Perimeter Solutions $PRM: The Transdigm Model Gone Astray?
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What if I told you there was an opportunity to own a company that:
Is a duopoly player in two of its three business segments
Sells mission critical products that are a small overall component of its customers’ total cost, giving the company significant pricing power
Has extremely low churn
Has a board that includes:
Nick Howley, co-founder and former CEO of Transdigm
Will Thorndike, author of The Outsiders
Tracy Cool, who spent 11 years at Berkshire
Sean Hennessy, former CFO of Sherwin Williams
Sees significant M&A opportunities
In other words, what if I told you it was possible to own a much smaller, relatively undiscovered version of Transdigm. This smaller company should also have less execution risk than Transdigm did in its early days, as Howley’s guidance should help management to avoid any pitfalls he may have come across during his tenure.
The name of this company is Perimeter Solutions, and while all of the above information is true, here’s the stock chart since it went public via SPAC:
Perimeter describes itself as a ‘global solutions provider for the fire safety and specialty products industries’.1 Its annual report divides the business into 2 segments, Fire Safety and Specialty Products, but it’s really better split into three:
Fire Retardants – used to slow, stop, and prevent wildfires. The customers for this segment are most often government organizations, which explains the State of California and the USDA Forest Service accounting for 54% of Fire Safety revenue for fiscal year 2022.2 At the time Perimeter went public, it was the only supplier of USDA Forest Service qualified fire retardant. Importantly, this retardant typically accounts for a single digit percentage of total wildfire suppression costs, which should give the company significant pricing power.
Firefighting Foams – reasonably self-explanatory. The key point for this segment is that it’s competitive, and so the pricing power dynamic present in Retardants and Specialty Products doesn’t apply.
Specialty Products – Perimeter produces and sells P₂S₅, which is a critical ingredient for lubricant additives that prolong engine life. Its customer base is a handful of companies, which are for the most part privately held.3 This is a duopoly market, where Perimeter competes directly with Chemtrade.
On its first earnings call as a public company, Will Thorndike called out three tailwinds for Perimeter’s Retardant business:
Broadly speaking, the US is experiencing longer fire seasons as a result of climate change.
Retardant revenue is extremely sticky. Customers rarely leave and often use more of Perimeter’s retardant over time.
A growing number of homes are built close to wildlands, which means the ‘let it burn’ strategy is less of an option for firefighters.
Increasing airtanker capacity. The larger the airtanker, the more retardant said airtanker can drop, and the more effectively wildfires can be put out. As fire severity increases, so should usage of the largest airtankers.
Critically, Thorndike also made a caveat:
“Investors should appreciate, however, that within this overall pattern of revenue stickiness, there is an element of year-over-year variability, primarily tied to the intensity of the North American fire season. That said, over time, we expect long-term secular growth to continue and to sort of overwhelm any near-term variability”
Investors, and Perimeter’s management team, perhaps failed to appreciate just how significant this year over year variability can be. The 2023 fire season was 54% below the 10-year average, and 71% below what it was in 2020. The 2022 season was also mild, with US acres burned ex-Alaska down 36% YoY. The business has been expanding internationally, but that was little help in 2022 when Australia experienced such an ‘unusually wet’ early season that the country literally didn’t buy any retardant in Q4. Perimeter has managed this season variability well, with Fire Safety revenue down 1% in 2022 and 8% YoY as of Q32023, but it’s much harder to get excited about a business that’s so heavily and unpredictably cyclical. In oil and gas investing one can at least come up with some approximation of whether there’s a supply shortage/glut; the same approximation can’t be made for how severe the wildfire season will be going forward.
Perimeter’s historic pricing power stemmed, at least in part, from being a monopoly provider. At the time of its initial filing to go public, its retardant was the only qualified product for use by the USDA Forest Service, a position the company had been in for over twenty years. Said differently, Perimeter not only sold its customers a critical product that accounted for a small amount of overall cost, but also a critical product its customers couldn’t get anywhere else. Unfortunately for management, this changed in late 2021, when Fortress Fire Retardant Systems’ retardants were approved as a Forest Service qualified product. It’s unclear what ultimate outcome this competition will lead to, but it’s undoubtedly more difficult to flex pricing power when there’s a new entrant eager to take market share. Perimeter management has pointed out that the company does more than simply supply the retardant, emphasizing its speed of product delivery (at times Forest Service bases carry as little as one day of inventory, making speed important!) and airbase trainings services.4 While this all may be true, at the very least a new competitor adds a level of ambiguity to Perimeter’s long-term prospects that wasn’t previously there.
To compound misfortune, Perimeter was unsuccessful at predicting demand for its Specialty Products segment. On its first call as a public company in late ’21, the outlook for Specialty Products was that revenue would be about flat. Instead, 2022 sales were up 32%, but with a significant slowdown in Q42022 due to inventory destocking. Management expected this destocking to ease in Q1, but it’s instead persisted through the most recent quarter, with Specialty Products sales down 35% YTD. Perimeter’s CEO, Haitham Khouri, said the following on the company’s last earnings call:
“We were surprised by the duration and magnitude of the destock….we’ve frankly been wrong on magnitude and duration so far, and therefore, I’m hesitant to make a future projection on when it will end.”5
Perimeter’s fortunate to operate in markets where it’s predominantly a duopoly player, which is a real advantage. That advantage matters much less, however, when the one’s customers are more cyclical than was initially expected. This is especially the case when the cyclicality is related to something that’s fundamentally quite unpredictable, such as wildfires. An investment decision based on the premise that ‘Climate change should make forest fires worse’ sounds good in theory, particularly when the year before Perimeter went public was the most intense fire year recorded in U.S. history.6 But that premise quickly became exposed as surface level once the 2022 and 2023 fire seasons rolled around.
Perimeter currently trades at 15x earnings, which will be looked back on as cheap should the company’s results rebound over the next few quarters. Betting on such a rebound confidently would require more insight into the oil additives and wildfire market than, according to earnings transcripts, apparently even the company’s own management has. Nick Howley described Perimeter’s goal as delivering ‘private-equity returns with the liquidity of a public market.’ Public market liquidity sounds nice in the abstract, that is until one realizes it’s harder to obfuscate meagre short-term returns.
Disclaimer: The information in this post is not intended to be and does not constitute investment or financial advice. You should not make any decision based on the information presented without conducting independent due diligence.
Pg 9, 2022 Annual Report
Pg 18, 2022 Annual Report
The exceptions here are Lubrizol, owned by Berkshire, and Chevron Oronite, owned by Chevron. Chevron Oronite’s results are unfortunately not discussed in much detail by Chevron.
See pg 11 of Perimeter’s Q3 Presentation. See also Pg 12, 2022 Annual Report
It’s worth noting that Lubrizol’s sales volumes were down 10% YTD, which likely limits Perimeter’s pricing power!
Pg 11, 2022 Annual Report.