Business Breakdowns
· Matt Reustle, Asif Jeevanjee
[00:00:00] S0: From an investor perspective, even from the business's perspective, is there a contract type of those three that is most preferred? What results in the highest margins, or something that you see a transition towards more and more? [00:00:00] S1: Contracts are evenly split across the business by those three types. And that hasn't changed very much over time. We don't have enough information to discern different levels of profitability by contract type. And the contract structure that's adopted is largely down to the circumstances of the client. Some clients prefer a fixed price contract because it gives them certainty about what the outlay is each month in a subsidized cafeteria. Other clients may want to share in the upside potential and elect a P&L contract. Whichever structure is written into the RFP, Compass will factor that into their bid terms to ensure that the structure is commercially attractive to them. And that's from a margin point of view, but also from a risk point of view. [00:00:00] S0: On that point, in terms of retention, I'm trying to get some appreciation for how sticky these contracts might be. Because you are on the corporation's premises, their facilities, I imagine there is some ability to switch and it's not going to be a complete overhaul. What does retention tend to look like for the industry and are there things that can make them more sticky? Good service and steady performance is certainly going to be one of those. But are there hidden things that maybe impact the retention rate and stickiness of any of these contracts?
· Matt Reustle, Asif Jeevanjee
[00:00:00] S0: On that point, in terms of retention, I'm trying to get some appreciation for how sticky these contracts might be. Because you are on the corporation's premises, their facilities, I imagine there is some ability to switch and it's not going to be a complete overhaul. What does retention tend to look like for the industry and are there things that can make them more sticky? Good service and steady performance is certainly going to be one of those. But are there hidden things that maybe impact the retention rate and stickiness of any of these contracts? [00:00:00] S1: There are switching costs involved. The retention rate for Compass is 96%, which is industry leading. That is very, very high. And when you think about the scale of the business, $42 billion of revenue, if you're hitting a 96% retention rate, that means you're losing 4% every year, which is a lot of business which they have to then replace. So to tread water, they've got to win, let's call it $1.5 billion a year. To grow as they have, they've got to do that again. Retention is really important. I like to think of it as... in investing, Warren Buffett's rule is don't lose money. I think in contract catering, it's do not lose a contract that you've won. This is really the secret sauce to Compass's ability to grow. They've excelled not only at winning business, but on hanging on to business that they've won.
· Asif Jeevanjee, Matt Reustle
[00:00:00] S1: There are switching costs involved. The retention rate for Compass is 96%, which is industry leading. That is very, very high. And when you think about the scale of the business, $42 billion of revenue, if you're hitting a 96% retention rate, that means you're losing 4% every year, which is a lot of business which they have to then replace. So to tread water, they've got to win, let's call it $1.5 billion a year. To grow as they have, they've got to do that again. Retention is really important. I like to think of it as... in investing, Warren Buffett's rule is don't lose money. I think in contract catering, it's do not lose a contract that you've won. This is really the secret sauce to Compass's ability to grow. They've excelled not only at winning business, but on hanging on to business that they've won. [00:00:00] S0: That 96% tells me that there's something very sticky about their business. And I appreciate that you mentioned it still requires them to replace a billion and a half of revenue each year just to tread water. What would you point to in terms of competitive advantage that they might have versus their peers? And anything else on the switching costs that would be associated with it? If I can comprehend what that would look like, it would be helpful. As an example, what would it entail to move from one provider to the next? Beyond we have this crew that's shown up and served the food out of here on Friday, on Monday, it's going to be this group. What else goes into it that makes it more complex?
· Asif Jeevanjee
[00:00:00] S1: Contracts do move around every time you win a contract from another provider. There are bid costs involved and there are mobilization costs involved, which can be quite high. So those are the switching costs, but also the incumbent operator is going to know how the operation works and what the needs of the client are. So there is an advantage to the incumbent. But I think Compass's industry leading retention is really down to making a science out of sales and retention. They keep a very close eye on what it is that the customer wants. And when I say the customer, one of the things that makes this industry quite unusual is there are two customer groups. There's the client and there's the consumer. Whether it's through surveys or through technology and data, Compass has a very, very good idea of if the client or the consumer is not happy. They will work very hard to fix that, long before the contract comes up for renewal. So by the time it's coming to the renewal point, they're in a really good position to hang onto it. It's also important to point out that it's going to be very difficult to achieve 100% retention. Because, for example, a client might change its factory footprint and close a factory or consolidate offices and therefore a site will disappear, which is out of Compass's control. So there'll always be some contract loss.
· Matt Reustle
[00:00:00] S0: Yeah, I can imagine scenarios. To your earlier point, the incumbent understands the operation very well. They can probably price the contract to that specific setup. While new bidders might not appreciate it, might come in with a lower price, and it might not be bad business to lose in that sense if what is required is going to undercut you on pricing, to the extent that that happens, I could certainly see it. What else goes into their model in terms of, as you mentioned, being the 800 pound gorilla? Maybe we should go back in time and cover some of the history and build up to it. That might be a good place to start because I want to work towards how they've gotten to this place. What is the origin story of Compass? Can you bring us back to the beginning and the formation of this company? How far it goes back and then we can work our way forward.
· Asif Jeevanjee
[00:00:00] S1: It's a really interesting history, fascinating because there have been so many plot twists along the way, but also I think it's a marvelous story of resilience because Compass has faced a number of challenges over its more than 80 year history. Every time it's come out stronger. The origin story really begins in World War II. The Churchill government in Britain at the time passed legislation that said any large munitions factory has to start operating a clean and safe kitchen and produce nutritious food for the employees in the factory. This was important because up until then, many of those workers would have been subsisting on meager rations. And it was important for their productivity and contribution to the war effort that they were well fed. What was interesting is some entrepreneurs saw this legislation and decided to start a catering business to help these factories meet their obligations. Two of the companies that were started at that time were Bateman Catering and Midland Catering. I'll come back to those companies. Interestingly, after the war, the catering business basically continued to flourish because employees quite liked the idea of meals being provided by their employer. And some of the more paternalistic employers quite liked the idea of looking after their employees, and looking after their health and well being. Also, there were more and more women starting to enter the workforce. In peacetime, the industry continued to grow and grow, and in the 1960s, a British conglomerate called Grand Metropolitan acquired Bateman Catering and Midland Catering, merged them together to form, effectively, what is Compass today. The business continued to flourish, and in the 1980s, the management of the division within Grand Met did a huge management buyout of what is effectively Compass. And a year later they took it public. Compass grew and grew through the 80s and 90s. It became known as the quintessential defensive growth stock, probably what today would be a quality compounder. The trajectory came to an abrupt end though, in 2000, when another conglomerate called Granada effectively bought Compass. There was really very little overlap between the two businesses, but the industrial logic was that Granada wanted to put its hospitality assets into Compass so that it could become a pure play media company in a red hot TMT market.