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<DAILY TROUBLE>
Tuesday, November 24, 1998
Mac-Gray Corp.
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Phone: 617-492-4040
Website: http://www.mac-gray.com
Price (10/14/98): $11 7/16
HOW DID IT FIND TROUBLE?
Since going public a year ago at $11 a share, laundry room operator Mac-Gray has been through the cycle. After rushing into 1998 with flying colors (cold water only, thank you), these shares have turned ashen as this double found trouble along with its largest competitor, Coinmach Laundry <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WDRY)") else Response.Write("(Nasdaq: WDRY)") end if %>.
A beneficiary of consolidation in the real estate development and management industry and of the aging of laundry room entrepreneurs, Mac-Gray seemed poised to use acquisitions to wring out efficiencies from a ho-hum business.
Technology was also part of the story, with Maytag's energy-efficient, front-end loading Neptune machines rippling through the market. Also, new smart card readers were allowing Mac-Gray to bypass the tyranny of the quarter and initiate more incremental price increases and establish variable-time pricing, an economist's fantasy.
Thanks to acquisitions, Mac-Gray's sales jumped 16% in the first half of the year to $60.9 million. Most of that gain came in the second quarter, when earnings per share increased to $0.16 from $0.07 a year ago and earnings before interest, taxes, depreciation and amortization (EBITDA) heated up 55% to $7.3 million.
Still, year-to-date pro forma EPS stand at $0.23 versus $0.21 last year, a nice gain, though not impressive enough to distract investors from the company's growing debt. As some investors raised questions about competitor Coinmach and others fled from debt-laden enterprises in a general flight to quality, Mac-Gray's shares were wrung out.
BUSINESS DESCRIPTION
With operations dating back to 1927, Mac-Gray is a leading supplier of card and coin-operated laundry services in multiple housing facilities, mainly apartment buildings, condo communities, and colleges. The firm is a leader in the North American college market. It operates over 155,000 machines in more than 25,000 locations in 27 states east of the Rocky Mountains. It also sells and services Maytag equipment and distributes machines for other manufacturers.
Mac-Gray operates machines in laundry rooms under exclusive long-term leases (average remaining life of seven years) in exchange for providing the room owner with a cut of revenues. The company says it has retained 99% of its existing machine base while adding 5.1% more machines on average each year for the last five years.
Since going public, the company has continued on a shopping spree. In March, it acquired Intiron, a supplier of combo refrigerator/freezer/microwave ovens to the college market, for 1.6 million shares plus $1 million in cash. Intiron had $23.5 million in FY97 revenues.
In April, Mac-Gray spent $33.5 million in cash to acquire Amerivend Corp., a laundry equipment operator concentrated in Florida and Georgia with $18.6 million in FY97 revenues. Also in April, the firm paid $11 million plus 250,000 shares for Copico Inc., an operator of card and coin copy machines in academic and other locations with $7.1 million in FY97 sales.
Competitors include Coinmach and Web Service Co. Insiders owned 28% of the stock as of the latest proxy.
FINANCIAL FACTS
Income Statement*
12-month sales: $103.1 million
12-month income: $6.4 million
12-month EPS: $0.67
Profit Margin: 6.2%
Market Cap: $148.8 million
Enterprise Value: $209 million
(*Based on reported pro forma results)
Balance Sheet
Cash: $8.6 million
Current Assets: $31.5 million
Current Liabilities: $27.5 million
Long-term Debt: $68.8 million
Ratios
Price-to-earnings: 17.1
Price-to-sales: 1.4
EV-to-sales: 2.0
HOW COULD YOU HAVE SEEN IT COMING?
Though Mac-Gray's shares have fallen over 50% from their high, the company's enterprise value has dropped just 25%. The reason is that acquisitions have pushed long-term debt from $5.4 million in December to $68.8 million today. With short-seller Manuel Asensio raising questions about operating results at the debt-laden Coinmach, it wasn't surprising that investors would start factoring in the challenges of growing a capital intensive business by taking on more and more debt.
WHERE TO FROM HERE?
Zacks shows consensus earnings estimates of $0.65 a share for FY98 and $0.83 for FY99. Yet those numbers look wrong given that the company earned just $0.07 per share in the first quarter rather than the $0.15 that Zacks is reporting. Even after including Amerivend, first half earnings would have been just $0.26 per share rather than the $0.32 those estimates suggest, and even that number includes a one-time tax benefit of $0.4 million.
While Mac-Gray should be able to squeeze out operating efficiencies from its laundry business, and the Intiron and Copico deals suggest the company sees more profitable opportunities elsewhere. That's not an especially encouraging sign since it is mainly a laundry room outsourcing firm. At the same time, the company already has about $59 million outstanding on a new $90 million senior secured credit facility.
Mac-Gray has plenty of cash flow to cover the interest expenses, but its ability to grow the business appears constrained. That may be one reason why CFO John S. Olbrych resigned August 28 "to devote more time to his family."
The company does operate in a generally recession-resistant space. And unlike Coinmach, it has actual earnings to report. In a market full of small cap bargains, though, you can probably do better.
-- Louis Corrigan
([email protected])
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