Wednesday, September 26, 2012

Silver Chef -- Equipment Leasing

Silver Chef is an Australian company with a straightforward business model. 

Hospitality start-ups – new restaurants – are often starved for cash. They need to invest in professional cooking equipment but purchasing it outright is risky and ties up more working capital than they can spare. The typical piece of equipment costs $10,000. Silver Chef offers them a lease-try-buy option. They commit to leasing, for example, a Middleby convection oven and Silver Chef then buys it and rents it to them. The minimum lease term is one year, and they pay rent monthly, in advance. Banks require Director guarantees, Silver Chef doesn’t. If they can’t pay, the oven is repossessed.   

If their business succeeds, they have the option to buy that piece of equipment and are credited for some of the rental fees they’ve paid. Some do buy but most don’t – they continue to lease because the rent is off-balance sheet.

One can see how it’s a win-win for both parties. Besides, banks concentrate on large businesses, Silver Chef concentrates on small enterprises.

Silver Chef succeeds in making this model work. No one customer constitutes more than 1% of revenue, thereby limiting risk. It grows fast and grows profitably. 

It has the bright idea that the best customers may be franchisees of well-known, fast-growing brands, and it now targets the franchisees of Dominos Pizza, Subway, The Coffee Club, Nandos, Outback Jack’s Bar & Grill,   Gloria Jean’s, and Wendys (an ice cream franchise, not the hamburger chain). These customers subsequently make up a substantial share of its business, are lower risk, and present excellent growth opportunities.

Better, once embedded in these brands, word of mouth makes it likely that there would be some protection from  price competition waged by potential entrants into the equipment leasing space.

The next bight idea: since this model works well in hospitality, why not extend it to other sectors? Silver Chef establishes GoGetta in 2008 and does very well indeed. Earth movers, gym equipment, cash registers, hydraulic pipe benders, trailers, you name it. Same value proposition, same sized businesses, different sectors.

Anyway, here are the financials:

 (NB: Silver Chef's been in business since 1986, went public in 2005, and I don't have access to 2004 balance sheet information).

The above somewhat understates the profitability of Silver Chef's business. The cash recovery rate captures it better:

As an aside, I am convinced that, when Buffett looks at a stock, its CRR is what he calculates first, because it is so quick and so reliable. Consider, for example, this discussion of his investment in Mid-Contental Tab Card Co.

In any case, Silver Chef is in the business of turning purchased assets into cash and one can see from the table above is that it does that quite well and it's getting better at it as it grows.

So, that's where we are: Silver Chef is a simple easy-to-understand business, with a CAGR of 45% over the last eight years, earning its cost of capital, with an as yet 3% penetration of its potential market. It is selling in the market at a yield of 11.65%.

It's no growth value, at an 8.5% cost of capital, is close to AUD$5.15.  If you ask a Buffett-like question -- "Will I earn 15% on $170m of sales?" -- the answer is much more likely to be "yes" than it is to be "no". 

I'd venture that Silver Chef's minimum true value is in the neighborhood of AUD$12.

Disclosure: No position.


  1. What is stopping Middleby (or others) from just doing this in-house and cutting out the middle man?

  2. Important question. This is my take:

    First, one restaurant requires equipment from a bunch of different manufacturers -- convection ovens, coffee makers, microwaves, oil-filters and so on.

    Second, if I were a start-up restaurant owner, I'd rather deal with a business that was dispassionate about brand. I decide, or I decide with some impartial advice from the equipment provider.

    Third, selling is one thing, but renting involves credit credit risk analysis. Silver Chef has 7000 individual customers on the books. Middleby (or others) would have to figure out whether microfinance is something they'd like to get into.

    Fourth, Middleby is selling to Silver Chef at more-or-less retail price. What does it have to gain by competing with its customer? Not much. It stands to lose more than it gains by doing so.

  3. What's keeping you from buying a position?

    1. The marginal opportunity cost of the last few dollars in my account. Will I find something better? etc. If I were at 30% cash, I'd buy it. But I'm at 10% cash, and the hurdle is higher.

      I don't like taking small positions: I know from my own experience that that leads to sloppy thinking, optimism, and sloth. If I go in with a substantial amount at stake, I think abut it more carefully. I might yet buy it, but maybe at a lower price point.

  4. Thanks for the writeup red.
    I found this:

    1. Thanks for the link. It represents the bull case, don't you think? High implied real interest rate and yet they keep coming. From a regulatory risk perspective, it's hard to distinguish this from angel and venture capital taking large equity positions in start-ups.

  5. Hi

    How do you calculate cash recovery rate? And why do you think its better measure of returns return on operating assets? Do you think that the true return of Silver chef is cash recovery rate or the return on operating assets?

    thanks again for teh blog

    1. Silver Chef buys equipment and rents it out. That's basically how it works. So, if we calculate how much it spent on buying those assets (Gross cash invested = gross fized assets + gross intengibles + net working capita) we can compare that to how much money those assets are generating (EBITDA - tax). That's the rate at which the cash outlays are being recovered, or the cash recovery rate.

      You can see from the table above that Silver Chef recovers 30% of its cash investment in a typical year. That's pretty good. It's like buying a house for 300K and renting it out for 150k every year; subtract taxes and you'd get your money back in 3 and 1/2 years. You could buy another house and do it all over again. It'd be a good way to accumulate wealth.

      Is 30% Silver Chef's true CRR? Barring some accounting impropriety, it does seems to really have been 30%. Will it be 30% in the future? Answering that requires thinking about why it earns such high returns: why can't their customers insist on lower rental fees? Why don't banks and specialty finance companies get into the game? etc. Good returns are always evidence of malfunction competition.

      I like CRR better because, except under some exceptional circumstances (inflation, for example), I think it captures the economics of the business better than ROIC: ROIC is always molested by management's discretion on how fast to depreciate the assets; CRR isn't.

  6. What is your current opinion on SIV not that it's fallen in price? Assuming you are watching or owning it.

  7. Hi Daniel,

    I'm watching it but don't own it. Gogetta's not doing well for obvious reasons and if China/commodities blow up, the trading pattern in Emeco tells me that SIV could get a lot cheaper than it is now.

  8. Interesting analysis around the CRR. Thinking about this some more, I somewhat disagree around your analogy of buying a home for 3.5x rental. Silverchefs equipment depreciates rapidly, so what your left with after 3.5 years is a worthless asset which you cant earn much income on. A house on the other hand may appreciate after 3.5 years and continue to earn rental with little capex.

    The reason why silverchefs CRR stays elevated is the revolving pool of inventory while its growing. If it did no new business next year would the CRR remain at 30%?

    So overall i think the CRR could be a little misleading as to the true economics of silverchef...

    What similarities are there between silverchef and midcontintental tab company that suggests using a CRR is appropriate... Are they both capital intensive businesses with fast depreciating assets?


  9. "If it did no new business next year would the CRR remain at 30%?"

    Yes. Spend X in year one and recover X/3 via cash flow every year and your CRR is 33%.

    But then I don't know what this means:
    "The reason why silverchefs CRR stays elevated is the revolving pool of inventory while its growing"

    House was a bad example. I should have used rental car instead.

  10. Curious if you are still following Silver Chef? Expansion into adjacent vertical went very poorly and now running into covenant issues.

  11. Sorry for the delay; whether or not i receive notifications of activity in the comments section has become a bit hit or miss lately.

    Yes, still following SIV. I don't think $5.75 to $6.00 is an unreasonable valuation, all things considered.

    However, as you know, there is some uncertainty with regard to the runoff value of the adjacent business (esp when including any possible fine levied by the government). It's a yield vehicle so I don't see any harm in waiting a little longer until news of the the restaurant business' margin deterioration has been fully absorbed,GoGetta's runoff picture is a bit clearer, the sub debt has been issued, and the analysts have had their say.

  12. Thank you for sharing information. Wonderful blog & good post.Its really helpful for me, waiting for a more new post. Keep Blogging!


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