Back in June 2019, a deep-dive into Integrated Holding (IHC) indicated a so-so business, tagged with a price forecasting a steep down-cycle for the upcoming 3-5 years. We did what we always do. We tore through public filings, financials, searched for strategic and economic strengths, read global industry reports on heavy-equipment rentals, and sent management a list of tough questions (some of which they honored with answers).

Did we do a valuation in the end? We sure did. With what level of conviction? Low at best. And why? Many questions remained unanswered. We sensed we were far from fully understanding the nature of the beast. 

A good valuation should posit a fair value range – followed by probabilities attached to each scenario. At the time we had low visibility on all scenarios for IHC. All except one – that IHC was not, and would not become, an outstanding business.

Sure, our low-conviction valuation suggested a mispricing. But it wasn’t nearly enough.

We suggested to the client that the business be avoided.

Here’s why:

1. High exposure to things outside the company’s control: Success in the heavy equipment rental business relies heavily on the oil price and overall economic health. This is a quality check at KIP that IHC did not pass. We prefer businesses that are relatively insulated from macro-variables.
2. High uncertainty | Cyclicality | Low ‘forecastabilty’: Thanks to the nature of construction – crane rentals is a cyclical business. Activity ebbs and flows depending on a host of external factors. At KIP, we generally steer clear of cyclical industries because a) it poses projection difficulties, and b) it invites plenty of (often efficient) pricing activity as traders ride the cycles in search of quick flips. Our valuation assumed a base-case and best-case – without accounting for the down-cycle that was priced in during June 2019. Even if COVID had not struck – the market seemed tepid about the company. Owing to our limited understanding of the industry – we found it hard to model. All this supported our low confidence in the valuation. We avoid games where other players know better than us. 
3. Scant data: We looked, but found no independently published, high quality data on construction activity in IHC’s geographies. Unpacking this would require much more field research – which was not in the scope of the report at the time. More reason for us to be skeptical.
4. Capital intensive: This is a feature of the business. IHC makes sizable investments in owning giant cranes – and then spends on keeping them in top shape. They do this so their customers don’t have to – giving (their customers) the flexibility that comes with rentals. At KIP, we like to avoid capital intensive (especially PP&E) businesses. Large, weighty balance sheets respond slowly to emergent strategies and to changes in the market.
5. High opportunity cost: Does the KIP watchlist have better businesses with vastly better economics? Absolutely. From a portfolio management viewpoint, other high quality businesses give rise to a high opportunity cost of taking a position in IHC.
6. Finally, we wouldn’t  want to be part of IHC’s long-term story. This is a natural conclusion to all reasons discussed above. Given our very long time horizons – we ponder the rationality of participating in the large-scale story of a company. Given what we knew, we wouldn’t want to be in the heavy equipment rental business for a decade or more – IHC or otherwise. We recommended the same to our client.

Shabbar Kothari

May 24, 2021