Business Breakdowns
· Chadd Garcia, Zack Fuss
[00:00:00] S1: If you look at the history of them buying back franchises, most years they're spending less than $10 million. It historically has been small. There have been a couple years. So if you look at 2018, 2019, they did a couple large transactions where cumulatively they spent just under $200 million M&A at Roto-Rooter. I don't think that there are too many of those opportunities out there where you can do a large deal in one fell swoop. There are 360-ish franchises around. I think they'd probably want to buy them all, but it's going to be a franchise here, franchise there. Probably less than $10 million a year in M&A. At Roto-Rooter, I think that the opportunities to do big deals are probably gone. When I talk to the CFO about it, the price isn't really as much of an issue. The determining factor is just when the franchise owner wants to retire and exit the business. [00:00:00] S0: And then in terms of business mix, I know emergency plumbing services are kind of their bread and butter, but their excavation business seems to be growing and significant. How have they been able to cross the chasm from that consumer to B2B side of the business? And what does the opportunity look like in furthering that?
· Zack Fuss, Chadd Garcia
[00:00:00] S0: And then in terms of business mix, I know emergency plumbing services are kind of their bread and butter, but their excavation business seems to be growing and significant. How have they been able to cross the chasm from that consumer to B2B side of the business? And what does the opportunity look like in furthering that? [00:00:00] S1: Well, they have a commercial business. So you have the residential drain cleaning business, which is probably about 17% of sales. You have another 13% for residential plumbing. So, just replacing faucets, replacing garbage disposals. But they've been in the commercial business for some time because they also need plumbing services and drain cleaning services. Excavation is a bit different. So that's where you're partnering with contractors on very large jobs. That's a little newer. I think it's something that they are focused on quite a bit. They talked about it on the call today. It's a more competitive business. They want to be part of it. And so they've talked about the margins coming down a little bit because they're pricing to be a little bit more competitive in that business, but again, it drives large volumes. [00:00:00] S0: And what's the margin profile of Roto-Rooter overall and how has that trended?
· Zack Fuss, Chadd Garcia
[00:00:00] S0: And what's the margin profile of Roto-Rooter overall and how has that trended? [00:00:00] S1: It's about 25% EBITDA margins in any given year, and it kind of goes up and down in any one quarter, any two quarters, but about 25% EBITDA margins. The one interesting thing from the call today was that their branches are performing remarkably well. And that makes sense because the corporate's got a lot more control over the branches than they do the franchises and independent contractors. Revenue grew overall, but leads coming in were down 7-8%. And so what that tells me is that they're probably being less aggressive on the search engine optimization and competing in that manner, which may have lowered their leads, but the leads that they get, they are converting those to sales at a higher rate. [00:00:00] S0: So they're seeing higher quality leads. I guess just to make sure that we have a good understanding: It looks like around two-thirds of their EBITDA is from their branches, whereas the remaining third are split between contractors and franchisee fees, with the franchisee fees being a smaller proportion of that. Can you just walk us through the basics of the three models and how they're different?
· Zack Fuss, Chadd Garcia
[00:00:00] S0: So they're seeing higher quality leads. I guess just to make sure that we have a good understanding: It looks like around two-thirds of their EBITDA is from their branches, whereas the remaining third are split between contractors and franchisee fees, with the franchisee fees being a smaller proportion of that. Can you just walk us through the basics of the three models and how they're different? [00:00:00] S1: With respect to the branches, you own the whole business. So it's a normal corporate income statement. With respect to the franchise fees, they have 360 franchises. So if you look at, maybe they have $7 million in franchise fees a year. So you divide that out, that's probably $15,000 per franchise. They'll tell you that what the franchises pay is determined on the population base that they serve, but they're not getting much money from the franchises and they don't spend any money on them. So that should be the highest margin business, if it's close to 100% margin, but it's small, 6% of their overall earnings. And then 21% of their EBITDA comes from their contractors. And so that's the 28% royalty that they get from their contractors. But they supply a lot of the marketing services and the back-office functions. So that's going to be higher margin than their branches, but less than the franchises. [00:00:00] S0: And then how has it been evolving over time in terms of mix? [00:00:00] S1: They've been slowly acquiring franchises and converting them either into independent contractors or branches.
· Chadd Garcia, Zack Fuss
[00:00:00] S1: They've been slowly acquiring franchises and converting them either into independent contractors or branches. [00:00:00] S0: And then, you know, you haven't made a lot of mentions to management, although typically in stories where capital allocation is a primary driver of value creation, management's important. I know the CEO of the business is a lifer. What's your experience with the management of this company and what does succession look like there?
· Chadd Garcia
[00:00:00] S1: Well, most of my experience has been with the CFOs, primarily the former CFO over the course of several years. Since I invested in this in the 2000s, I've recently started spending a lot of time with the current CFO. But they are hard to get in front of. They are covered by one, two, three sell-side firms at any given time. These sell-side firms tend to be on the smaller side. So it's hard to get to some of the conferences that these guys go to and get in front of them. Back to the CEO, Kevin McNamara. He started out at the pharmaceutical services business Omnicare. He became general counsel of Chemed in the '80s. He became Chemed's president in the '90s. In the early 2000s, he became the CEO. He's 70 years old and doesn't seem to be stopping yet, but given his age, it's good to be looking at who's next in line. Nicholas Westfall, the current CEO of VITAS. He's been with the company, I believe, since he graduated from business school in '09. He's been a long-time participant of the quarterly calls. It would be my guess that he's probably next in line for the CEO job, given his age and VITAS's relative size to their overall business. Regarding the company's culture, I see it in their actions. Like how do they allocate capital? Are they consistent with what they said they would do? Are they consistent with what they've communicated to me that they exist to grow their free cash flow per share in the business units, like at VITAS? How do they treat their patients? Do they go above the Medicare cap for high-acuity patients from time to time? From time to time they do. It costs the company money, but it's the right thing to do for the patients. When you go back to the fine that they paid for the False Claims Act charges, it seemed to me that in that situation they were treating high-need patients when the reimbursement rates were too low. A lot of the other industry players weren't doing that. In my mind, that shows the integrity that the team has and management's culture. Do they treat their employees well? During the post-COVID healthcare-worker crunch and high inflation, they implemented a substantial retention program in their business, and they were able to recruit employees from other firms. Are they good spokespeople for the industry? During that same time, their margins were lower than usual, but their margins were still satisfactory.