Acquisitions Anonymous - #1 for business buying, selling and operating - Should we buy this $12mm seller of lock systems to prisons? - Acquisitions Anonymous 220

Episode Date: August 18, 2023

Girdley (@girdley), Heather (@EndresenHeather), and Bill (@BillDA) have quite the interesting deal this week. The company manufactures locking devices and security devices used in prison systems. While it fails the cocktail party test- it has some interesting elements as well. Today's deal comes from Axial.  Axial is a trusted deal sourcing platform serving professional acquirers in the American lower middle market.___________________Thanks to our sponsors!Rejigg - Get connected to owners looking for exits.Rejigg is a platform built for searchers who want to meet directly with small business owners. They have an in-house team doing outreach, finding owners who are excited to meet with people ready to buy their companies. Searchers who join their platform often have 5-10 meetings scheduled directly with owners for the very next week. Their sweet spot is $500k-$10m in revenue, but they have other opportunities as well.Get started on their platform to fill your calendar with owner meetings. Rejigg does the calling - you do the closing.-------------CloudBookkeeping offers adaptable solutions to businesses that want to focus on growth with a “client service first” approach. They offer a full suite of accounting services, including sophisticated reporting, QuickBooks software solutions, and full-service payroll options.-------------Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel.Do you enjoy our content? Rate our show!Follow us on Twitter @acquanon Learnings about small business acquisitions and operations.Subscribe to weekly our Newsletter and get curated deals in your inboxAdvertise with us by clicking here Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel. Do you enjoy our content? Rate our show! Follow us on Twitter @acquanon Learnings about small business acquisitions and operations. For inquiries or suggestions, email us at [e-mail]

Hey, everyone. Welcome to Acquisitions Anonymous, the internet's number one podcast on buying, selling, and operating small businesses. I am one of your hosts, Bill Dallessandro. And today I am with Heather and Michael. And we talk about a really interesting deal that none of us want to own, but we love the business. It is, its end market is prisons. So really great market dynamics, really tough to talk about a cocktail party. This is a bigger deal from Axial. It's growing 45% year every year. It's 40 years old. Super cool deal.

I think you really enjoy this episode of Acquisitions Anonymous. Our sponsor for today is Rejig, a platform that is built for searchers who want to meet directly with small business owners. They have an in-house team doing outreach, finding owners who are excited to meet

with people ready to buy their companies. Searchers join their platform and often have five to 10 meetings scheduled directly with owners for the very next week. Learn more about Rejig's model at Rejig. dot com slash a a and again that's r e jigigg dot com slash a a and rejig does the calling you do the closing

yes you're in charge bill i'm in charge here we go all right everybody touch your head uh here we go i'm in charge okay welcome another episode of acquisitions anonymous uh this is our second one today and it's friday so i'm a little bit punchy uh which is good because we have a very very much as we have a very lighthearted deal today. It is a manufacturer of locking devices for prisons. So super lighthearted, but really interesting. So this one is from our friends at Axial. If you guys aren't familiar with Axial,

they're kind of a two-sided marketplace for buyers and brokers. A little bit different, though, than places like Biz Buy Sell, because everything on Axial, almost everything on Axial, has a sell side representative and also they're a little bit bigger deals. So if you're looking for bigger deals, Axial is a great place to go.

We found some really fun ones on there. So we're doing some more digging in the Axial platform. Oh, I was going to say, Bill, I also like that they curate both sides of the stuff, whereas like, let's say any of the other listing sites, like anybody could put anything on there if you pay the fee and anybody can look at the deals. Axiol at least manages the marketplace much better to where, like, if you're a seller, you have a better chance of getting high quality folks. And then as a buyer, I know I don't have to, like, shift through, like, you know, some scammy oil royalty stuff, which, by the way, shows up on other sites.

I'm working on a couple of live deals with axial buyers right now, helping them place their debt. And what's also interesting, and actually, one of them's bigger and one of them's smaller. So there are even some small deals there still. But what's interesting is you can roll the fees, the deal fees, into the loan. So we're doing that on a couple of axial deals, which is nice. Oh, cool. That's nice. Okay.

Do you want to get into it? I will share it. Okay. So this is the company Manufacturers and Services locking devices for prisons and jails. It is a 45-year-old business. Locking devices in security electronics used in more than 1,500 jails and prisons, primarily in the United States. So no Russian gulags here. The company has built an outstanding reputation for its unique and different. That took a wrong turn really fast. Well, you know, some people don't want

to be in the Russian gulags business. Yeah, I know if I'm okay with you, Michael, but. Okay. Okay. Please continue, sir. So in theory, these are, you know, people jailed for lawful reasons, I guess. So the company is built an outstanding reputation for its unique and differentiated ability to address complex and differentiated customer needs with their highly experienced engineering solutions. The company's product

mix used primarily in retrofit jail construction can meet any design or security need for sliding or swinging doors. So that's what they do. They're located in the east-south Central, which sounds like a neighborhood in the Bronx, the east, south central United States, which is Kentucky, Tennessee, and Mississippi, or Alabama. And here are the financials. It goes from 6.5 million in sales and 1.7 of EBITDA in 2019, very smoothly to about 12 million

in sales and 3.4 million in EBITDA in 2022. So kind of really smooth growth 5%, 24%, actually 43%, so accelerating growth. And their EBITDA margin hovers around 28, 29%. So Heather and Michael, what do you guys think? There's something that I hate about this business, but also why I think it makes a good investment. And to me, this business totally fails the cocktail party test, which is there's a lot of people that would not be proud to go and say at a cocktail party, like I'm a major supplier of locks for prisons.

I mean, because the reality is, like, America, for sure, like we have an incredibly high-incorcerated, you know, the population, like, it's inequitable. Like, it's pretty messed up. Like, private prisons, all that kind of stuff. The drug war, like, bad, bad stuff, right? Like, it's pretty screwed up. And, like, so that is something where I think a big percentage of buyers.

And I was thinking about you, you were reading this. I was like, do I want it, would I want to be in this business? This is something where, you know, like they write my obituary and they're going to be like, Michael, you know, he owned different companies, coding school, fireworks business, real estate, you know, started software companies and created tech jobs in San Antonio. Also, supplied prisons. Like, I'm not sure, you know, that that's like what I'm looking for on the old, you know, regret minimization framework. But I think that presents like a huge amount of opportunity with a business like this. We're just like, it doesn't pass. It, it,

it fails the distasteful, you know, test for potential buyer. And, you know, so now the capitalist to me is like, well, you know, you can make money. So that's, that's, that's the, that's for my two-faced, two-headed mind is on this deal. But that's immediately where my head went. So you're saying it, it cuts the buyer universe, right? So if you're willing to buy this, like there's a, can be opportunity here. But you are profiting from a system that is overbuilding prisons, has too many people prisons is inequitable and you're making money and living off of that, right? So it cuts the bio-universe for sure in terms of that stuff. Now, could you justify that? I mean, people justify a lot of stuff. Like, the Sacklers have justified selling opioids like

crazy and I'm sure they sleep well at night because they figured out how the middle gymnastics to feel good about themselves. But like it presents a problem and an opportunity here, I think. I feel like it's a private equities kind of deal. And I don't know that they, have that ethos as much in those private equity funds, you know, but you're right. It's going to, it's going to eliminate some of them. But I think at this level, probably a pretty high degree of interest. I'm more interested in what is the growth cycle, what was driving it, and where is it going or where can it go? Because are these retrofitting existing prisons, or is this new build, new prisons.

I'd really be interested in that and I'd really be interested in what kinds of contracts they have. Once you install these locks, are there maintenance contracts? That would be interesting, much more so than just installing the products. Because if it's just products, installation,

that's project revenue and that probably goes away at some point, depending on what's going on. You want that sweet, sweet, recurring revenue. I want that so bad. That is what I like. It is. I've been brainwashed by the lending community. So it does, I mean, and I think that's a great point. Like, I've encouraged listeners, like when you hear things like people like the lending community, for example, to some extent, irrationally loving recurring revenue and hating project-based revenue or hating recurring revenue, that's where you're like, oh, like, they're zigging. I need to consider zagging. Like, you can see that now.

like vertical market software, right? Everybody and their mother and grandmother has decided they want to buy vertical market software now. But if it's slightly not vertical market software, like their heads explode. So like that creates, that's where you're like, okay, if everybody else is zigging, like as an investor or a potential buyer, like it's time to go a different direction. So anyway, the good news is that like all the SaaS recurring revenue stuff gets really in favor and everybody wants that and it blows up the multiples.

but that means like the other stuff goes really out of favor. And you might be able to get great deals because these people are just philosophically, the herd followers, they're like, oh, is project revenue? I'm out. But like maybe it's a very high quality business and they can't see past the fad. So, okay, so here's this thing that happens as I've gotten involved and exposed to the professional private equity industry. I've learned some stuff.

Number one, those guys all chat like crazy. They are the gossipiest stuff. So if you show a deal to one of them, like you can prove. pretty much assume everybody else is going to know it exists. You might as well just, like, get past it because they're all gossiping like crazy. But the second thing is, like, they are much more interested in how they look than what the real opportunities are. And so let me explain that a bit. If somebody, for example, goes into a space as private equity as a fund, they do a deal there and they get burned and it's a very high profile burn, everybody else is suddenly terrified of that

space irrationally because they have a huge principal agent problem, which is they're not going to be able to raise future funds. If they go just repeat, if they go do the same thing the previous people did, if it works out, great for them, perfect. But if that deal goes bad again, like the, everybody would just be like, those guys are morons. Why are they doing that? Everybody knew that didn't work. So it's like all reputational risk for them. So you'll see this natural dynamic because of that thing where they're so interested in making sure they raise their next fund and look good amongst their peers and more importantly, the potential LPs, that they will just ignore very juicy spaces. They'll just be like, oh, we're not even going to get, you know, fund two from BlackRock

got murdered in that deal. So we're not going to do that space ever again. And everybody just stays away from it. And so it creates opportunities there. I know. I have friends in private equity, right? But like it is the most trend following. Nobody gets fired for buying IBM. Like, you know, everybody talks. No one actually has original thoughts, but all pretend they have original thoughts. It is the most group think industry I have ever seen. So group thing.

Which creates huge opportunities if you can actually be an independent thinker. And I intentionally did not say contrarian. But if you can actually be an independent thinker, a huge private equity opportunities. All right, taking a quick pause here. I have something to tell you. This is Michael. I hate bookkeeping. I hate bookkeeping.

I hate doing HR. I hate doing all that kind of stuff. But for bookkeeping, I have found a solution. It is my friend Charlie's business called cloudbookkeeping.com. So that's cloudbookkeeping.com. They are your perfect partner. If you want to get bookkeeping out of your hair and focus on making your company, your customers happier and more successful.

So please give them a call. call Charlie, cloudbookkeeping.com, tell them we sent you. They're a great way. If you're a business buyer, if you're a business owner, you're tired of hassling with getting your bookkeeping done.

He's got a whole fleet of people that are well trained and work for him. He's located here in St. Antonio, so I can tell you because of that, he's awesome. And they're a great partner for you to potentially call

to help with all your bookkeeping needs so you can do the important stuff in your business rather than worry about getting your books right. So give Charlie a call, cloudbookkeeping.com, and now back to the episode. So my thesis, by the way, is they are that way because that's what the LPs want.

The investors from the endowments, they don't want to get fired for doing anything about IBM. So that's why you see these funds that are like, they're these weird family office hybrids where you have some scion of like a big family office who made a lot of money doing something. And he's like, congratulations. You guys are my captive fund management team. Here's $100 million. Go take some risks. and they're the ones that'll go actually go do those reputational risk deals.

So if you end up with one of those deals, you go to those type of groups, you don't go to classic like, I got my money from the university endowment, P.E., because they're never going to do those kind of odd-bought deals. Yeah, and so really it's not so much just being independent thinker. It's being able to find a capital source that is an independent thinker and will back you. And I have to give a shout out to our mutual friend, Brand Beeshore, and the permanent equity guys because that's exactly what they did, right? Like they had a very different fund model where they wanted to buy and hold forever.

They didn't want to do the five to seven year fix and flip. And he was, and Brent was a new manager, right? He'd never run external capital before. And he had to scrape and claw because he had a different model and he was new. And they've been wildly successful. I mean, I think Brent is totally brilliant. But like, if you ever talk to him, like the mountain that he had to crawl and scratch up because he was trying to do different types of deals.

And so he needed different minded capital. capital to do that. So check out the permanent podcast or Brent if you want to see an example of how hard this is to do and somebody doing it right. Yeah. And I would say banks have the same kind of issue going on. If you talk to a bank that it'll stay away from a certain industry, it's not like they got slaughtered in that industry. It's that they lost money on one loan a lot of times. That's the story. You know, there's this one time back 10 years ago and this guy, you know, or lenders will carry that story with them to the next bank. And it's usually just one scar. And then that's it. They, write off the whole industry or that characteristic or whatever it might be. It's very irrational.

100%. To your point. You see in private equity firms or venture for, oh, venture firms also too. Like one partner got killed in one deal. And it's like, oh, well, that firm weren't invested in my deal. Don't even call them. They lost money and that supplements one time. It is, it is fascinating. You know, you see people playing this venture capital game where it is basically just like, you'll sit down and talk to the partners. And then you, you know, you're just, you'll sit down and talk to the partners and then you realize like it is just high school like they are just doing an adult version of high school with other people's money and like they'll sit there and they'll be like okay well um you know what i've heard is this over thing this thing over here this is super hot have you heard about this

a i thing whatever this company blah blah and you'll you realize like you're talking to it for 20 minutes about how hot this company is or this sector is or whatever and they've never actually explained to you what the company does and you're like wait does is this is this real who cares because all you're doing is figuring out what the people in the previous round thought was hot what's going to be hot for your stage and then what you can sell to the next chumps down the road who are going to think that's hot and then those guys are hoping eventually they can sell it to the public markets because it'll still be hot by that point it's just like high school and guess what I hated high school it sucked like it sucked yeah but at the same time like it works for a lot

of these funds you know like if you could be a fast one like there's a whole category of funds who like, if you were to like really dig in, like, what is your competitive advantage? We have awesome deal flow and we're really good fast followers and we're really good at dumping on the next guy. Like that is actually a repeatable strategy. They'll never say out loud, but it is. Dude, you just diagnosed the entire Andresen Horowitz strategy, which is pay the most for the hottest deals possible and that's it and put more money into the other people.

That's their entire their fun. And they made their fun of money. Foodles doing it. Which is interesting because it shows how smart Andresen those guys are because, like, nobody else truly understood that before Andresen and Horowitz showed up. Like, like, everybody was playing that game and, like, you would talk to the different, like, top-tier venture funds. And they never really understood, oh, I could just put this, turn this up to 11 and, like,

crush everybody. And then Andreessen Harwich was like, well, we're just going to come in. We're going to spinal tap this and turn it up to 11 and, like, we're going to win all the deal. and that's what they do. So I think it's funny that a manufacturer of locking devices for prisons took us down this side pass. So I'm going to real. Yeah, back to prison.

Back to prison. We're going to put Michael back in the prison box, this conversation back in the prison box. I want to own this business, but I don't. That's the trouble. So this business, I mean, like all the things Michael, you said about the stuff that's wrong with the prison system in the United States are true. But all of those things are massive tailwinds. for this business.

100%. Right? I mean, like the end market tailwinds for this business are phenomenal. And I mean, if you just look at this, its revenue goes from $6 million in 2019 to $12 million in 2022. Its growth rate is accelerating from 5% to 24% to 43%.

It's probably, you know, there is project work here, right? Because they talk about their different initiated ability, their engineering solutions. Like these are, you know,

this is almost like a subcontractor or like you're doing this by project for sure like there's engineers on staff et cetera but that's also a moat and in this industry too like the more jails you do the more jails you do right it's like you're proven you've done a bunch like they because just like the private equity guys the people who retrofit jails also talk like oh what did the other county do you know and it works good for them and they use your your locking things and if you could graft on you know it does say that there's electronics involved in you here, if you could graft on maintenance or some sort of SaaS contract on of these things, cool boy, the dynamics of this business could be exceedingly good.

This definitely has like a Transdime style opportunity, which is, you know, you guys are familiar with Transdime? Have you done any of this stuff there? One of the original industrial roll-ups, right? So they, well, they actually, it's, there's a great podcast that comes from Patrick Osson, sees colossus stuff. They did it with the guy who wrote the book, The Outsiders. And so basically, they went through and did the whole saga of Transdime, which is actually one of the most successful roll-ups in the history of private equity and actually went through subsequent private equity firms

and then went public and then kept going. So it's like Transdime, Constellation, Roper, all these serial acquires. And so Transdime is one of those. But like Transdime is actually, you know, I think it's an $80 billion business or something right now. It is a business that is totally built on a single insight, which is that people who buy airplane parts want to buy the best airplane part possible because it's not worth crashing your plane over saving 20 cents on a $2 part. That's the entire, that is the entire business model. And so what they would do is they would go in and they would go buy these airplane part manufacturers. And there might be one or maybe two that make the entire part. And then they would go in,

and they would generally raise the prices a little bit on the new part purchase. But then where they would make their real money is they would go into the replacement part price catalog and everything would go up through the roof. And that maintenance and all the repairs and all that kind of stuff, like for to replacement parts, they would hammer the customers. And margins would go through the roof. They run the business a little more efficiently and all that kind of stuff. And they talk about that.

But it was basically like, oh, the insight is that a business like this prison lock business, most, almost always, the owners have been so focused on making margin at the upfront purchase that they forget about the repair and maintenance opportunity on the back end, and you have so much pricing power that you don't even really know about. And that's the whole TransDAM idea. And I think that's a thesis I would have looking at this deal is, oh, could I double my margins by just getting a fair price for repair maintenance and replacement parts? I bet you, you could. I bet you. Think about this is like the only thing you want to not fail in the jail. This is the airplane part of the jail. It's the locks. It's the locks. Like that's the whole thing.

This is the whole jail. Otherwise, it's a hotel. Right. I mean, this is the only thing that makes it to jail. I have, I have a neighbor friend who works in the jails. It's a husband and wife that are in law enforcement and she's told me her stories. I mean, it's definitely you want your locks working. Absolutely. It's pretty scary. Yes. So like, will you pay the most for the best lock that is definitely going to work? And then will you pay the maintenance repair on it to make sure the locks keep working? That is the last service contract you are going to cut when there are budget cuts. I just want to defend my lender brainwashing because you guys came back around to repair and maintenance too. Oh, yeah. Oh, yeah.

They're covering bombs. I mean, it's true, though, right? I mean, it's a great business. It's a great business. So, all right, so we like it from an intellectual point of view, though it would be difficult or maybe difficult for some people to justify owning personally. Okay. Let me pitch you on this. Let me put you on this. Instead of the worm farm, we make this deal number one. for the acquisitions and I was podcast. But here's how it's a win-win.

Because there's four of this involved, then we're actually just part of a partnership that happens to own a jail supplier. And we don't actually own the jail supplier. So then we get air cover there, and we get good radio, and we maybe get canceled. Yeah.

And we complain about, it's really Michael's jail thing. It wasn't mine. Yeah. You know, it's going to be really tough for Mills because he's going to have to go be the CEO. on site, you know, like in the jail. So it's going to be tough for Mills, but it'll be fine for us.

Look, he can fix their roof and then he fixed their locks. Synergy. I mean, let's be real. If you, Mills is on today, so we're going to pick on it. Like, if you line the four of us up and you're like, who's the last one that's going to get murdered in a jail? It's definitely Mills, right? Like, all three of us are going to last for mere seconds.

And like Mills might make it like, you know, it's four years later and he's become one of them, you know? I'm like 50 counts bigger than all of you guys. Give me a break here. Michael would do okay, right? Do it right. Why would they, nobody messes with me? I'm huge.

You are big. That's true. But the facial hair is sorely lacking as compared to Mills, right? I mean, mine as well, like all of us. No one touches the Mills beard. This is a fun deal. I like this deal. There's a lot to like about this deal in terms of just, it smells like opportunity.

So hopefully somebody goes to do it, given we're evidently not, because we're, wouldn't want to talk about it at a cocktail party, but someone's going to buy this. Private equity is going to buy this for a big number. That's what I think. Yeah. Yeah. That's all right. Good little business. Let's wrap it up. That was a cool one. Good discussion. Happy Friday to everybody. This is probably coming on Tuesday or something, but vicariously, happy Friday, whatever day of the week you're listening to this on. And we will see you on the next episode of Acquisitions Anonymous.