Business Breakdowns
· Matt Reustle, Lucy Adams
[00:00:00] S0: Thinking about the trajectory of that revenue growth, you mentioned the acquisitions over the years and joint ventures. The carrier deal we touched on a little bit might be good to paint a bit more of a picture about that. How have they approached growth? Whether it's just an organic pricing-plus-volume model that's playing out, with occasional M&A, or how deliberate they are about M&A? More just in terms of the top line and expansion of the business. [00:00:00] S2: We would expect organic revenues to grow at around 5%. Let's break that down between volume and price. If we start with volume, we have industry unit volumes growing at around 3 to 4%. Therefore we'd expect both equipment and parts to grow in line with that. Watsco tends to grow a little bit more, and that's a combination of market share gains and the fact that 60% of their network are in these faster-growing Sun Belt states. If we turn to price and mix, that adds a further 2 to 3% of growth each year. This is primarily driven by two things. First, we have the typical annual price increases by the manufacturers, so they typically realize a below-single-digit growth rate each year. Then we have a regulatory-driven mix impact every 10 years or so, and we smooth that out over time. If I add volume and price together, that gives us a 5% organic growth rate. There are other growth drivers that we've seen over the years. M&A is a key one, and it's opportunistic. If we smooth that out, we expect that to add another 2% to growth.
· Lucy Adams, Matt Reustle
[00:00:00] S2: We would expect organic revenues to grow at around 5%. Let's break that down between volume and price. If we start with volume, we have industry unit volumes growing at around 3 to 4%. Therefore we'd expect both equipment and parts to grow in line with that. Watsco tends to grow a little bit more, and that's a combination of market share gains and the fact that 60% of their network are in these faster-growing Sun Belt states. If we turn to price and mix, that adds a further 2 to 3% of growth each year. This is primarily driven by two things. First, we have the typical annual price increases by the manufacturers, so they typically realize a below-single-digit growth rate each year. Then we have a regulatory-driven mix impact every 10 years or so, and we smooth that out over time. If I add volume and price together, that gives us a 5% organic growth rate. There are other growth drivers that we've seen over the years. M&A is a key one, and it's opportunistic. If we smooth that out, we expect that to add another 2% to growth. [00:00:00] S0: I know it could be hard to model any future M&A or take any forecasting or view on that. How much does that play a role? Whether it's new joint ventures, acquiring more distributors, is that a key piece of the DNA? And maybe it was in the beginning, and it is now. But how would you describe that in terms of playing a role?
· Alan Murran
[00:00:00] S1: It is an important driver of returns through the cycle. It's worth understanding what types of companies that Watsco does buy. These are family-run distributors and they can be up to third generation. As a consequence, deals can take years to come to fruition and often require some sort of catalyst within the family. In the meantime, Watsco's pitch to these companies is compelling. They say, come and join our Watsco family. That's not just talk. It's backed by a decentralized philosophy with the companies retaining their brands and their teams. Then they benefit from Watsco's expertise, their capital, and their technology. Broadly, there are three components to Watsco's M&A philosophy. One is cultural alignment. The second one is about the fact that Watsco looks to acquire quality businesses. The third is around financial discipline. If you think about culture, this is all about the alignment between the selling family and Watsco. It's probably the most important thing for Watsco. The second is around the fact that Watsco looks to buy performing businesses and not turnarounds. Finally on financial discipline, they look to use minimal debt in their M&A. As the leadership of Watsco likes to say, they never bet the ranch. This philosophy ties back to the family ownership that wants a company to endure and succeed over the long run. When you look at 15-plus years of transcripts, you can see this philosophy consistently articulated by the entire management team. What's also interesting is the growth potential for a company underneath the Watsco umbrella. They did a deal with a distributor called Russell Sigler here. They bought a 35% stake in the business back in 2017. If you look at the accounts today, you can see this value of the stake as it's based on a fixed multiple of operating profit. Therefore you can calculate that the operating profit has grown over 400% since they did that deal. That's a great example of the potential benefit of these acquisitions to investors. This is due to both hard work at the subsidiary, and also Watsco's expertise, relationships, capital, and technology. These technology improvements have been and continue to be an additional catalyst for deals. Since 2017, they've done over nine deals, adding over $1.2 billion of revenue. They have the balance sheet in place and the appetite to do more deals.
· Alan Murran, Matt Reustle
It's really about whether the opportunities arrive, which are driven by what's happening with the families and also by the technological improvements that Watsco is adding. [00:00:00] S0: The 35% is notable, catches my ear. Is that common for them to acquire minority stakes in businesses or sub-50% ownership in businesses or was that more of a one-off? [00:00:00] S1: Normally, they acquired the entire business. In the case of Russell Sigler, it was one of the larger acquisitions and it was structured so that the family did not want to sell the entire business. From day one, there's an agreement in place that allows Watsco to purchase additional equity at a fixed multiple. [00:00:00] S0: Nice that you get to see the stake and you can track it over time. It helps the analysis. To touch on the JVs, the carrier-type deal, how much does that play a role in the growth engine and how much flexibility do they have to do more of those in the future? It's different than M&A in terms of tucking in a distributor. It's more strategic in terms of what they're doing. How would you describe that and the potential for that to happen again in the future and how key it is to the business?
· Matt Reustle, Alan Murran
[00:00:00] S0: Nice that you get to see the stake and you can track it over time. It helps the analysis. To touch on the JVs, the carrier-type deal, how much does that play a role in the growth engine and how much flexibility do they have to do more of those in the future? It's different than M&A in terms of tucking in a distributor. It's more strategic in terms of what they're doing. How would you describe that and the potential for that to happen again in the future and how key it is to the business? [00:00:00] S1: It's an interesting opportunity with Carrier. In terms of future opportunities with Carrier, in a number of those nine deals, Carrier continued to partner with Watsco during acquisitions by folding the deal into a joint venture structure where Watsco owns 80% of the acquired company and Carrier owns 20%. They continue to partner on that, and Carrier has remained Watsco's largest supplier, representing 65% of their purchases. [00:00:00] S0: Might be good to get into the history of that transaction as you mentioned.
· Matt Reustle, Alan Murran
[00:00:00] S0: Might be good to get into the history of that transaction as you mentioned. [00:00:00] S1: It is a very interesting deal. The history of Carrier itself is interesting as well. This history starts 120 years ago. The story is that there was a printing plant in Brooklyn where, during the summer, humidity was ruining the paper. The company asked a man named Willis Carrier to come up with a solution. He invented a system that used chilled coils to cool and dehumidify the air. That was the start of the modern air conditioning industry. Willis went on to found Carrier, which today is one of the largest manufacturers in the HVAC space. Then, throughout the 1990s and 2000s, Watsco wanted to manage more of Carrier's distribution. In 2009, they executed an original joint venture with Carrier that nearly doubled Watsco's revenue at the time, adding about a billion dollars. It was a transformational deal. Watsco financed this with equity. This was similar to the deal with Gemaire 20 years ago. This was designed to align Carrier with this joint venture and to the ultimate success of Watsco. What's interesting is that if you study the disclosures at the time of the deal, you can see that Carrier's margins were only around 2%. That was roughly a third of Watsco's margins at the time. Those margins have now grown sixfold. Win-win for both parties. The next step of this collaboration was that they agreed to pursue additional joint ventures for additional regions in 2011 and 2012. They have done more deals more recently.