[REPLAY] Ironclad Environmental Services – Chris and Rob Michalik (Kinderhook Industries), (PE Deals, S3E8)

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2:31Hello, I'm Ted Seides, and this is Private Equity Deals. Middle market businesses are where the real action takes place. Around 200 ,000 businesses in the United States fall into the middle market size range, generally defined as generating revenue between$25 million and a billion dollars. These businesses collectively employ 50 million people, or almost a third of the U.S. workforce, and represent two-thirds of total U.S. private equity deal value. Big deals may grab the big headlines, but a lot of action in the economy and private equity industry takes place in the universe of middle market businesses.

3:12Season one of Private Equity Deals shared deals from eight well-known GPs. In season two, we discussed eight well-known companies bought by private equity firms. We can't begin to cover the massive middle market in just eight deals, but in season three, you'll get a tiny sliver of what the middle market is all about. All opinions expressed by TED and podcast guests are solely their own opinion and do not reflect the opinions of capital allocators or their respective firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Past performance is not indicative of future results.

3:49Clients of capital allocators or guests may maintain positions in securities or managers discussed on this podcast. On episode eight of season three of Private Equity Deals, Chris and Rob Mahalik discuss Kinderhook Industries' investment in ironclad environmental services. Chris and Rob are twin brothers and co-founders of Kinderhook, a 20-year-old private equity firm that manages$5 billion specializing in middle market businesses across healthcare services, environmental services, and automotive and light manufacturing. Ironclad is a leading provider of logistics-based solutions focused on the containment of industrial waste.

4:32It has 50 branches and a fleet of 29 ,000 specialized rental assets that store, separate, and transport liquid and solid industrial waste. Our conversation covers Kinderhook's identification, due diligence, and negotiation of the deal. We discuss a significant early add-on acquisition, progress to date, and the future of Ironclad. Please enjoy my conversation with Chris and Rob Mahalik. Chris, Rob, great to see you guys. Great to see you, Ted. Why don't we start with a little background on Kinderhook. Kinderhook Industries is a private equity firm like the thousands of middle market private equity firms are out there.

5:15When we started our firm 20 years ago, Tom Robb and I decided in a competitive private equity space that we needed to really show the long-term commitment to the business. So that started with being investors. We've now built an investment team of over 20 that has been with us for a very long time. Average tenure of our investment team is 14 years. We think we have a great culture, but frankly, I think most of that 10 years because we've aligned their interests with long-term value creation and stability. From a strategy standpoint, it's about the detail in the three legs of a stool that make private equity.

5:49It's our team. Everyone has to deal with deal flow. For us, it's industry expertise. We've developed strong, deep industry expertise in three distinct verticals, which we believe are non-correlated. Healthcare services, environmental services, and industrial. My partners, Rob and Cor, have been doing that for over 20 years. And this is probably our strongest franchise and one that shows real consistency. And I'm not going to steal Rob's thunder, but a lot of good things going on in the environmental industrial space. And then the third is the automotive services and aftermarket. It's not always the sexiest place to be, but it's an opportunity to continue to service the car park in the United States.

6:27Cars are still an extension of people's personality. And aftermarket accessories, aftermarket service, support for those vehicles to stay on the road longer so that people can get to work is an important component of what we're looking at. So Chris, within those three verticals, what are the types of companies or your particular style of investing that you like to find? What we're looking for is businesses that are a little bit off the beaten path, businesses that we and our operating partners know well, but maybe are pre-auction and really driven by our operating teams and our teams. I think this is an important component.

7:02Probably 70 % of the businesses we buy, we are buying control. 100 % we're buying control, but we're probably only buying 51 % to 80 % of the business and the entrepreneur family is rolling the balance. So for them, it's much more important who their partner is and what the second bite of the apple is than it is, quote, the highest price. And I was going to comment, we're looking for businesses that have a growth orientation. Our strategy is about taking lower middle market businesses and getting them to the next level. So we're often partnering with family-owned businesses or taking a controlling interest in businesses that are in transition, divestitures from larger entities where they're non-core, but we're invigorating those companies with a growth orientation and bringing the capital and the strategic advice to help get them to the next level.

7:52And often the situations an entrepreneur, a family-owned business will be started by a young person who's taking risk and they create value. And over 15 or 20 years, they build a nice company and they get to a point where to take the next step, they now need to take risk when they're at a point in their careers where they're now protecting wealth and preserving wealth. Perhaps they have a family or other consideration that they need to be mindful of that doesn't allow them to go to the bank and say, I'll take an additional personal guarantee and I'll try to buy my competitor. We step in, we offer that entrepreneur an opportunity to take meaningful money off the table, ensure that the family's taking care of the kids' education, the retirement for the family, and then they can now be entrepreneurs again and really go after the market opportunity just like they did when they were the young startup.

8:42So that's where we play. I would say the vast majority of businesses have that profile when we get involved. So before we dive into Ironclad, I feel obliged to ask, what's it like working together as twin brothers? So it's second nature when you're an identical twin. And my brother and I have been doing the same things for our entire lives. We went to college together, we went to graduate school together and we've been in the same industry our entire careers, it was really always our thought and our plan to be in business together. So I would say it's just second nature. I would say for the rest of the people that work at Kinderhook, I think it's entertaining.

9:26Because being brothers, it's hard to turn it off. So there's brotherly debates, there's brotherly arguments, and then there's firm dynamics. But overall, I think the stability of our relationship, the consistency, know each other forever, I think helps provide a sense of comfort to the firm that frankly, they know what they're getting when they're working at Kinrook and being part of this organization. And I think the consistency that knowing that the partnership is stable is something that's over time created a lot of value for all of us. Rob, we're going to dive into Ironclad. So why don't we start with a description of what this company is?

10:02Ironclad Environmental Services is a industrial and liquid waste containment solution primarily servicing industry, petrochemical, refiners, large construction sites where you're managing primarily liquid waste for removal and disposal. And environmental services is a sector that I've been investing in for over 25 years. There are some core characteristics of the industry that make it very attractive from an investment perspective. And really the most important one of those is that it's necessary. Environmental services means removing the trash, whether it's liquid waste, household waste, industrial waste.

10:43People expect garbage to be managed. They expect it to disappear. It's a necessary tenant to having a functioning society. So I always like to say, when you think about that, you need running water, maybe you need electricity, and you need waste services. So when you think about a stable business model, waste really fits the bill. And it's in some measure like a utility, yet there's not a rate cap on the returns. So good service, good assets, being in the marketplace and having a strong presence allows you to build reliable service models. In the last 24 or 36 months, as we've entered into what has been a very rapid inflationary environment, waste services have been able to maintain margin by passing price to their customers.

11:29Why? Because it's necessary. And when you think about what happens if you don't have your waste removed, it piles up in front of your house, behind your business, and that's not a tenable situation. So as long as you're able to provide that service, the customer is prepared to and willing to pay for it. And on that basis, we've always loved this industry. We've really taken the approach to find and back managers that have a good business. It is a capital intensive business. So you need to invest in new equipment, that's trucks, that's transfer stations, that's roll-off boxes and tanks. So our 20 years here at Kinderhook, we've built and owned 13 different environmental services business, seven on the municipal solid waste side, six in the industrial and hazardous waste side.

12:20And it's an opportunity. We continue to have great relationships across the industry. My brother mentioned it's one of our strongest franchises by virtue of the fact that many folks in private equity have stayed away from environmental services in the past. In the last three years, it's become pretty sexy. All of a sudden, everyone wants to own a garbage company. I've dubbed it the golden era of garbage. And he plays the Homer Simpson garbage man song. You can look it up on YouTube. The garbage man can. Anyways, and because of the ability to pass price and the stability, a whole bunch of new entrants have come to the environmental service business and looked at that as core infrastructure.

13:03So you think about some of the large pools of capital that have been raised in the last 36 months around infrastructure, environmental has come to fit their target. And that's brought a whole new level of interest in the industry. Ironclad Environmental is a business that we were introduced to about 36 months ago. One of our operating partners was previously involved with the company, had an inkling that the public parent, Will Scott, was interested in divesting their mobile mini tank and pump division. We reached out to the CFO at the time, expressed our interest in the business. He indicated that they were considering their alternatives, but weren't necessarily looking to sell at that time.

13:47They approached us a few months later and said they are going to look to divest. We quickly got our team together to evaluate the opportunity and get our work done, and were able to negotiate an attractive purchase of the business from Will Scott. And that gave us one of the top five players in the marketplace for the liquid waste containment. Their primary presence was along the Gulf Coast servicing the refiners and the petrochemical companies. You're essentially providing industrial roll-off services. So you're putting a tank in a facility, you're collecting waste. That waste is sometimes processed in the tank.

14:28Either way, you're going to pull that tank and take that volume to a treatment plant, a landfill, or other end disposal market. It's recurring. if the waste isn't removed from the plant, they got to stop the processes. So our customers are very focused on service. And when they have turnarounds in their facilities, or they have a storm event along the Gulf Coast in their facilities, they need our equipment, they need it real time. We led with service. We rebranded the company from Mobile Mini Tank to Ironclad Environmental for that reason. So let's go back into the process of your owning this.

15:09So you mentioned this came to you from one of your operating partners. What was that initial conversation like? Got a phone call. He sits on the board of our Messino Industrial Pump Division. He has pretty good knowledge of the industrial equipment as a service business. He had been involved with Mobile Mini Tank before. I think it was pretty well known that this was the orphan division of Mobile Mini. Mobile Mini's industrial storage, they lease shipping containers for storage purposes. It's a great business, very high margin, very high cash flow business for Will Scott. The tank and pump division was a much more service oriented, requires more people and more fleet as opposed to dropping a box, collecting rent, and picking up a box, which was their core business.

15:56So this resided under that umbrella. It was the runt of the family, if you will. So it didn't get its share of the capital allocation from budget. So they decided that it would be better owned by another party. When you first started looking at it, how did you dive into the due diligence? Part of being an industry expert is we have the players in our operating partner network who live and breathe these spaces and these industries all the time. I mentioned the gentleman that introduced us to the company. We also have a number of executives that operated the disposal side of the house with these types of industrial waste streams.

16:32We've owned a company called Circon Environmental. Their team was instrumental in helping us understand these assets and their customers' uses. We used to own the Environmental Quality Company, which is a large hazardous waste treatment disposal business. They utilize this asset and this service for their business for many years. So having those industry players that literally use the service, use the assets that an ironclad environmental provides on an everyday basis gives us great insight into the pricing, the value proposition, what the customers look for when they go to market and sign in a master service agreement with the provider in this category.

17:12What were your key due diligence points as you went through the process? We looked at the business and very quickly came to the conclusion that they had a great fleet of assets. They had great geography. They had great customers. They had relatively low utilization, and they were unambitious in their pricing. When we went into diligence, we spent a lot of time with management about how they drive utilization and why they haven't been more aggressive in driving price. This was in 2021 and 2022 as we're looking at the historical results. They've been targeting 2 % price increases and what at that point was starting to become a 9 % inflationary environment.

17:56And we very quickly had an aha moment with the team where they said, you're right, we have a lot of opportunity here. The cost of replacing the equipment was up double digits. we're talking 20 % and 30 % increases in the price to build a new frack tank or a new dewatering box. And that cost needs to be borne by the marketplace. And so we were able to work with the management team at Mobile Mini Tank as we went through diligence to really get a sense of which part of their asset base was most highly utilized and how we priced those, which ones were less well-utilized and how we price those, and to really come up with a good go-to-market strategy post-close to drive utilization and to drive incremental price.

18:45And that was the key to our underwriting and the diligence process. What did you see as the biggest issues or risks in the deal at the time? These assets were used heavily in the shale boom and the fracking boom in really 2012, 2013. There was almost no price that a shale driller wouldn't pay for an asset that led to a large overinvestment in fleet in the 2012 to 2016 time period when the shale boom became a bit of a shale bust and the assets flooded into the market and you saw a large drop off in demand. That sense of cyclicality presented a concern to us as you go, well, geez, when you look at these assets, did you have this boom-bust cycle?

19:33And what we did to get comfortable, that was really a one-time phenomenon, is we looked at 20 years of industrial waste tank demand. And over that 20-year cycle, you really had one bust. And you could see the bust coming by the overinvestment in the preceding three years, 2012 to 2015, 16, and then the bust in 2017, 18. Other than that, you had an up and to the right curve for utilization and growth of units and fleet, et cetera. So we're able to look at this business and really get comfortable that it provided the type of stable, predictable demand curve that we're used to and we expect from our environmental services businesses.

20:18So what happened when you went in to try to buy the deal? Talk me through the actual process. So the seller had a view of value. Naturally, that view of value is higher than our view. They contacted other parties to try to gin up a better price and a better opportunity for themselves as sellers of this asset. Fortunately for us, we had the team and the resources to be in a position to speak for our price. When push came to shove, the seller took the bird in the hand of certainty with us versus the incremental price that they may have been able to get by pushing and giving time to other parties in the market.

20:59So the dynamic of having the intellectual capital in our team, as well as having completed our diligence process early, allowed us to get the deal done at the price that we were prepared to underwrite. There's always that uncomfortable conversation and the seller went pencils down on us a couple of different times because they weren't going to move forward at the price that we were at. In a situation like this where it's clearly in your sweet spot, it's in one of your three verticals, you understand the business well, you understand the assets. How do you think about negotiating just that incremental price when you're close to the finish line, knowing that you want to get the asset?

21:39That is the secret sauce. It's not always easy. To your point, when you really have a deep knowledge and appreciation for the beauty of the asset, and I would argue that our view of the beauty was far greater than the seller's view of the beauty. There is a propensity to want to cave and just pay and get it done. We had as good of intelligence as we could gather on the alternative buyers and we felt good holding our cards. But no question about it, Ted, that is where the rubber meets the road in these types of situations. We were very happy with the price that we paid? Was there more on the table from us?

22:18Yes, but we were able to get it done. And I think part of the value proposition we have in our diligence processes, it's not just understanding what we're buying, it's trying to come up with the thesis for growth. And I mentioned that earlier. We were looking at the mobile mini tank division. We had gotten pretty close to getting a deal, we had in our back pocket the opportunity to acquire the Adler Tank business, which was their largest competitor. We knew that at the point at which we finally agreed to terms, and that made us pretty pleased with the outcome that we were able to drive. We're going to take a quick break in the action to tell you about SRS Aquium.

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23:45Learn more at srsaquium.com. That's S-R-S-A-C-Q-U-I-O-M.com. And now, back to the show. Where'd you come out in terms of pricing? We bought the business for less than seven times EBITDA. It was a very attractive price for a business that was really starting to get its legs under it. From driving price, we've been able to create a tremendous amount of value in our short ownership period by changing the expectations with our customers. So you mentioned the Adler acquisition, taking price and increasing utilization. I'd love to hear once you own the asset, how you mapped out your game plan. So I think we closed on the mobile mini tanks October 1st of 22, February 1st of 23.

24:33We closed on the Adler add-on acquisition. That made us the largest player by assets in the industrial waste tank business in North America. We looked at the overlapping geographies and we were able to take cost out of the system from a facility's perspective, leasing of yards and redeploying equipment to the greatest geography of demand and to create incremental utilization in that regard. And then we really looked at how we're going to go after price. So many of our large customer relationships are operating under master service agreements. So we'll go to Dow Chemical and we'll negotiate a master service agreement.

25:14They'll have pricing for our services and assets in that contract. It's usually a five-year MSA. And historically, for 15 years prior, there hasn't been a heck of a lot of inflation. So the notion of consistent pricing increases and new conversations on price on a regular basis wasn't part of the historical MSAs that Mobile Mini had or Adler, for that matter. Given the environment we're in, we're in a position to go back to these same customers and say, look, price is coming. We can work with you now under your existing MSA, or we're going to work with you later when the MSA comes up for renewal.

25:51But either way, we're going to have to get a price that's going to cover the overall cost of service and the expectations of what we're providing. And really, one of the benefits in the marketplace today is that new equipment is very expensive. Interest rates are a lot higher. So the notion of someone just going to the market, buying a few hundred boxes and some pull-off trucks and starting their own business, isn't that easy. Seven years ago, you could get new trucks from the manufacturers at 0 % financing. You could walk out the door and pay nothing. They were giving you the truck. Please just take it and pay me back later.

26:30Today, that environment's completely flipped. Access to equipment is much longer lead times. The price of the equipment's much higher. And therefore, the alternatives for the customer are fewer. And ultimately, it's about service. It's environmental services. One of my mentors in the industry always told me the most important asset in the waste industry, it's not garbage trucks, it's not landfills, it's not processing facilities, it's waste. The most important asset in the waste industry is waste. And you have to control the waste to drive value through your operation. And how do you control the waste?

27:05By providing great service at a fair price. And that's really what this is about. The mantra that we lead with is service. Our salespeople, our management teams make sure that our customers are getting the highest level of service. And when you're providing great service, they're going to be prepared to pay the better prices that we demand. Our competitors are not in a position to drop 300 boxes in 24 hours notice when they have an event. We are. And that's meaningful. And I think one of the things on top of all this is our environmental services team did a great job of not just understanding the assets, because understanding the asset utilization price, that's all operational.