to move away towards the owner direct piece.
Andrew: It makes sense. I agree, right? The owner directs pieces with less inventory, and less cost overrun risk. You've got that direct relationship, as you said. I think they actually give an example on their calls. They say, "Hey, this is a business where something breaks Saturday, 2:00 AM you're not going to wait till Monday." I guess my first piece is, okay, it sounds really nice, but everybody says they want to transition into a better business. Like to me it does seem like this is a business like Mom-and-Pop down the street can try to do it maybe like a one-person shop can't because you can't be on call 24/7 all the time. But what is their edge in transitioning to this versus the hundreds of HVAC owner-repairers in New York or Chicago or wherever they're competing? What is the edge that lets them do this?
Yaron: Limbach tends to not operate in these big primary markets. They had an LA...
Andrew: I saw they closed the LA down to [crosstalk].
Yaron: They closed in LA.
Yaron: They tend to be in these secondary tertiary markets and still have growing populations and good economies. But where they could be the number one, number two player in those local markets. They've been around for a hundred-plus years. They're trusted within their local markets. I think developing a relationship with building owners, giving them advice, showing up at their location, and just saying, "Hey, let's work on a plan together to help improve your energy costs, to help make sure we can extend the life of your equipment and when you're ready to do a new project, we can be there and quote it for you." I think holding their hands and becoming a more trusted consultant to the building owners is what makes them a better business over time. The OES also does this a little bit. The OES, it's not really their primary business. Their primary business is to sell new equipment, not to [crosstalk] extend the life of the equipment. I think if you're focusing on doing the right thing for these building owners instead of just trying to sell them this expensive equipment, I think you can become a trusted partner through these [crosstalk].
Andrew: It does remind me and it was percolating in the back of my mind, but I didn't get in my notes. But now that you said, if you ever look at an elevator manufacturer, what is it? It's like ThyssenKrupp or whoever.
Andrew: The best part of their business, yes, they sell the elevator, but that's not actually where the money is made. Now, elevators are different than HVAC, but the elevator, all their money is made on, they get like a 20-year service contract on the elevator, and that is money, good revenue, right? Nobody's going to stop paying to maintain their elevator. So that's where all of their profit is made. As you said, an HVAC system like you sell, but you're going to sell hundreds and thousands of those HVAC systems and you probably can't service them all. So it is probably going to these guys, I do hear you...
Yaron: Especially on secondary markets, right, where you might not have a lot of density of your service network.
Yaron: Yeah, even if your primary focus is the HVAC system, it's not necessarily a common be like, how can we save you money? How can we extend the life of this? When you're ready for a CapEx project, how can we be, the guy that you want to go to? So even new construction work now, the customers that are building these relationships with them are going to the general contractor and saying, "Hey, we want you to use Limbach for the HVAC portion of this new project." Which obviously allows them to price at more attractive margins for that business as well.
Andrew: Let me just ask this in a different way. So part of the story is, right? They trade for six times EBITDA and maybe eight or nine times three cash flow. We can talk about multiples in tier comparisons a second, but part of the story is that they're pitching that you're thinking of those we're going to grow through acquisitions. I always really struggle with growth through acquisition stories because it does rely on them, right? Like, "Hey, if we're going to grow on acquisitions, well, we're assuming you're going to grow profitably through acquisitions." It assumes that the sellers are going to give you a deal to grow profitably. There are two ways you can do that. A, you think about classic M&A where there's just massive synergies, cost synergies, right? I buy the station next door, we can fire all of their accounting teams. If it's a TV station, we can do better retrains on cable stations. That's not really the case here. I was looking at their last merger call and they were really clear. I think the quote was, there are limited cost synergies here. They were like one or two, but it's not about cost synergies. They were talking all about, "Hey, the quote I have is front-end revenue-driven sales business development and marketing synergies." I don't even know what that is, but I do worry. It's like, "Hey, this trade's for six X, they want to go buy stuff for four X and create value, but why are the sellers selling for four X? Why is that going to create value if there's not really these cost synergies here?
Yaron: Yeah, for one, I think the businesses they're buying are just small businesses and that tends to be the market price, right? If you're getting closer to retirement and you don't have a kid who wants to pick over your business and you want to shop your business at this scale, not just in this industry, but in lots of industries, businesses trade for lower multiples when they're smaller. This business specifically gets lumped in with these construction-related assets that people are generally more skeptical of, right? What does the seller know? There's variability in margins here. People tend to be scared of these types of assets. I think LMB has shown an ability to with one acquisition since they've come public, but it's been a very successful acquisition to buy an asset and be the right steward, the Berkshire Hathaway if you're a seller and you care about, right? The sellers is if they've built this business for a long time and they have a relationship with their employees, they don't want to sell to someone [crosstalk].
Andrew: It does sound silly. You and I are sitting here in like 1 Main Shop, it's just my podcast. Me and all, I think Penny's behind me. Penny's behind me for people on the video.
Andrew: I don't have any place. But as you said, if you're a seller, you're selling your business, you built it for 30 years, you've got guys who've been with you 5, 10, 15, or 20 years, you do care about if you're selling to a private equity firm, who's going to fire your best friend or the guy whose kids you've seen growing up, or if you're going to sell to Limbach who says, "Hey, it's going to be mainly business as usual. Maybe we even improve the business that sells something does matter."
Yaron: Yeah. I think improving the business is by implementing best practices, how to maintain and developing these relationships with building owners and help grow this owner direct type work. So that you can say no to construction work that isn't priced to margins that are appropriate and just improve your business mix such that gross margins mix higher. This business used to do a consolidated low double-digit, call it 10% gross margins and now it's over 20% gross margins. I think you could probably get it into the high twenties or low thirties over time as you continue mixing the business. Even within the owner's direct work, there are two types of projects. There's within owner-direct, there are more CapEx-oriented projects and more OpEx-oriented projects, more maintenance-related stuff consulting-related stuff within the owner direct. Owner direct is already 22.5 X the margin profile of the general contractor margins. But within that, the operating expense stuff is an even higher gross margin than the CapEx stuff. As you continue mixing the business towards owner direct which you can do with acquisitions as well, and as you continue mixing within owner direct to the higher service, higher value add stuff, which there's a lot of corporate know-how, right? That you can implement best practices and send them to your local markets, which improves the business and rights. A single business by definition is when we spoke about RCI, we talked about this as well, I think a single business just has less geographic diversification and less customer diversification. it's just worth less. It's a riskier cash flow stream than when it's owned by a parent that has natural diversification within it.
Andrew: I'm laughing because RCI was actually the next thing I was going to mention. Yes, it had that, but the other thing is, this is not common because I know some of your other investments, and not all of them have this but RCI in this, and I think it's something you look for. Look, they're small enough that they can go buy those Mom-and-Pops that might trade for two to four turns cheaper than the small private equity-owned business. They're small enough that they can buy those in-budget needles. They both also have some I'll call acquisition here where like your traditional private equity players might not want to play in that space. Obviously, Ricks with not many investment committees are okay with Strip club purchases these days. But Limbach, smaller touches construction on the GC side they've got cost overrun risk. They're obviously trying to switch more to the maintenance type contracts, which everybody wants those, but it's still got the construction, it's still smaller, it's still macro exposed quote-unquote. It is something that I can see a lot of private equity firms just instantly vomiting on themselves in passing instead of really wanting to do, especially at this size.
Yaron: Yeah, that's exactly right. If you're ever going to buy anything for four times EBITDA, you're talking about a business with minimal CapEx, which this business does, you're talking about a 25% pre-tax return on your investment unleveled. You have to start asking yourself, why am I able to get that? If you can get it for a reason that makes sense to you that you're generating excess returns without taking on excess risk, I think it's an interesting situation. The best situation is when you could buy it into the platform at a low valuation that can then deploy its cash flow at those attractive valuations because then you can get a double whammy of the accretion, the earnings growth, the free cash flow per share growth from deploying your capital into those acquisitions and the benefit of getting multiple expansion on the platform over time as it scales and as people get more comfortable with it. That's how you end up with an RCI going from $15 a share to $75 or $80 a share and that's how you end up with LMB going from $3 when it was in 2020, low double digits earlier this year. I really believe this could be a $75, $80 $90 stock in a handful of years. Some of that is through earnings growth and some of that is through multiple expansions, of course.
Andrew: Let me ask one more on these maintenance contracts or "Hey, we're going to have you on call to come to repair the AC at 2:00 in the morning or something." Is that also something that a Mom-and-Pop, it's tough to say this because Lambach is not really acquiring in markets, so they're going to enter new markets, but is that something that Mom-and-Pop might have more trouble offering than a corporate with that corporate knowledge, or is Limbach generally going and buying Mom-and-Pops that already have those maintenance contracts in place? Is does that make sense as a question?
Yaron: Yeah, if you have multiple employees, it's generally easier to be available all the time for sure.
Yaron: You have the ability to take on multiple projects at once, right? If you have multiple customers who have issues and you have the ability to service a single customer in multiple markets, right? HCA, which is a customer hospital corporation of America, which is a customer of LMB, trusts them and they're using them in many markets at once. So a Mom-and-Pop can't offer that. I'm sure there are some purchasing obviously synergies from having scale. But yeah, I think it's mostly just being trusted, having your operating history there, and having a staff that can support, customers with multiple locations.
Andrew: Just data centers. We've mentioned a few times hospitals and data centers, these are things that 2:00 AM on a Saturday, HVAC breaks, [crosstalk]
Yaron: Disney and NASA. Yeah, stuff like that.
Andrew: Well, just data centers are the ones I wanted to think about because these are big things, they are generally really big, and they're making a lot of money. Why do they need to outsource this? I guess my question is, why don't they have one person who's handling all operations and internally anything that goes down 24/7, they can fix it?
Yaron: I think their utilization would be too low.
Yaron: I think their utilization would be too low and end up costing them more than having someone who's focused on this 24/7 and who has all the expertise, the engineering expertise, the pre-fabrication, the onsite ability to source whatever materials are needed to fix something instead of having all, if you own a data center, what are you going to have? You're just going to carry inventory for repairs on site and have one person who might not be doing any work certain time. Right? If you want someone sitting there at 3:00 AM ready to take your call, who's dedicated to your facility that's going to cost you money all the time, every night at 3:00 AM you're paying for that person to be available with LMB that's not every night. It's as needed, but they're available.
Andrew: Is there a way to measure local market share?
Yaron: I don't think so. I don't...
Andrew: I'll ask you a separate question then I'll come back to that. When LMB has this, we're on call 24/7, you call us will come, they're not getting a retainer fee, are they? They're only getting paid in something?
Yaron: No. They're ingraining themselves in the building owners, right? Phone book for when work comes up. They're the trusted guy who gets the work and so the owner's just less price sensitive in that environment, right?
Yaron: Now, if you're trying to extract way too much value for yourself, if you're bidding, 2 X the price of someone else, I don't think the owner will have that loyalty to you. But that's not the case here. You can provide good service and charge a little bit more and still do much better.
Andrew: See, it does seem to me like something, as you said, if you're in a secondary or third market where you could get economies of scale, like, "Hey, everyone works with us because as you said, you need somebody on call 24/7." You can only do that with a huge book of business, especially on weekends and late nights and stuff. So we can get there and our customers, it's Uber surge pricing, right? Your HVAC breaks at 2:00 AM on a Saturday, you can pay us 5 X the regular rate now or you can wait till Monday, and we can send someone out there. I do think that is something, there's probably what in a secondary market, 200 people who need 24/7 coverage of their thing. Because a house does not need 24/7 coverage.
Andrew: Even if my AC broke, it would be an emergency to me, but there are 200 people in a secondary market, that is really only enough to support one person paying four people, to cover a whole week or something. So it does seem like there could be, "Hey we have 100% market share in these third markets, we're the only player, we have two people on call at all times. So we can always service people it." Yeah.
Yaron: I would guess the market share for owners of infrastructure mission, and critical infrastructure within markets I would guess the market share is pretty high for LBM within their local market. I've asked them recently, and I'm like, "Hey if office buildings are troubled, is that going to impact your business?" They're like, "Offices aren't really the mission-critical infrastructure asset you would think of that needs to have their HVAC fixed at 2:00 AM on a Saturday. We don't have a lot of office exposure in our portfolio." Again, it's stuff like the data centers, hospitals, and stuff like that. Yeah, I think within that core customer base, I think they're market share, my guess, my intuition is that their market share is pretty high within their local markets.
Andrew: You said offices they're not our customers and I was just laughing because my WeWork, the air conditioner would be broken at it, I'd say too out of every five days. So I can guarantee they weren't too urgent about having the air conditioners fixed. Let me ask, the office discussion though is a nice transition to, "Hey, I got 3 DMs. I think two people on the Twitter thread said it was probably the most popular question, right? People see Limbach and they think, "Oh, a lot of the business is still GC, general contracting type stuff, macro recession, commercial real estate recession, all that type of stuff. Top of mind. The first question everyone asks is, so how do you think about if we have a soft landing, hard landing, whatever the landing we're going to have is, how do you think how that impacts them back?
Yaron: Yeah, first of all, their end markets tend to be less economically sensitive, right? If you're talking about higher education not that economically sensitive healthcare, not that economically sensitive data centers we're about to have a [inaudible] data center spend.
Andrew: I liked when you and I were talking to chatting the other day and you said self AI play Limbach, somebody's got a service those data centers.
Yaron: I was actually, someone messaged me that and I was like, "Oh, that's funny." I tweeted it and then some people thought I was being serious about an AI play and they called me an idiot.
Andrew: You weren't being serious, but you were.
Yaron: Yeah, not really. I just think generally, the end markets that they play in tend to be less economically sensitive. From the last few years, there's been a lot of deferred CapEx and these systems don't last forever. So there's going to be an eventual deferred replacement cycle. In the meantime, we could still be there helping people extend the life of their existing act equipment and improve its operating efficiency of it, which has an immediate payback, right? That's not a spend money now just to for status quote, it's a spend money now and I was having lunch with the CEO a few weeks ago and he was like, "Listen, we're still going into some of our customers and at first they don't want to share their utility bills with us, right? For some reason, there's just a trust component where it's like, "Why should we be sharing our utility bills with you?" But more and more of them are starting to share utility bills with LMB and LMB'S going back to them with a plan of action on how you can actually have an immediate payback on spend today that's going to reduce your cost of operating your facilities immediately. I think there's a lot of stuff like that where they could win near-term projects and then position themselves well for the longer-term CapEx investment as well.
There's Emcor Comfort Systems. If you listen to their earnings calls, you look at their earnings re results, they're not seeing any slowdown. They're super optimistic about what their customers are telling them they're seeing. Same with LMB, if you talk to management and you ask them how things are going, they seem to see no end in sight in terms of the amount of continued growth they expect to get from owner-direct business has been really strong. I think it's continuing to be really strong. Of course, look, if we go into like a 2008 like recession where everyone just has to cut, spend on everything OpEx, CapEx and just delay, delay, delay, and not even do immediate payback stuff, then every business gets hurt. But the nice thing here is we're sitting on a net cash balance sheet at a low valuation. We'll be cash generative in that environment as well and we'll be able to do acquisitions at more attractive terms than we're even doing than that today. You have a natural hedge when you're sitting on the net cash position with a business that is now cash generative and should be continuously cash generative because of this owner-direct type of work that they've positioned themselves to take on. I think you're hedging if things get bad, you can deploy capital more creatively if things are good. Obviously, your operating business continues to perform well.
Andrew: Two more questions because I am really interested in this business. The first is we've mentioned several times, they can do work that makes your building more efficient and you get a payback, right? The classic would be you take an old HVAC and you install a new HVAC and the new HVAC uses less energy, it's much more coefficient, all that type of stuff. I understand that example, but are there any others? Because I'm sure there are, but if the way they make things more efficient is, "Hey, we're just going to install a new HVAC, it's more the HVAC unit that's doing the efficiency improvements. [crosstalk] come out about it.
Yaron: Yeah. I don't think [crosstalk]. I think it's improving the existing HVAC. I think every building is different. They see the bill, they go inspect the equipment, and they see if there's part of the equipment that could be replaced, not all of the equipment. They could see if there's leakage, right? Pooling or heating that's causing the bill to be higher than what it should be for a building of this size. Then you could address that. I think there are lots of different things they could look at. That's where they come in and become trusted partners to the building owners.
Andrew: Last one and then I want to move on to the valuation a few other things. The example we gave earlier is where Limbach comes and I'm getting ready to retire. They buy my business for four times EBITDA and I'm sure they keep me on for a year or two to make sure the transition goes smooth and stuff. Right? But this is in part a knowledge business. Let's say I retire and you were my general manager, right? I guess, how do they keep you instead of you going off and starting, "Hey, Andrew was my buddy, he retired, and some corporate overlord owns the business. Now, why don't I just take all my people and go start my own competitor down the road?" Like the classic because they are trying to get into what is more consulting-type work.
Andrew: That has been the issue with a lot of these smaller consulting firms. If a private equity guy buys them all, the mid-tier people leave once the top-tier people are done and they go and start their own company.
Yaron: Yeah. I think compensating a whole team of these skilled professionals, especially in today's world where it's a tight labor market, would be a big upfront investment for whoever's trying to steal that team out of the acquired asset. Then if you build it, they will come in and hope the customers actually come with you. But the customers, a lot of them have a loyalty at that point to the business that's been serving them for a long period of time. So you have to invest a lot, try to get the whole team, and then try to win over the customers. I think it's easier said than done. They haven't done a bunch of these acquisitions so like, I can't say go look, get their history and proof is in the pudding. But that's my intuition.
Andrew: The one they did at the end of 2021. Was it James or something?
Yaron: James Marshall?
Andrew: Yeah. It seems like that's gone pretty well.
Yaron: Yeah, it's gone really well. There were two earn-out thresholds where I think they needed to generate like $8 million gross profit in 2022 and then $10 million in 2023 to make both earn-outs. I think they're on track to hit both earn-outs. Yeah, I think it's gone really well. If they could do more acquisitions like that, I think it'd be great.
Andrew: Let's quickly talk valuation. We've said a few times the company trades at six times EBITDA, eight or nine times free cash flow. It's funny because it has some big add-backs, but they're actually add-backs that you'd be okay with except they do have some restructuring charges in there, but we can talk restructuring charges if you want later. I guess my overall question was how do you think about valuing this business? Because you've mentioned they've got some peers that trade at 2 X to multiple that they do. Right? Low double digits, but those peers are also 10, 20, and 30 times bigger than Limbach. So I think people might say, "Hey, you're comparing a tiny almond to a giant orange or something, you know?"
Yaron: Yeah, there's IESC also, which is not that much larger. That also traded.
Andrew: I haven't looked at that one in a while. I remember that, who was it, the guy who had the best stock of the past 20 years [crosstalk]
Yaron: ... or something, right?
Yaron: [inaudible] guy.
Andrew: [crosstalk] capital. I think his fund was, ooh, that's done really well, recently.
Yaron: It's done really well and without multiple that I think it's low double digits also, right?
Andrew: I haven't looked at it in a while. They actually had one division that was really struggling that dragged down their entire EBITDA outlook and I think they put it behind them. But yeah, I've got a trading net eight or nine times trailing EBITDA, I think.
Yaron: Got it. Yeah, I thought it got into the low double-digit EBITDA multiple, but that's another one, it's not that much bigger than Lumbach. I think the point is you build scale here, you build the diversification, the cash flow stream becomes smooth, less volatile and it's going to grow into a higher multiple. I don't think it's going to get that higher multiple overnight, but I just think with scale the blowups are behind them. Hopefully, I really believe the blowups are behind us. Especially, since we've exited some of the troubled markets like LA and we've moved the business more towards this smaller ticket less working capital intensive, shorter duration projects that are just higher margin and with more visibility and less variability. I think the blowouts are behind us in consistent operating results. Diversification through M&A, accretion through M&A I think you naturally gain the trust of the market, and if a business can grow its free cash flow per share at a really attractive rate, I think eventually it's a reward, without doing anything that's too risky, like taking on a lot of leverage or doing things that are illegal or something like that. I think eventually it's rewarded with a nice free cash flow multiple. But looking at a few years, I don't think it's crazy to think this trades at 12 or 15 times free cash flow, right? Like I just don't think those are crazy. I'm not arguing for a 20 times free cash flow multiple here. But I think a lot of free cash flow per share growth through continued margin expansion through acquisition and then you get a little bit of multiple expansion and that's how you end up with a home run result.
Andrew: Would I be putting words in your mouth if I said, look right now it trades for six times EBITDA and you think it should trade for, let's call it eight to nine times EBITDA, which would get you into the very low double digits free cash with multiple pluses maybe slap an extra EBITDA, turn multiple on for it to account for future accretive acquisitions done at a low multiple as you discussed because you're buying Mom-and-Pops and all that. Would that sound about right as a framework to you?
Yaron: Yeah, I think that sounds right. It depends on which EBITDA number you're looking at. If you just take this last quarter where they did almost 9 million of EBITDA and annualize that you're looking at 36 million of EBITDA on a run rate basis, the first quarter is a seasonally slower quarter for the company historically. So I would think they probably do higher than 36 this year, even though that would be higher than their guidance. I think organically they could probably take it to 60 from 36 over the next four or five years just by continuing to mix the business towards owner direct and getting some operating leverage. I think it really depends on how much M&A you think they could do. They're going to generate a lot of cash. Now, if you think they could redeploy all that cash into M&A, then they're going to grow free cash flow per share really quickly because M&A is super accretive.
If they can't find enough attractive acquisition targets such that they either build cash on the balance sheet or have to buy back stock at 10 times free cash flow or whatever, then obviously that's much less accretive. But the way I model the business is to continue to mix the business towards owner-direct redeploying all their free cash flow into acquisitions. But I have the acquisition multiples increasing over time because they need to put more money to work. So they probably have to pay up a little more to just get more deal volume. I have free cash flow per share growing from 250ish this year to over $7 by 2027. So call it, three, four years out. If they could actually grow from 250 to seven, I don't think, it's crazy to think this trade's at $85.
Andrew: It certainly, as you and I are talking, it's treating about $23 per share if it's got $7 of free cash flow. I don't know in today's market, maybe, there are some things that, but let me ask another question on M&A. So we already talked about the synergies and everything, but I guess the other question in M&A is, can they do M&A? What I mean by this is they did the Jake Marshall deal in late 2021. That deal has been great and that was a pretty nice sized deal, but they didn't do any M&A in 2022. We're six months into 2023 at this point. I don't believe they've done any M&A unless I missed a press release or something. But so that's 18 months since their last deal and we're talking here about. I'm questioning you, can they do a creative M&A? How do they make it acc creative? You're building out models that they do a creative M&A.
Yaron: There's not a lot of proof in the pudding that they can do M&A. I know they're asked about this on every call, but like, when are they going to do M&A? Are they really going to be able to grow creatively through this? Because as you said, look, it's not like you're really paying a lot for future creative growth. You're not paying anything for a platform. But there's going to be a difference between if they can do consistent accretive M&A or if they just limp along and have to pay out dividends and buy back stock, which I love, but that makes a big difference, especially at this size.
Yaron: Yeah, look, I think without M&A, my back-of-the-envelope math says this business is worth around 35 today at probably like, not 10 times EBITDA, but eight, eight, or nine times EBITDA. It's worth 35 today. I think they can grow the value of that 35 today organically just by continuing to grow the owner-direct part of their business, which would allow them to get higher margins and better free cash flow conversion. So I think you could do well. Like I think without doing M&A, there's a credible path to getting the stock into the forties, I would say over the next few years. So like a double, I believe they could do M&A. They have someone dedicated full-time looking at acquisitions. Matt Katz, he's been with this business for a long time. He's looking at a lot of opportunities. In evaluating acquisition targets. He's very disciplined and the new CEO Mike McCann is also very disciplined. I don't think they're in a rush just to do deals, just to tell investors they did a deal. I think they're looking for the right cultural fits in the right market at the right valuation and I think they're willing to be patient.
The pipeline sounds big and they're looking at a lot of things. I think they were really close on a few things and they turned them down towards the end of the deal processes because they were trying to be disciplined buyers. I think that should be a good sign to investors who have been burned in the past by this company which came public via SPAC and had to take down guidance a bunch and did some things that destroyed it over a short period of time. Their reputation with investors. They're trying to regain credibility and they want to do good deals, good cultures, good valuations, and good end markets. I think it sounds like there are lots of things in the pipeline. I think they've said that they're hopeful to do one or two deals a year. Obviously, we're sitting here in June and they haven't done any yet. So like, "Can they do two in the back half?" I don't know. Could they do one in the back half? I would hope at least one. But I think they'll get a few deals done every year, maybe not this year, but every year going forward, the pipeline continues to grow as like with when we've discussed RCI, like when you become a known buyer, you can develop a big pipeline, but you can't force people to transact.
People transact when they're ready, right? When they're getting older, they're ready to retire, and they might be fearful of a downturn, so they might be more inclined to sell right ahead of the downturn. Right now, things are really good in the industry, right? We just talked about how Emcor and comfort systems and Limbach and IESC, like their stock charts, are up, and to the right, their businesses are doing well. I think you sit there and you develop those relationships as a buyer and when people are already to transact, you're hopefully the buyer of choice. I think they'll be able to put capital to work. It's hard for me to say timing, just like with RCI it's hard to save timing, but I think they'll be able to.
Andrew: Let me ask one more way. Just looking at the company starting in 2021, you see a ton of insider buying when the stock is in the single digit. I'm looking at March and May 2022, Michael McCann, who was the CO at the time, now he's the CEO who I think you like a bunch and he's done a really nice job. He buys probably got $50,000 worth of shares in the $6 to $7 range. There's a board member, Josh Horowitz, who I don't know, but who runs a fund. Do you know him? Have you talked to him at all? haven't
Yaron: I haven't spoken to him, no.
Andrew: I don't know. Maybe this [crosstalk] this way to...
Yaron: I had some email exchanges, but no, I haven't spoken to him.
Andrew: Yeah, maybe this will make his way to him and I'll just tell him, come on the podcast, if you're running a small cap fund, it's ridiculous to have somebody running a small cap fund who hasn't. But he does some pretty consistent buying throughout last year with the stock in the $6 to $9 range if I'm looking at this buying, right? That's not to say it can't be a deal here, but it does strike me like, "Hey, last year the insiders are buying pretty aggressively into single digits." Now, they've all got 2, 3, 4 baggers on their hands, which is a nice prompt to have, but it does strike me that they're not buying shares right now. Do you read anything into that signal? Like maybe it was really cheap last year and now they just look and say, "Okay, yeah, it's fine."
Yaron: Yeah, it's at $6 bucks you were looking at a 60 million market cap on a business that we just said, I think could do close to 40 million of EBITDA this year. So it was just, it was a broken SPAC, the CEO running it, I think was having a hard time attracting new investors into the story. Given the guide downs and the way, they did the equity raise in 2021. I think a lot more people now are willing to look at the story. I think if you were an insider and you had the opportunity to buy at six, you bought everything you wanted to buy because you knew how silly it was. I think you're top-up. I don't think you need to keep buying the whole way up, but I don't think you're going to see aggressive selling in the 20 my guess. I have no idea. It's not like they've shared their plans with me.
Andrew: You've mentioned the equity issue and stated in 2021 and it tickles the back of my brain. I think I remember you saying something to me at a time, but I didn't really research it for this podcast. What was wrong with the equity issue and stated in 2021?
Yaron: During COVID, as we talked about, the stock went to people who thought this might be a distressed company.
Yaron: Stock went to $3 bucks then it was clear that it was not going to be a distressed company. They were generating some cash, and they still had some debt but the stock was up to, I don't know, $8 or $9 bucks. I think they started evaluating an equity raise around that time. I caught wind of it. I wasn't approached by a bank or anything, but I caught wind of it, or I suspected it. No one told me Limbach going to do an equity raise, but someone told me, "Hey, a company you're interested in is looking to potentially raise some capital. Like I told the banker, the banker should really reach out to you to talk to you about this opportunity. I suspected it might be Limbach, but so I reached out to the company, and I was like, "Hey, I think you guys might be trying to do an equity raise." The initial response from the first person I reached out to was, "I can't, no comment, I can't discuss this with you." I reached out to the CEO and one of the board members and I got on the phone with the CEO and explained to him for like an hour why I thought raising $8 unless there was something about the business that I didn't know that led the CEO to believe the business would be in distress without an equity raise. Like, of course, if you have to do an equity raise to save the business, do what you have to do.
But if you're viewing this as an opportunistic raise, because the stock just tripled off below, I think it would send a very bad signal. The stock's still very cheap, low single-digit EBITDA multiple. The message the CO gave me was, "I hear you, I appreciate this feedback. Let me think about it, discuss it internally and we'll figure something out, we'll decide what we do." That was in October and November-ish of 2020. Then a few weeks pass, and no raise. I'm like, "Okay, good. I've talked some sense into them. Hopefully, some other investors talk some sense into them." In December they go to a conference, and they're talking about how great the business is. In January, they go to another conference to talk about how great the business is. This is all the former CEO talking about how great the business is and saying, "You can't wait to report Q4 results." Like implying the business is crushing it. At that point, the stock's still really cheap. 30 to 35 million of EBITDA, you were still looking at 8 million shares outstanding. It was like a hundred-and-something million-dollar market cap. So you're still looking at a stock that's like three or four times EBITDA. The stock got up to $15 bucks. People were excited and then one day, I think it was after the close, all of a sudden an AK comes out, they're doing an equity raise, and it's already been priced. The stock, company had 8 million shares outstanding before this was raised. They were selling 2 million shares.
Andrew: Jesus, this was all primary.
Yaron: This was all primary, 2 million shares all to new investors. They went and walk crossed new investors. They didn't contact any existing investors and they priced the offering at $12 a share. The stock close at around $15. With 8 million shares outstanding, they sold another 2 million shares. So 2 million on a base of 8 million is like a 25% increase in your share account. Everyone gets diluted by 20% at three times EBITDA and no one has the opportunity to participate in their pro-rata share if you've been supportive of this company and been a shareholder for a long time. They priced it, I think at around 12 stock opened up to maybe 13 or something like that. I sold a big chunk of the position. Then there were a few other things that frustrated me and I ended up selling out of the rest of the position and getting out entirely. I think it blew my mind that they were willing to do an equity raise. Well, first of all, the initial one I thought that they had decided not to do, but then they go and like talk up the stock and then say things are great and then you do an equity raise, which implies maybe things warrant as great because you really need cash.
Yaron: You only go to new shareholders. If I thought there was a good use of the cash, I probably would've bought the stock at a higher price than 12 to support the company. Instead, I think they destroyed their credibility with investors. Again, after coming public via SPAC after missing earnings a few times with these big project blowups and then doing that. I think there were lots of people who look at small caps that are institutional only who would not take a look at this no matter how cheap it was.
Andrew: It is just funny. It is just two things from that story. A, it's funny, they went public as a SPAC in 2016, right? I understand being a SPAC going public through a SPAC puts some black mark on you, especially after 2021-2022. But it's funny like it's seven years later, it's a completely different company, and still, people say, "Oh, they went public through a SPAC. Yeah, it's a company that went public through SPAC, probably lower quality, but it's also probably smaller." It's just funny how it's going to overhang them for the next 50 years. it'll be 2052 and be like 2016 they went public through SPAC.
Yaron: I honestly, think it's starting to change. I think more people are like, I think what they needed was just a change in management.
Andrew: I think three years should be the due date for they went public for SPAC where it's, "Hey, this is the season." But the other thing I was going to say is...
Yaron: I do think like, there were some big working capital swings in the business going into COVID, coming out of COVIDand then they still had some big blowups they needed to work through on the general contractor's side of the business. They're done working through them. 2022 was a clean cash flow year and a clean margin year 2023 hopefully will be another one. I agree with you. If they can string together three years where margins are good and cash flow is good, I think they get a lot of credibilities and people stop talking about the SPAC base.
Andrew: The other thing I was going to say is like management in the board owned before that 2 million raise they owned approaching 20% of the stock and it seemed like a bad deal at the time and in hindsight, it's probably proven to be a bad deal. The only way it probably would've been a good equity raise is if they had immediately had acquisitions to you, right? Where they say, "Hey, we're issuing stock at six X to go buy an accretive acquisition at four X and after some cost synergies it's three and a half. But that is not what happened. They just went out and raised equity and it's just funny. You are probably right. They probably saw their stock up to the right and said, "Hey, now's the time to do it and COVID was a scary time." I get it. But they own 17% of the company and they probably cost themselves a decent chunk of change. The stocks at 23 and they raise a 12, they cost themselves a decent chunk of change with a needless equity raise and just shows you even high insider ownership sometimes doesn't fully align you with management or doesn't guarantee they're going to do the smart decision.
Yaron: Yeah. Look, there might have been more uncertainty in the business at the start of 2021, right? Like no one knew what was going to happen with the economy at that point. They did have some leverage. The business wasn't highly leveraged or anything and they did have some known working capital unwind because they did rebuild customers and get paid in 2020 to help their cash flow position.
Yaron: But like if they would've flagged those things and said, "We just want a little extra cushion because the M&A pipeline's in good shape, and just in case the economy slows and go to their existing investor base, I think it would've been a little better received. Instead, the way they did it just was very poor. You priced something at a huge discount. You don't let your existing investors participate and there's no good use of proceeds where you can explain to people why you're doing it. It felt almost like they wanted to get more liquidity into more flow, and more liquidity. Some new blue chip investors...
Andrew: I call it getting compromised by a banker, right?
Andrew: A banker comes and whispers in your ear and says, "Look, you rode the stock from 2 to 15, how smart will you look if you take a print at 12 like your investors are going to love you for taking some chips off the table, getting some liquidity. You're the next Warrant Buffet, you can take this cash and use it."
Yaron: Yeah. Also, you're going to get some new high-quality blue-chip investors...
Andrew: Every time a company tells me, "Hey, we had to do this primary offering because we had a high-quality shareholder who wanted to get added to the rate, every time they said an angel loses its wings, it's insane. I can't believe how many... Who believes that, high-quality investor. If they really want to get in instead of buying all primary at a discount, they can just go on the secondary, they can go on the stock exchange and buy it and push the shares up.
Andrew: Why can't they do it that way if they really want to get in?
Yaron: Yeah, and listen, we have a net cash balance sheet today, which we might have had a little bit of net debt if we hadn't done that raised, but like not only do we have a net cash balance sheet today, we also have 30 million of claims against general contractors from former projects gone bad that we've shown an ability to settle historically and get most of those claims. We have another 30 million claims outstanding that hopefully settle over some period of time. Who knows, the litigation process is inherently uncertain and that's another $3 bucks a share of additional net cash on top of the net cash we have today. Plus the business will be generating, they've basically said 70% of EBITDA should convert to free cash flow. So we're going to be generating 25 to 30 million a year free cash flow plus 30 million potentially in settlements of those claims. There's a lot of cash here to do attractive stuff. Even if you can't do a lot of M&A and the stock stays at these levels, I think you just buy back stock and you grow free cash flow per share. That way if the stock goes up and you can't do M&A, then maybe you sit on the cash and wait for a potential recession. I think there are just lots of things you could do to create a lot of value here over time from this starting valuation. You don't need to do M&A from this starting valuation. You just need to not do dumb things.
Andrew: I have one more question I want to ask you, but before I get there just on Limbach, is there anything about the story that we haven't discussed you think we should have discussed or that we lost over that you think we should have hit harder?
Yaron: They're getting added to the Russell 2000 that's going to create some buying demand over the next few weeks. There are some warrants that expire in July that came with the SPAC. Some are 1250 strikes, and some are 15 strikes, so they're all in the money at this point. Those expire in July. There will probably be some cashless exercises and sales.
Andrew: one of the directors three or four days ago cashless exercise like 2 million of them or something.
Yaron: I think it was like a hundred thousand shares or something like that.
Yaron: He had a hundred thousand warrants, but he cashless exercise them, so only got 30,000 shares or something like that. I think the net buying from the index edition is going to more than soak up and more, the potential from the warrant. Yeah, other than that, no.
Andrew: Let me ask you my last question, and this is a new question I've been meaning to ask the guests. So you're going to be my first Guinea pig on it.
Andrew: I put out a quick blog post on this, but is there anything you're doing with AI to improve or change your process? Maybe I'm just riding the bubble and hyping on the hop train, but I personally haven't like, found out any real use cases that I think improve it or anything, but I'm just asking anything you've tried or seen that incorporated AI into your process?
Yaron: No, the only real change in my process or updated thinking in my process related to AI is to try to avoid businesses that I think could be impacted over the medium term by AI. Whereas, historically I hadn't really given it as much thought. Now, I certainly am. I like owning businesses that I think have no secular issues with good balance sheets because they're going to survive through downturns. They can deploy capital aggressively into downturns when valuations get cheap. In the long term, their value is their ability to their enterprise value. I think Limbach checks all those boxes like buildings are going to need good HVAC systems, whether it's 5, 10, 15, or 20 years from now. So no secular issues. I think cyclically things are improving for their end markets right now. They have a net cash balance sheet. So I just think when you buy something at a low valuation and generate a cash-clean balance sheet with no secular issues, I think the question in your mind should be like, what will my return be? Not will I make a return here? Even at today's price up in the 20s, I wonder like, am I going to double my money here? I'm going to going to make 50% of my money if I'm going to triple my money. It's hard for me to think, of course, every investment has risk. Like things could go wrong. You could lose money if you buy this, so don't go out and buy this and reach out to me and say, "You promise me I wouldn't lose money." But I like these situations where I think the skew to the upside is so much higher than the skew to the downside.
Andrew: I think what you're saying, it's a low multiple and they repair air conditioners and stuff like people are going to need air conditioners repaired. Maybe as you said, maybe it's a stealth AI play. They going to need to repair big buildings no matter if AI over the Lords takes over the world or not. I don't know if you still have it, but you used to have a position in Google, I'm guessing you still do. Have you thought about how AI affects you, or you don't have a position at Google anymore?
Yaron: I don't, no.
Andrew: No. The question was more just AI as it relates to investors because my first thought with AI was I was going to be able to be like, "Here's my portfolio. Find me five stocks that have similar characteristics that I can research and find new longs." or like, "Here's a 10K tell me all the risk factors that aren't in the risk factors or something."
Andrew: The best I've heard is some people use, I think a lot of people are using AI as an improved Google or a differentiated Google or something. But I haven't heard anyone using it in a way that as a concentrated value fundamental investor really improves anything in the process.
Yaron: Yeah, I don't know. I'm sure there are definitely use cases. If you run a really big fund with huge data feeds and you have...
Andrew: Oh, well they've been doing that for years and I'm sure they get better and better at it.
Andrew: But that's different than what you and I do, right?
Andrew: Hopefully, we're focusing on a couple of companies and doing well and finding interesting situations.
Yaron: Yeah, I think that's long.
Andrew: Not a hundred short. Anyway, Yaron, I'm starting to ramble. I've got the dust apocalypse out here. I'm sure you've got it too, it looks like Mad Max outside. But I appreciate you coming on, congratulations. I hope next week or the week after goes really well.
Yaron: Thank you.
Andrew: I'm here for you if you need anything and we'll chat soon.
Yaron: All right. Thanks, man.
Andrew: Bye, buddy.
Yaron: Bye, Andrew.