McGrath RentCorp (MGRC) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the McGrath RentCorp Conference Call to discuss the Design Space acquisition. [Operator Instructions] This conference call is being recorded today, Friday, May 14, 2021. Before we begin, note that matters -- that the matters the company management will be discussing today that are not statements of historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The transaction being discussed today subject to a variety of risks and uncertainties, which should be considered carefully. A summary of these uncertainties, included in the safe harbor statement contained in the press release and investor presentation related to the transaction, important risk factors that could cause actual results to differ materially from the company's expectations are disclosed under Risk Factors in the company's most recent Form 10-Q and other SEC filings. Forward-looking statements are made only as of the date hereof. Except as otherwise required by law, we assume no obligation to update any forward-looking statements. In addition to the acquisition announcement, press release issued yesterday, the company also filed with the SEC, the asset purchase agreement on Form 8-K. Speaking today will be Joe Hanna, Chief Executive Officer; and Keith Pratt, Chief Financial Officer. I will now turn the call over to Mr. Hanna. please go ahead, sir.

Thank you, Josh. Good morning, and thank you, everyone, for joining us on today's call. We have some exciting news. As you may have seen yesterday evening from our press release, and an investor presentation posted on our corporate website, we have signed a definitive agreement to acquire Design Space Modular Buildings, a leading modular building and portable storage provider in the Western U.S. for a purchase price of $260 million. I will start with the transaction highlights. After that, Keith will run through the key financials, and then we'll take questions. Design Space is a highly complementary addition to our modular building rental business. We have always held Design Space in high regard and as we've learned more through the due diligence process, our respect has grown further. Design Space is a top-tier modular and portable storage provider with a commitment to excellent customer service and a fleet of high-quality, well-maintained assets. The Design Space team members we've worked with in this process are experienced and dedicated professionals, and we believe the entire Design Space team will be an excellent cultural fit with the rest of our modular organization. Through this strategic acquisition, we will expand our coverage into 8 additional states. This accelerates our expansion into attractive long-term growth markets in the Pacific Northwest and other high-growth states, including Utah, Nevada and Arizona. One of the important qualities we look for in an acquisition is a well-maintained fleet. Design Space has done a very nice job keeping their assets in rental-ready condition. The fleet composition is predominantly commercial and provides us with an excellent base to continue investments in that product segment, while opening up geographic locations for us to build our education business. The Design Space acquisition also aligns closely with our work to expand the solutions capabilities of our modular business. With a larger combined geographic coverage, we expect to have additional opportunities to provide our offerings for site-related services and custom modular solutions. Our site-related services provide a one-stop solution to customers by providing everything they need for a successful rental or sale project inside and outside the building. Our custom modular or turnkey solutions support customers who want to purchase a new permanent facility or have a unique design consideration with the benefits of shorter lead time and attractive cost compared to conventional construction. Our combined team will be able to offer a compelling set of solutions to a broader customer base. With our available capital and combined sales and operational resources, we look forward to building on Design Space's successes and achieving future growth together. Design Space has a strong, capable and experienced team. We are excited about welcoming our new team members as an important part of our future. With that, I'll turn the call over to Keith, who will take you through the financial highlights.

Thank you, Joe. Echoing Joe's comments, we are very excited about the addition of Design Space and we see many benefits arising from this addition to our company. First, let me recap some of the financial highlights. We are paying $260 million cash for Design Space, subject to certain adjustments. On a trailing 12-month basis through December 31, 2020, Design Space generated $81 million of total revenue and $32 million of EBITDA. The purchase multiple is approximately 8.1x last 12 months EBITDA. This acquisition is about growth, and it will immediately expand our modular business coverage in the Western United States. With the addition of Design Space, we expect longer-term synergy opportunities primarily from incremental revenue growth. With our combined resources, we anticipate additional growth investment in the new Design Space coverage areas, more opportunities for site-related services work and a stronger offering for custom modular solutions, new equipment sales and leases. On the cost side, we see potential for optimization of the combined California fleet. In addition, there's enhanced purchasing power for operational cost savings and better leverage of marketing spend over a larger geography. In terms of fleet composition, approximately 72% of the units for modular buildings, with the remainder being portable storage containers and ground level offices. The original acquisition cost of the rental fleet assets is approximately $140 million. This transaction fits well with our disciplined capital allocation with an expected attractive internal rate of return compared to organic investment. We expect the transaction will be accretive to earnings per share and free cash flow this year. The funding for the transaction will come from our existing revolving credit facility, where available capacity was $323 million at the end of March. We estimate our leverage ratio will be approximately 1.8% on a pro forma basis at the time of closing the acquisition. Hart-Scott-Rodino review has already been filed and the 30-day window has expired. The transaction is subject to other customary closing conditions. We will not be updating our financial outlook until after the transaction is closed, and which we expect to communicate when we announce our total company second quarter earnings results. That concludes our prepared remarks. Josh, you may now open the lines for questions.

[Operator Instructions] Our first question comes from Scott Schneeberger with Oppenheimer.

I noticed the implied margin for Design Space is quite high for a private company. Could you speak to perhaps what they've been doing with rental rate, if that's a contributor? If perhaps mix of the business is a contributor as well? Just some comments on that elevated margin.

Sure, Scott. This is Keith. A couple of comments. And the first thing I would say is the business had a very good year in 2020. And I think you're spot on. We noticed very nice margin profile from an EBITDA point of view. And as we dug into it, I would say, if you look at the last 3 years, which is more of a sort of average view of the business performance, their EBITDA margin is actually very comparable to our Mobile Modular segment. And by that, I would say, an EBITDA margin in the sort of mid- to upper 30% range over the last 3 years has been more typical. So that's the first comment. As a private company, I think they won lean. They're very cost conscious. They won lean, particularly in the overhead areas. So they're well managed and have a very good margin profile. We think our modular business is a good margin profile. Theirs is also very good. On a 3-year average, we're very, very similar. And I would say, last year, they had a notably strong year. So if that helps, I think that sort of gives you a feel for how they operate.

It does. it. Next question. The -- if you could just please, speak to areas where you feel that Design Space is competitively differentiated to some of the aspects that their business model has that really, you found compelling?

Yes. I'll take that, Scott. They -- there's a few things that were really attractive to us. They're very good at complex rentals, larger complexes, and they have a very nice avenue into government business, which we thought was also very attractive. It's an area that's been strong for us recently. They do a lot of government business, which was really great. The other thing that was very nice that they do well was their custom modular group. They do a lot of turnkey larger projects, which are typically more complicated. You need to have expertise and infrastructure setup to be able to do that. And they do that very well, and it's been a growing -- nicely growing part of their business. So you take those things we thought was very nice. Additionally, for us, their container business and the inroads that they've been able to generate in areas outside of California and the branches that they set up in these other states, also was very attractive to us. So just some really nice facets of the business that are poised for additional growth, and we're ready to invest in them. So very excited about that.

And then, the last one for me, and I'll turn it over, plenty I could ask on revenue synergies. But curious on cost synergies. You didn't quantify anything as far as costs that you may be able to take out from the combination, but in your presentation deck, listed a few areas of focus. And I heard you mention that they have very well-maintained fleet. So if you could just elaborate on the cost synergy side. And is there a potential that the multiple paid could be driven down over time and how?

Sure. Scott, let me take a crack at that. I think I'll start by saying, keep in mind, as we've gone through this process, we both compete against one another in California, which is a big market for both of us. So as a result of that, until the transaction is actually closed, there are limits on some of the integration planning work that we can do and some of the sort of longer-term forecasting, both on the revenue and the cost side. And that's the primary reason that we haven't tried to put numbers to these topic areas. Now having said that, I would focus really on the revenue side here. I think you heard that in our remarks. That's really the focus. It's going to be growth. And I think it's going to be a great combination to do more in the marketplace. There will be opportunities on the cost side. When we look at the 2 organizations, I will tell you, we've worked through this process together for several months and as a result, on the McGrath side, there were positions we were planning to hire this year where we've simply delayed. And now, when we combine the businesses, we're going to have some slots where when we put the organizations together, we're actually going to be able to retain the full Design Space team. But from the point of view of the cost structure, there will be synergies there. They're actually coming more on the McGrath side, where we've delayed some hiring. We kept some slots that were open a little longer in anticipation and hopeful that we would close the transaction. So if that helps you think for framing costs, there will be opportunity there. And then, operationally, I think once our teams start working through this, they'll find numerous areas. Both businesses are well run. You put them together, there'll be more scale. There'll be best practices on both sides for how to do things smartly. We have a little bit more on the IT side. Our systems are much more comprehensive. There'll be operational benefits there. And the way we're thinking about that is there's some time that their team spans, I would say, on the transaction and operational side, that will melt away when they take advantage of our systems. And that frees them up to spend more time with customers. So those are the sort of things where we haven't put a dollar number to it, but there'll be opportunity there. When we -- if we're successful in integrating well, there'll be good opportunities, particularly revenue side, but also the cost side over the next few years.

Our next question comes from Sam England with Berenberg Capital Market.

Congratulations on the deal. The first one, could you talk a bit more about the opportunity on the education side in some of the new states that you're adding with the acquisition. I suppose, which do you see as the most attractive for expanding the education business?

Yes, Sam, I'll tell you, in some of these states, there is really significant population trending, folks moving into states like Utah and Arizona, Idaho, and the influx of population to places like that are going to generate business on the commercial side for infrastructure and other things, but also on the education side. I mean there's just no way that these places are keeping up with the amount of students that are going to be coming in. And so, this is a great opportunity for us to be able to increase our education rentals. It's a platform of additional branches that will be really attractive to us. And so, you have that. And then, you have the Pacific Northwest, which also has been a market that we've been eyeing for a while now. And this just gets us the opportunity to get in there. And not only can we get in there with our education business, but the solutions offerings that we have now makes it more economically attractive for us as school districts, not only want a classroom, they want more to go along with it. And so, we'll be really well positioned to be able to make that more attractive for us and the customer.

Great. And then, the second one, can you talk a bit about the impact Design Space has had from the pandemic over the last year? How badly was it impacted? And how far along the path are they to bouncing back? Yes, that'll be great.

Yes. They've actually done really well. Very similar to us. We kept our operational tempo up and they have done very -- the same thing. And so, we've been very impressed with how they've handled the pandemic, and they're in a very strong position in the market, and they've been a good competitor for us over the years. And so, they've been out there competing vigorously and so, we're glad to take a strong business and bring it in and help them grow.

Great. And then, maybe just one more and then I'll turn it over there. You talked about the strong team that they have in place. Is the management team sticking with you longer term? Or are they planning to exit after the transaction?

Yes. Everyone is coming over with us, except the current CEO and he's agreed to help us through the transition process. But we're taking the whole team, and we're really excited about that.

Our next question comes from Marc Riddick with Sidoti & Company.

So wondering if you can talk a little bit about maybe what their footprint looks like from -- as far from a real estate perspective, not the geographic actual locations, but maybe what their use of space, use of land might look like and maybe what the opportunities might be presented there. And then, I have a couple of follow-ups after that.

Yes. I'll take that, and Keith can chime in, in here if he has anything to add. Their -- our model has typically, and we continue to operate that way, has been larger production centers and -- covering fewer of them that cover larger geographies. Design Space has had a little bit of a different approach. They have smaller facilities that are more sprinkled in at kind of key locations. So even though that's different, we view it as very interesting because they made it work very well for them. And I think we've got some things to learn here as we look at their business. We're happy with the locations that they're in. We're happy with the infrastructure they have in those locations. It suits them well. It has served the market well as they've grown. And we're just going to learn over the next year or so here and take the best of both our companies and combining them together. So not much to say in terms of any changes there at this point, but a lot to learn.

And I guess, that kind of feeds into my next question, as I was thinking about what the -- are there any sort of top of mind go-to-market strategy differences that you could call out? Or is it too early to go over those?

Yes. It's probably a little early. As Keith said, we are a competitor. So we've been having -- we had to be careful about how much we can get into that. But I do know Design Space, they compete in parts of these markets that -- where they've developed relationships over the years, and they've done it very effectively, like the government and some of the infrastructure clients that they have in California, as an example, where they've operated for a long time. And they've been a strong competitor. And we're going to learn a lot more from them over the next months ahead here as we get into their strategic initiatives and things like that. Some of that we know already, but more to learn.

Can you talk a little bit about that government mix? Are we talking state, local, federal? And what maybe -- where some of that might come from? Or is it too early to get deeper into that?

Yes, it's a little early, but basically all of the above, state and federal. They have a very nice GSA. They're in with -- they have a GSA number. They've had a contract for a while now, but they also have good relationships with state government agencies also. So it's a combination of the both. That's very attractive.

That's very interesting and helpful. I guess maybe the last one for me for now. How should we think about the revenue mix that -- from a perspective of services -- rental-related services versus the rental [ mix ]? Is it somewhat similar to Mobile Modular? How should we think about that?

Yes. What I'd say, Marc, is if we look at the business mix, and I'm going to sort of use one numbers here to give you a feel for it. As we mentioned, they've got a very strong capability around those custom modular sales. So their sales mix as part of total revenues is higher. If you look at our Mobile Modular segment, we're roughly 80% rental operations, 20% sales. I think that their model has been more 60-40. So they've got a higher percentage of sales in their mix, but it's a very well-run business. We, as you know, over the last couple of years, have been putting much more emphasis in that area as well. It's going well for us. We've grown it. And so, our percentage is increasing, and we like how they've been operating on their side. They've done a really nice job with that.

It looks like -- and as you mentioned, as far as the leverage that was a post deal to be able to do this and kind of stay below 2x certainly is attractive. So congratulations.

Thank you.

Thanks, Marc.

Ladies and gentlemen, there appears to be the last question. Let me now turn the call back over to Mr. Hanna for any closing remarks.

Thank you very much. So I'd like to thank everyone for joining us on the call today and your continuing interest in our company. We wish you all health and safety in the months ahead. We look forward to speaking with you again in early August to review our second quarter financial results.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.