Next up, we have Target Hospitality. I'm lucky enough to have Eric Kalamaras, the CFO, to my right. I always say this, so you sort of heard it before. This is one of the more enjoyable moments for me because he was a competitor at one point. That's a long time ago now. So, Target's a company that's transformed magnificently in the time I've been following it, just from what was more of an energy company to now a government services company. I will pass the mic to Eric to give a State of the Union, and then we'll go into some fireside Q&A questions.
Great. Well, good morning. Thanks, Lloyd. Thanks for joining this morning. So a lot's transpired at Target over the past, over the past several months, over the past, you know, couple of years, really. I think the most interesting thing that's happened over the past few months and, and most impactful thing is the, you know, the IDIQ process with the government has been. It's been out there for a number of months now. Our nonprofit partner, which we announced in the third quarter call, has received, you know, their contract with the government, which is fantastic. And, you know, we're working on our contract with the government.
So, you know, when we think about Target Hospitality, we look back over the past number of years as what's changed, and the business has changed us so much, from our margin profile to our cash profile to the business mix and all the government work. We're looking forward to expanding on all that today and look forward to having those discussions.
You've obviously diversified your business. Can you remind us how that's progressed from, let's say, a few years ago to today?
Yeah. It's, it's been an amazing transformation, and we're still-- we're still working on it. You know, we're not done. You know, we started three or four years ago, 80% of our business was predominantly in the Permian Basin, and what we call the HFS business, traditionally the hospitality and facility solutions business, which is really our core remote accommodations business. Here we are, fast-forward three years later, we have completely flipped that. We are now roughly 25% on the HFS side, and it's, you know, 75% on the government side. Continuing to grow that, continuing to look at ways to grow that, continuing to evaluate ways we can continue to add services to the government, in a variety of mechanisms. And really, the growth is... In some ways I feel like we're just getting started in many ways.
You know, it's been a massive transformation of business, you know, EBITDA from when we started in SPAC, from $140 million to where we are today, and so it's really been tremendous.
Then, so we're at that conference. You've just completed an exchange. Can you talk a little bit, just for those who are not familiar, remind folks what happened, and we'll start with that, and then maybe you can highlight why you did an exchange and not a straight refund.
Sure. So, you know, we had the original $340 million in notes that were outstanding, and we had been kicking the can down the road. And frankly, like being the ex-leveraged finance guy, I just did not like the way the Lev Fin market was acting. I didn't think they were appreciating the credit profile of the story, and we were a little bit in flux with how we were handling the new contract and what was happening there. And so we wanted to, you know, really just give the market a little bit of time to breathe and let the equity markets settle a little bit. That has happened. Decided to do exchange for 15 months. You know, we had tremendous reception and...
Which worked out well, so now we have, you know, $190 million of bonds. We called some a little over almost nine months ago. And so, you know, right now we've got roughly $990 million in the notes, and we'll keep those in the system and then just see how the markets react over the next year or so and before we go out and do, you know, a bigger refinancing.
The plan would be to refinance this, not necessarily pay this down in cash.
It is. I mean, it was really just a function of, of just flexibility. You know, I think as a corporate culture, and certainly from a financial hygiene perspective, I really like flexibility. And a lot of variety of instruments we could have looked at, and we did look at, but frankly, I felt like at the end of the day, this is a better approach for us. And, and it's what's unique about Target is when you look at our, our balance sheet and you look at our margin profile, right? So 0.3x leverage, margin, EBITDA margins that are, you know, 50% margins, the cash accretes very fast. And so, you know, sometimes conventional structures just don't always work as well, and so we want to have a little bit of flexibility in the system.
That gave us that for about 15 months or so, and we'll address it as the time comes.
Then, how do you... And then, shareholder returns, how do you think about that? What's the, what's the long-term plan?
So when we think shareholder returns, we're obviously, in this case, we're talking about the total return aspect, right? So, you know, there's a right, I would say, cadence for all that. Target is very much a growth business, and we have tried to position it as a growth business. And so there's time for dividend, there's times for share buyback. But I think when we look at those at the end of the day, and you know, obviously, so never saying never on any of those, but when we look at those right now, I really think the better opportunity is to continue to grow the business. And I think it's better for the credit holder, I think it's better for Target writ large, and that's really the focus.
I mean, that's where we've been spending a lot of time the past several years, is how do we continue to grow this business? And, and so we look at that and say, "You know, can we continue to develop our platform, right, and, and develop it where we can be a, a provider to the government and to other organizations, and not just in a modular and solution way, but, but also in a way where, maybe in a way that creates a bit more media immediacy, right? Where we can put in solutions that are a bridge to another solution and really extend that value chain, and that requires capital." And I think the return on that capital at the end of the day, is likely, you know, better than, you know, a dividend or share repurchase or et cetera.
I appreciate that. That leads me to the next question. So you've expanded the government business magnificently. You know, if you talk about the growth outlook, and one of the things you've talked about in the past is you want to—you have $500 million of investment opportunities through, I think through 2027. What—Where are you on that with that? And that's my first question.
Sure. So when we made that statement, I think last March, our view on this was to the marketplace to say the following: You see the cash generation that we earn. You see the likelihood of that continuing through our continuation with the government contracts, which, you know, we now have the five-year IDIQ contract that we're working on. So you see that cash flow continuing into the future, and it was really designed to say, "Look, we have an eye towards capital deployment. We have an eye towards growing the business, and let's give a framework as to what that looks like." And shortly after that, we had also announced that we are working on a number of new ICF facilities, and so those are the influx care sites the government has sought.
We obviously have PCC. They are seeking another as well, and so we've put-
Just, just let me stop you.
Yes.
So I have to look these up every time I talk to you. ICF and PCC.
Yes.
Just remind people.
Yes, thank you for the acronym clarification. So, PCC is our core site that provides housing for 6,400 individuals, and specifically unaccompanied minors, in West Texas. And that has been the core site that has wrapped around the $75 billion five-year IDIQ contract. The ICF is the influx care sites, and those are the sites that the government has requested three of, of which PCC is one of those three. And so they want. Basically, they've said, "Look, we want three PCC-like size sites." So we're obviously in the running for trying to capture that third site, and we've. So we've offered up a number of opportunities for that. Those are not insignificant capital deployments.
But in those unique cases, there's also reimbursement mechanisms with the government. So what we're also trying to illustrate to the marketplace regarding our capital deployment was, look, we want to create a full value chain extension on the business. And right now, when you look at Target, what you see is a modular solutions business with a hospitality services wraparound, which has been working out very, very well. However, we have also recognized there's tremendous white space for contracts with the government that could also use nice turnkey wraparound services, but aren't necessarily modular related. They are more temporary related, and a lot different type of contract structures. So what do we think about? We think about things with FEMA, for instance, right?
Long-term contracts, they are year, two years type contracts, could be even 6-month type contracts, but it's a different application. It's not a modular application. And so what we've looked at a variety of ways to continue to go into that value chain, and there is tremendous opportunity there for us. And so when we look at those opportunities, you know, those are likely to come through acquisition primarily. And, you know, again, it gets back to where we are in the $500 million of capital. So I would just say, you know, sit tight on all that, feverishly working on it, and, you know, hopefully, we have some announcements in 2024 that will be productive.
But it feels like you have deployed some capital towards that $500 million. Is that correct, or it's or-
Yeah, when we said $500 million of net capital.
Yes, okay.
So we actually have deployed against that $200 million against that already. You know, we're working on that, you know, as now. So we made certainly progress on it, but I think... Look, I think when we look down the road in three or four years, we'll have met or exceeded that number.
Yeah, and that's, that's where I was going. So you had $200 million. $500 million was a goal.
Mm-hmm.
Goals are meant to be broken. So, how much bigger is the opportunity? And, you know, could you get to $500 million before 2027?
Yeah, I don't. It's hard to put a timeline on these sort of things. I would just say that the contract structures that we're looking at, and we feel that we've missed on, are in the nature of the billions of dollars. And so it's important to be participatory in that and at least be a part of that discussion. We have. Over the past decade, Target Hospitality has made itself known to the government as being a solutions provider of very high-quality services. And what we'd like to do is continue that with in other applications. And so to be in part of that discussion, and be part of that sort of contract profile would be very important for the business.
You say other applications, it's vague. I know it's not modular, but what is that?
Yeah, so think about, think about it as being more, more emergency-oriented, right? There's a whole amount of contract structures. By the way, and these aren't just government, these are also business and industry as well, right? There's other commercial contracts where there is a need for temporary structures or temporary solutions, and again, it's not necessarily, not everything fits into a modular solution, right? The modular build time is three or four, five, six months. Sometimes, sometimes there are contractual needs, whether it's for the government or whether it's business and industry, where the solutions may not last that long, right? They may not last for two or three, four year, five contract, five-year contracts. You know, they may be multiple contracts, but they last six, 12, 18 months.
You stack those up, and the contract value is tremendous. And there's a lot of turn, which is okay, which is okay. It's fine. It's a little bit different mechanism, but it bolts in actually very nicely with what we're doing on the modular solution side.
Now, you... I'm sure you get this question a lot, and I think the answer is it doesn't change, but how does who's in the White House impact your business? Does it, if we had a Republican take office in the next election, would that impact how things, how your business grows?
You're right, we do get that a lot. But here's the thing on that. What's really important to understand about Target, and the answer is, the short answer is, I don't think it really matters, and here's why. When that question is asked, it's often asked about in the context of immigration and what's happening with immigration. The key critical piece of information that is important to remember about Target is who our census is in our communities, right? So we have had our Dilley community for going on nearly a decade now. The census, the primary census over that timeframe has been women and children, asylum-seeking women and children. In the case of PCC, it's all children, all accompanied minors.
However, under Title 8, under federal law, which has been for over 40 years, once a child under the age of 18 steps foot on U.S. soil, they are here, and they have to remain here, absent, you know, any sort of other situation with Interpol or child abduction or something like that. And what that means is that once the child sets foot on the soil, they're here. And so that further means the facilities we have are needed. The whole purpose around why Dilley's been in place for 10 years, the whole purpose around why the government spent two or three years going through emergency funding to then fight for a five-year IDIQ contract to let that last, right?
Which is critically important, because that's the funding mechanism, which is not easy to get, that creates funding for a number of years for this. And, you know, the government doesn't go through all those steps if they don't see an absolute need. But the need, you have to come back to the census, and the census is, is the child, and, and that's what's critically important to understand. And for that reason, we've been through a number of administrations. We've been through three already, and maybe we're, maybe we go through a, a fourth here.
So you, you alluded to the contracts that you have. So could you just talk about the quality of contracts and then the five-year contracting vehicle that is... That's been established with, early this year with the U.S. government for, for ICF contract awards? Help us understand that. And then you also mentioned that it, it was key to securing a long-term contract for the existing Pecos Children's Center, PCC-
PCC, right.
Influx Care Facility contract. So how so?
Yeah, so let me... I'll, I'll walk through this contracting process briefly. We can make it really complicated, or we can make it really simple. We'll take, we'll take the simple approach. It's, it's more effective. So the government creates a funding mechanism, and it's important to understand this. The government creates a funding mechanism, and prior to doing this, the government was under emergency financing and emergency funding. And emergency funding, by default, means the government can only effectively fund one year for any project, which is the case with PCC, right? There was a panic at the border. Children were coming in, were not enough space at all. Prior, they were sitting on an Army base, and it was not a conducive solution. And so created the...
created PCC, went through a couple of years of emergency funding, and during that time, we've worked with our nonprofit partner and are part of a $75 billion multiyear funding mechanism. So it's five years and then potentially five years after that. So you know, we look at this and say, "Look, this is probably like a 10-year deal at the end of the day." But the government, when it creates that vehicle, effectively what it creates is an underwriting process, and they go through that underwriting process for funding for multiple years. Then what happens is, when you come into your yearly term, they have removed all the administrative burdens. They've already pre-funded it, and it basically, from that point in time, it goes from capital spending budget into an expense account effectively, and that's what we call the period of performance.
And so every year, that goes from capital to think about as being expense, and we then, with our nonprofit partner, received the funds for the year. That's super important. It was a huge milestone for the company because it got us out, got us and the government and our nonprofit partner, we got everyone out of the mode of, "Look, PCC is here." Gave the government surety, gave us surety, gave the marketplace surety, and so critically important. That was the nature around PCC and the IDIQ and why that was so important.
Maybe shifting gears, just the traditional hospitality services business for energy services. What's the outlook there?
Yeah, so look, that business has been really a GDP plus type business, and we continue to afford to remain that way. You know, we have dominant market share, where nothing in that has changed. We have... I think we've done a pretty good job of taking supply out of that business from a competition perspective, and so we've really solidified ourselves there, even stronger than where we were, I think, even a few years ago. Margins there continue to remain very healthy, you know, in the mid-30% area. We expect those to hold in that area, hopefully even go up here in 2024 with some additional improvements that we can make and some... perhaps with some help from some cost items.
Look, that business continues to generate a significant amount of cash. I mean, you want it in your portfolio every single day. It's effectively a little lower touch, and from a, at least from a, from a management perspective, it's higher touch from a customer perspective, but from a management perspective, it's a little lower touch, and it generates a tremendous amount of cash. So you know, look, we continue to harvest that business in terms of, you know, its caring and feeding. We'll continue to tuck in things there to the extent we see opportunity. We'll continue to put some capital in place where we need to. But by and large, it has been wonderfully self-funding.
You were talking earlier on the stage about the... When you reported earnings, your stock got beat up, and there was some misunderstandings. Maybe you could talk a little bit about that?
Yeah, I appreciate you asking that. So I think there was a misunderstanding around just how the contract works with the government and a misunderstanding around what the contract really means. And I think when people understand the nature of the IDIQ process and the longevity of that and the funding and the underwriting, couple that with the fact that we're still looking at another ICF opportunity. I'm not sure the marketplace fully appreciated all that's happening, and I'm not sure that they appreciate the value chain extension opportunities that are in front of us and with the amount of contract value we're seeing that we could potentially go after. And there's a lot of, there's a lot of, I would say, a lot of white space that is very much left untapped here.
I think, I think once some of that clear becomes more clear, I think the market will start appreciating kind of where Target is in a, in a better spot.
And just last year, everything was about inflation. This year, it's about deflation. Where are you seeing deflation? Can you talk a little bit about that, how that's impacting your business?
Yeah, no, it's a great question. So you know, interesting, so we were probably one of the last companies that, at least that I follow, that were getting impacted by inflation. You know, we have, we're one of the top five largest wholesale food purchasers in the United States. You know, produce 15 million meals a year, and certainly, that pricing power helped us. We, it did catch us a little bit towards the end of last year. As we look forward, though, we do start seeing some moderating. That is happening. The tricky thing with inflation, though, is rate of growth, right? And so, you know, what we're not so much seeing is, we're not seeing a notional across the entire portfolio.
We're not seeing aggregate costs necessarily come down. You are seeing input costs, though, come down, right? Which is helpful. I mean, if you look at most of the commodity curves, particularly the softs, they are starting to see some backwardation there, which is nice. And so that will start to flow through. So I do think by the time we exit 2024, probably be in a fair bit better spot. But, you know, it, you know, inflation, unfortunately, it's geometric growth, right? It's just growth on growth. So, you know, we're probably here at higher levels than we would otherwise like to be, but I think we're gonna be in a much better spot heading into back to 2024.
I'm trying to remember what you substituted for chicken. It was chicken wings?
Chicken thighs.
Chicken thighs. Cheaper than chicken wings.
Cheaper than chicken wings.
Are you still serving chicken thighs?
We're moving back to chicken wings.
Okay, but is-
You know, you know, yeah, after... You know, it... Chicken wings are a crowd pleaser, right? Who, who... Chicken wings are a crowd pleaser.
I don't think we're serving them here this year, and there was definitely a protest, for sure. Now, you mentioned M&A. You talked about that as an opportunity set. How big can that be?
Yeah, it's a good question. So, you know, historically, we have not been... We have not been very acquisitive. You say: Why is that? And the reason is because we have been exceedingly disciplined. I can't tell you how many opportunities we've turned down, for a number of reasons. And whether it's valuation or whether it's the management or whether it's the fit into the portfolio, commercially, operationally, we have passed on a number of things. And however, over the past, I would say six months, our portfolio of opportunity sets has never been more active. In fact, Target's entire portfolio, commercial and otherwise, has never been more active. So, you know, we've got a commercial pipeline into the billions dollars that we're looking at.
We have a continual pipeline of transactions that we're looking at. You know, I think 2024 is a breakout year in terms of how we look, how we think about transaction activity. You know, I'll pause saying much more than that, other than to say that I think we've honed in on the value chain piece pretty tightly. We're being shown a lot of things, and I think our message has certainly resonated with some of the buy community, and I'm sorry, the sell community and in that market. And so we are looking forward to seeing what we can execute there, you know, through the year.
You've mentioned this year, it's picked up, the opportunities. Is that just because you've realized the opportunities to add to your business based on where you are today, or has something happened in the industry that's things have picked up?
Yeah, it's two things. So one, we have honed in much more clearly on the contract value where we think we can really add tremendous value to the government, and the government's looking for solutions, right? They're not trying to find more parties to do less work. They're trying to find more parties that hopefully can put them in a spot that eases the burden on the contracting office. And so when you look at a company like Target, we can come in and really do things that it'd take a handful of parties to do, that we can do with one call. So within that, we see this white space in the government. Okay, so that's point one.
Point two is, we're getting many, many more inbounds than we were receiving even a couple of years ago. And the reason is because they're seeing our portfolio, and they're seeing the competitive pressure. We are showing up against a number of companies over and over and over again. And as some of those companies look to monetize or look to make structural changes in their business, Target is receiving the call. And that's actually a great spot to be in, right? That tells you that your business plan not only is it working financially, it's also working from a structural perspective when other counterparties are seeing that. And so you want to take advantage of that opportunity, and we are.
Are the counterparties, private equity backed, or is it just mom and pop? Is it... Is there something about a need to exit that-
Yeah, I think it's a little bit of both. I think it's a function of some of these companies are perhaps reached, reached scale, where they can't take it to the next level, perhaps. And a lot. You know, and again, we're dealing, we're talking about companies that are not modular solutions-oriented, that have a capital spending profile that's, that has historically been different than ours, right? I mean, you know, we've spent $500 million of capital in the past five years, six years, building out this entire portfolio. Their capital profile looks different, but for even for them to continue with the growth, it's heavy, right? And for us, it's very different. We say, yes, it's very, very doable, right? We'll facilitate your growth profile.
For them, it's a heavy ask. And so I think for any entrepreneur, you ask yourself, you get that natural question, okay, you know, how much longer can I, you know, can I functionally do this with the organization I have intact, or is it time for me to scale up? And that's really hard to do at certain levels. Sometimes it's a lot easier just to sell.
I didn't ask you how you think your debt's come down so much. I didn't ask you this, but how do you think about what the right capital structure is? Clearly, you have room to buy things. Just-
Sure.
What does your capital structure look like in terms of leverage, and how are you thinking about it?
Yeah, and that's, it's a great question. I mean, we... Yeah, the leverage has come down so much, we rarely get asked the question anymore about how you view long-term debt profile of the business and the credit quality of the business. Look, and the reality is, right now we are in a bit of an over-equitized position. However, that being said, you know this from our years together, you know, we are not of a mindset of over-leveraging. Our view has been, and it continues to be, commercially and operationally, as well as financially, is ultimate flexibility. You cannot react to near-term opportunities if you don't have the balance sheet structure in place.
What that doesn't mean is over-leveraging to then this is a great, the common corporate approach is over-leveraging, then you bring it back down, and you go back to your 4x, you come back down to 2.5x, and then you go through that two-year process. You know, we're not interested in doing that because during that two-year process, you lose all your flexibility. What we're looking at is coming in from an undercapitalized position, over-equitized situation, right? Effectively undercapitalized the business, to then have immediate opportunity sets to continue to get to a, what would be kind of a 2x-3x. And that would be it. And that's it. But here's the reality. With our cash profile, we have the ability to do $200 million of deals on balance sheet and keep leverage flat.
And so that is a very unique spot to be in. And so when we look at... You know, I don't think our, our, I don't think our acquisition engine will, will likely be able to keep up with our cash profile. And that's the other thing that's geometric, right? Is your cash profile then builds even faster. And so, so I think from a balance sheet perspective, just by definition of our, of our capital base and by definition of our, our margin profile, you know, I expect us to be in a kind of a perpetually under-leveraged situation.
I mean, why not if... Debt investors love hearing that. Obviously, you understand the value of having a clean balance sheet. But why not add...? But I think you said, why not add more leverage and return more value to shareholders?
Well, you could. You could, and but also at the same time, what happens is it also gets paid down very quick, right? So you absolutely could do that, right? I mean, we likely would do something on balance sheet. I'm not suggesting we're using equity here at all. That would depend on the size, of course, but everything we're looking at, we would likely do on balance sheet. But you know, inside of a year or so, it's you're back to neutral-
Got you.
which is really a good spot to be.
You said the Target's 2-3 times, or I think you used that number. I feel like you're less levered than that, less levered than that.
Yeah, no, we're 0.3 now, right?
Yeah.
We're effectively gonna be net zero by the end of the year. But I think if we were to look out over time, you say, what's kind of Target's kind of peak leverage profile? 2.5-3 would probably be peak for us.
So that you'd go there to acquire, but you bring it back down again.
It'd come down fast. Yeah.
Got it.
Yeah.
We have a few minutes left. Are there any questions from the crowd? I guess I'll ask my final question. Is there anything we did not ask you, that you think would be a great thing to highlight, especially for those that are on this webcast?
Well, look. That's a good question. Thank you for that. Look, I think the critical takeaway from this is a couple things. One, we are in many ways kind of. I still think some of the early innings of the growth engine in some ways. That's point number one, and then point number two is continually remember who our census population is, right? Women and children critically important to think in terms of target. Just to give comfort in terms of the population mix and the durability, you know. We oftentimes get caught up in terms of the immigration discussion, right? And how temporal that is, and we see the emerging crisis, et cetera.
And it has been, and a lot of that was brought on because of COVID. That concept, when you understand that, and that this isn't so much a policy decision, that it is a function of what's happening in the southern border, and it's not Mexico. It's entirely of Central America. But you're seeing similar things happen in Europe, or you're seeing similar things happening in Italy. You're seeing similar things happening in what previously had happened in Germany. And so you're seeing this happen all over the world. You say, "Why is this happening?" Well, it's happening because there has been... I think COVID was so impactful to certain economies and certain countries in the world, that the citizenry just frankly could no longer tolerate the incivility of it.
There's been a trend from tremendous global migration to Western communities. I think our policy work that we've had done, our consultancy work, suggests that that is not going to stop. The critical thing, then you take that one extension, is to say, okay, about Target, their population is children. So even if there were policy adjustments at the adult level, it's nothing to do with the children in our population. I think when you marry that and understand all that, and then couple that with the way the government has approached the funding and the multi-year underwriting on this, it probably frames the story a bit different.
I think just helps illustrate and give, you know, the marketplace a much greater sense of confidence as to how this looks over the next several years.
Well, that was a great way to wrap it up. Let's have a round of applause for Eric. We really, really appreciate you making the trip here. Thanks, Eric.