Business Breakdowns
· Matt Reustle
[00:00:00] S0: To paint the real world picture, I can remember distinctly having an issue with my heating system this past year; I called someone for maintenance. They checked it out. It's some very old system that needed a very specific part. They were calling around for it. I'm imagining that is where a Watsco distributor comes into play. Can you tell me if that is the correct example? And in general, would you say that the just-in-time, I need this at the moment is a big piece of their service? How much are they doing that versus well in advance project planning around HVAC equipment installations, maintenance, and more.
· Lucy Adams
[00:00:00] S2: I think that residential end market example is a great one, not only because we can all relate to it, but because that immediate need for repair and replacement products in the home is what generates the majority of Watsco's revenues. If your unit breaks, you want it fixed quickly. But it's not a DIY job. It requires a licensed professional. As you said, that first step is searching for and calling up your local contractor who visits your home, diagnoses the issue, and recommends a solution. It's at this point that the contractor would go to their local Watsco store to search for and buy that part that is needed to fix the problem. It's also at this point that the contractor might draw on the technical expertise of a Watsco salesperson. You use the example of helping to find a compatible part for an older system. Once they have both that knowledge and the part, they return to the home to complete that repair. What's interesting here is that the contractor makes a recommendation to the homeowner on what they should do. That's what puts the contractor at the center of this industry. It's why Watsco is laser focused on the contractor. They put them at the center of their universe and are focused on improving that contractor's experience, for example, by thinking about ways to make their life easier and helping them to be more efficient and more productive so that the contractors can grow their businesses. Fundamentally, the success of the contractors is what drives Watsco's growth.
· Matt Reustle, Lucy Adams
[00:00:00] S0: Can you give a sense just in terms of the market competition where Watsco ranks in terms of whether it's market share or any other numbers that you could just put around the business? [00:00:00] S2: This North American HVAC distribution market is valued at around $64 billion today. And that is primarily served by over 2,000 distributors. It's highly fragmented and primarily served by many local and regional players. Watsco is the largest national distributor. They have 11 to 12% market share and they're actually more than two times the size of its next largest competitor. After the top three or four players, the size of the competition drops away quite quickly to these smaller local players. A key differentiator between Watsco and its largest competitors is that Watsco is exclusively focused on the HVAC market, whereas the number two and number three players are actually more diversified across HVAC, plumbing, and other industrial end markets. They have that slight competitive edge in being able to focus on that narrower addressable market.
· Lucy Adams, Matt Reustle
[00:00:00] S2: This North American HVAC distribution market is valued at around $64 billion today. And that is primarily served by over 2,000 distributors. It's highly fragmented and primarily served by many local and regional players. Watsco is the largest national distributor. They have 11 to 12% market share and they're actually more than two times the size of its next largest competitor. After the top three or four players, the size of the competition drops away quite quickly to these smaller local players. A key differentiator between Watsco and its largest competitors is that Watsco is exclusively focused on the HVAC market, whereas the number two and number three players are actually more diversified across HVAC, plumbing, and other industrial end markets. They have that slight competitive edge in being able to focus on that narrower addressable market. [00:00:00] S0: I love markets like this where you have a lot of fragmentation. You see some players emerge as having market shares that are significantly larger, as you just mentioned, but still a fraction of the overall market. Maybe we can get into a bit of the history. Alan, you tapped into it at the very beginning in terms of late '80s launch here. What have been some of the evolutions of this business, how did it evolve into what it is today and whether there were key players involved or anything else along those lines.
· Alan Murran
[00:00:00] S1: It's a 50-year journey of entrepreneurship and evolution that was driven by Watsco's founder and CEO, Albert Nahmad, and now carried forward by his son, A.J., whose background is a true entrepreneurial story. He was born in Panama and then got a scholarship to study in the States. After graduating he got a job in consulting and then moved into mergers and acquisitions. It was here that he really learned this lesson that continues to impact Watsco's culture today. That's the power of decentralization. The conglomerate where Al worked had a command-and-control approach that he felt stifled innovation and eroded value. He wanted to do it differently. He left and went to look for a business to buy. After about a year of looking, he found this company called Wagner Tool and Supply Corporation, whose initials form Watsco, and they were a manufacturer in the HVAC industry. Al, with some financial help from friends and family, bought his original stake back in 1972. Now if we turn to his son and Watsco's president, A.J., he's really been immersed in the business his entire life, and as a consequence, he's learned about all aspects of Watsco. He interned during the summers before joining the company around 20 years ago. We've been invested in Watsco for about eight years now. We've been out there and met with A.J. a number of times. What's always come across is his passion and energy for the business as well as his deep interest and understanding of the benefits of technology. I would think about Watsco's history in a series of chapters and I'd probably call out two of them. One would be their initial move from manufacturing to distribution, and then the second one would be the transformational deal that they did with Carrier. This move from manufacturing to distribution is quite an interesting story. It goes that one day, Al received a prospectus from his bank, giving him the opportunity to buy one of his customers, a company called Gemaire, who were a distributor for the manufacturer Rheem. Watsco entered an auction and bought the company. Interestingly, they've done over 70 deals since and have not entered another auction. Al structured this original transaction as a joint venture. The reason was he wanted to align the incentives between Watsco and the manufacturer and share the risk with them.
· Alan Murran, Lucy Adams
This thoughtfulness on incentives is something that we continuously see across many areas of Watsco. In fact, they also use this same joint venture structure when they did the Carrier deal 20 years later. [00:00:00] S2: After this initial move from manufacturing into distribution, Watsco looked to grow by buying more of Rheem's distributors. As that became more difficult and slowed, they knew that they needed to go out and form relationships with key leaders at other manufacturers. During the 1990s, we saw this shift from single-brand to multi-brand distribution. That was an important strategic move for Watsco because it decreased their reliance on this one manufacturer, Rheem, and it also acted as the next leg of growth for the business. There was a period of three years in the 1990s, from 1995 to 1997, where we saw them complete over 20 deals as they partnered with other manufacturers. This meant that they were able to broaden their footprint, broaden their product offering, and reduce their risk profile. This buy-and-build strategy has helped it to become the multi-brand business that it is today. You can think of Watsco as an aggregator of about 10 or so major operating companies, and each one of these operating companies or subsidiaries has an exclusive relationship with one of the leading domestic manufacturers to sell their products in specific regions in the U.S.