Business Breakdowns
· Lucy Adams
[00:00:00] S2: They take a unique approach to their restricted stock program. For most companies that grant restricted shares, they typically vest over a period of a few years. Typically three to five years. But at Watsco, they cliff vest at retirement, so they vest all at once at age 62 or older. If an employee leaves the company for any reason other than death or long-term disability, 100% of the awards they have amassed over the years are forfeited. But if they remain with the company until retirement, that's when they truly benefit from this wealth creation developed over time and aligned with shareholder wealth. The plan seems to be working. Since its inception over 25 years ago, only 8% of these shares have been forfeited. Now, there are over 160 of the company's key leaders who get to participate in this plan. And what that means is that there's a large family all pulling in one direction and working to drive change at Watsco and even in the industry itself. We've actually heard firsthand how motivational that is and the energy in the room that it creates and that alignment. I think it forces them to think long term and ultimately make long-term decisions. You'll hear management say that quarters are important, but quarter centuries are mission critical. This really is a business that is setting itself up to hand down to the next generation. This plan reinforces that ownership culture, while also creating stability in their leadership team. They retain these key leaders for the duration of their careers, and they are industry veterans. They have a wealth of industry knowledge. They've been through a number of cycles, seen it before, and then share that knowledge with the next generation. I think that's quite powerful. But it also influences the type of new talent that Watsco can attract. It's essentially a great recruitment tool because it appeals to those who can think long term. New joiners must really want to be part of this business because they've got to wait many years for these shares to vest. As you'd expect, the family are significant shareholders of this restricted stock, and they typically receive Class B shares. They have enhanced voting rights versus the common stock. This dual-class structure allows the family to maintain decision-making power, ensuring the continuity of their long-term vision for the company.
· Lucy Adams, Matt Reustle
This plan underpins that ownership culture. It provides stability and consistency in this business. [00:00:00] S0: The sub-10% forfeiture of those RSUs is quite a startling number, and the stock performance may tell the story in terms of it being too much to give up or very hard for a competitor to bid on. On the point of the Class B shares and that different structure, was that something that was always in place, or did that evolve over time? [00:00:00] S2: It dates back to that period in the 1990s that we spoke about earlier. When the business was growing rapidly, it partnered with other manufacturers and issued additional shares to support its growth and acquisition strategy. The dual-class structure was introduced to allow the family to maintain control while also allowing for broader investment through the common stock. This move is consistent with what other founder-led and family-controlled businesses have done. It's about balancing external capital needs with internal control. [00:00:00] S0: It's nice when you have a good track record and precedent as investors. I've come across some businesses before with similar setups and perhaps didn't have as much confidence. One of those things has a certain nonlinear impact on how I view a stock, depending on the success rate of that management team. When you think about risks for this business, they have a long track record and have executed on this playbook. What stands out as a risk for Watsco?
· Matt Reustle, Alan Murran
[00:00:00] S0: It's nice when you have a good track record and precedent as investors. I've come across some businesses before with similar setups and perhaps didn't have as much confidence. One of those things has a certain nonlinear impact on how I view a stock, depending on the success rate of that management team. When you think about risks for this business, they have a long track record and have executed on this playbook. What stands out as a risk for Watsco? [00:00:00] S1: There are a couple of risks that we think about. One would be increased private equity involvement in the space. It's more on the contractor side. That's where we've seen private equity consolidating, but it still remains highly fragmented. Increased consolidation here does give the contractors greater buying power. That being said, larger contractors would probably want to deal with a larger distributor to benefit from the density of the stores or the breadth of the product offering. In addition, PE consolidation on the distributor side is harder given the family ownership dynamics and the requirement to have manufacturer consent. But success here could drive up prices or make it more expensive for companies to execute their M&A strategy. In addition, you'd have the risk that there's some product disruption to the HVAC industry. This would be where new technology replaces traditional air conditioning or changes the distribution model. That being said, Watsco is pretty adaptable and it's quite hard to bypass licensed contractors in this space.
· Alan Murran, Matt Reustle
[00:00:00] S1: There are a couple of risks that we think about. One would be increased private equity involvement in the space. It's more on the contractor side. That's where we've seen private equity consolidating, but it still remains highly fragmented. Increased consolidation here does give the contractors greater buying power. That being said, larger contractors would probably want to deal with a larger distributor to benefit from the density of the stores or the breadth of the product offering. In addition, PE consolidation on the distributor side is harder given the family ownership dynamics and the requirement to have manufacturer consent. But success here could drive up prices or make it more expensive for companies to execute their M&A strategy. In addition, you'd have the risk that there's some product disruption to the HVAC industry. This would be where new technology replaces traditional air conditioning or changes the distribution model. That being said, Watsco is pretty adaptable and it's quite hard to bypass licensed contractors in this space. [00:00:00] S0: The contractor roll-ups by PE—they're getting their benefits from the consumer base to start and slinging maintenance contracts for whatever it might be, and tying in that recurring revenue makes them easier targets or prey compared to a business like Watsco. An interesting one to monitor. Would you point to anything else structurally about the culture that really stands out outside of the incentive program? Even if it's qualitative in nature, is there anything you picked up on?
· Lucy Adams
[00:00:00] S2: Watsco has the gold standard ownership culture, underpinned by a decentralized model. You can think of Watsco as a company of entrepreneurs. Management and employees think and act like owners of this company, and they are making decisions for the long term. We went out to their headquarters in Miami, and it truly brought the concept to life for us. We sat around what I'm sure was a purposely round board table, and the door was open throughout our conversations with key leaders popping in; it was clear that we were sitting amongst their chosen family. I noted the phrase "competition of ideas," and they had a passion to continually evolve, be better, be smarter, and do things differently. Also, what's important is that they are looking to disrupt themselves as leaders. At their headquarters, there are about 120 people. There's only a small team of at most 20 people involved in the business operations. They support the 700 or so sales locations, and it's their job to be helpful to the local leaders, with no one telling these managers what to do. Instead, it is that small team's job to encourage the businesses to share best practices, to give them the resources they need to grow their businesses, and then correctly incentivize them through various equity programs. What's interesting is that across their 700 or so sales centers, not one of them has Watsco above the door. This decentralized model empowers these local leaders, giving them the autonomy to make decisions and ultimately the flexibility or agility to react to changing market conditions or the evolving needs of these contractors. What that means is that multiple people are innovating in this business, trying different ways of doing things, and learning from one another. Buffett has spoken about the power of decentralization. When it's done correctly, the people working in these decentralized businesses find it almost identical to running their own show. That's exactly what we have here at Watsco.
· Matt Reustle
[00:00:00] S0: We always close these conversations out capturing the lessons. I think Watsco is a business that is studied, and we've delved into many reasons throughout this conversation. But what stands out the most to you in terms of lessons from Watsco that you could potentially apply elsewhere as an investor?