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Forum Transcript

Cleaver-Brooks – US Boiler Market Dynamics & Outlook – 29 March 2021

  • Credit
  • Consumer
  • North America
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Specialist

Former VP at Cleaver-Brooks Inc

Agenda

  • US boiler market
  • Margins and pricing pressures
  • End markets and new technology

Questions

Transcript

1.
Could you contextualise the US boiler industry pre-coronavirus and share any market changes or impacts that may have stemmed from the pandemic?

Specialist (SP): That’s a very general question, so I may need you occasionally to interrupt me and bounce me back on  that straight and narrow path, but for the time being, let’s just start by saying that the industry is characterised  by perhaps two, maybe three major business segments. You have a very large portion of the activity boiler  companies are involved with relate to comfort heating and hot-water production, so you have an enormous  market that boilers are being used in to heat your apartment complex in New York City or other similar  applications. You have that and then you also have a much larger, and when I say much larger I mean scale wise, there are not more units but the dollars at stake are far greater, and that is the industrial boiler market  which pertains to everything from food production to manufacturing to actual power generation in what’s  known as combined-cycle. Combined-cycle is you have a boiler, it generates steam, the steam drives a turbine,  that turbine creates electricity, and that’s a big segment that Cleaver-Brooks has a unique market position in  that they play. Then on the other end of the spectrum is a much smaller application which is typically light  commercial and/or residential. Cleaver-Brooks has a very, very small offering there, but they do participate in  that marketplace with some of their commercial products. 

You asked the question about the impact of the pandemic. I would suggest to you that there have been impacts  with the pandemic, certainly they’ve been more temporary in nature, but I’ll talk about a couple of them at a  very high level, and if you want to dive in a little deeper, feel free to ask specific questions. At the very highest level, the pandemic, when it first came about, the knee-jerk reaction of most industrial concerns in North  America was preserve capital, so if you were in process, if you were negotiating, if you were about to issue a  purchase order, until we understood what the economic impact of the pandemic was going to be, everybody  locked their cheque book in a safe and said, “Let’s wait this out”. Not that I work there anymore but I am  pretty confident that they experienced a significant slow down in purchases, especially on the larger stuff,  primarily because capital equipment investment would have been significantly reduced by most players as a  result of the pandemic. 

If you’ve heard the phrase “long COVID”, long COVID is a medical diagnosis that speaks to the longer-range  impacts of COVID-19, but it’s medical. In my estimation there’s a long-COVID economic, which are the longer term impacts of what COVID has done. Right now what we’re seeing is we had such a tremendous knee-jerk  reaction as a global economy to the pandemic that most industrial concerns had workforce reductions, they  closed their capacity down considerably, and as we learned more and as the mortality rate has decreased and  the vaccine has been introduced, the economy was still healthy. In fact, there was more income available for  discretionary spending than there was even pre-COVID, based primarily on government spending. As the  economy tried to wind back up again, we started to experience significant constraints due to capacity  limitations. In the last 3-4 weeks the price of steel is up by as much as 20-25%, if you can get steel, and most  companies who are heavily dependent upon steel for manufacturing are experiencing broken contracts or  seriously extended lead times.

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2.
Have any specific end markets been particularly impacted by the pandemic, perhaps institutional, industrial, commercial or residential customers? Are there any markets you think will be permanently impacted or at least have a long-term recovery timeline?

SP: I want to answer that question slightly differently and then if you want to talk in specific segments, I’d be  happy to go into it. The pandemic, and I’ve said this to other people in other conversations but similar threads,  didn’t create new things. What the pandemic did was it accelerated or exacerbated existing trends, and so if  you look at it from that framework, there’s been significant exacerbation or acceleration of market trends. I’ll  give you a perfect one, the global environmental awareness has ebbed and flowed and it’s been very much  depending upon who was in The White House. What we’ve seen over the last several years, and this is very  specific to one of the most important markets that Cleaver-Brooks serves, is power generation. 

One of the mega-trends in power generation is environmentalism. The cheapest fuel you can buy is coal, and  it’s the dirtiest. The more Btus you get out of it, the dirtier the fuel. Second to that is oil and third after that is  natural gas. There is definitely a trend away from the heavier fossil fuels, the dirtier fossil fuels, and with the  Biden administration now in place we expect to see that even further accelerated. COVID didn’t have much of  an impact on that, but the change in administration really did and what we’re seeing, and no, this not just the  US, this is all over the world, we’re seeing a migration away from fossil fuels. You have a lot of pressure to find  other ways to create energy and boilers is one that is absolutely dependent upon fossil fuels. Fortunately for  the boiler industry, there’s no easy substitute. Wind power doesn’t, solar doesn’t replace all of the power that’s  created by steam turbines through combined-cycle and industrial boilers, but that’s one of the things that’s  happening in the market that is creating headwind for Cleaver-Brooks. 

The other thing that is a significant headwind for Cleaver-Brooks is, a boiler is nothing but a steel tank. A bit of  an exaggeration, but that’s really all it is. It is not an enormous piece of technology, it’s just a vessel. The  technology typically exists in the burner and that’s where you determine how clean it’s going to run and how  efficient it’s going to be. A major decision point in whether I replace a boiler or not, or whether I put a new  firing system into that, is really a function of what are the economics of fuel savings if I were to replace old  with new. I’m going to say the Arab Spring is really where this began. When you started to see the overthrow of  governments and the royal Saudi family start to abandon its commitment to Opec, fuel prices began to decline  and we see that today. Even to the extent where fracking is way below where it was previously and a number of  major oil producers in Canada have wells that are still waiting for the per barrel price to get up over USD 60  before they reactivate. If one of the single biggest drivers in making the decision to replace an industrial boiler was the return on investment through energy reduction, a more efficient design, then when fuel prices decline,  there are fewer people interested in buying boilers. There is another impact from COVID-19, fuel prices  diminished significantly during COVID because nobody was buying oil, so that would have been another both  near-term impact of COVID-19 as well as something that will continue to persist as time goes by. What you  saw was exacerbation of a mega-trend.

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3.
What are your thoughts on the impacts of the Biden administration on the boiler industry? Might this administration’s increased focused on green energy generation, solar and renewables than the Trump administration limit near-term market growth as it relates to power generation? Will it have a significant or meaningful near-term impact?

SP: I think you can’t underestimate the impact of the change in The White House there. We know that Biden  has stated that he is in favour of more green policy, period. That said, if you are a utility company, you have  choices about how you generate power. One of those is through combined-cycle, steam-generated, but you can  generate electricity in other ways. If you’re going to spend money on capital equipment, and certainly any  power-generating station is an enormous capital equipment requirement, you have choices about what fuel  you’re going to use or what the motive of energy is going to be. I’m going to say just about three years ago I  attended an industry event and at the time the gentleman who was a lobbyist and consultant to the petrochem  industry was discussing that the people who make electricity, the utility companies, had for the next five years  not a single power plant driven by coal. It didn’t matter how inexpensive the fuel was, there was absolutely no  interest in that any further. Then in a subsequent industry event that I participated in, I learned that the next  product that is high on the list of things to eliminate from the atmosphere is the hydrocarbons that come from  diesel. Under the Obama administration, the EPA was accelerating its energy cleanliness mandates. There’s  just so much you can do with oil, so you’re about to lose a significant market segment, and steel production or  oil production are two of the biggest customers you actually have in that industry. 

For example, if you frack, you are injecting steam into the ground and that pressure that it builds forces the oil  up to the top, so there’s an industry that will be further impacted by, “Fracking is a dirty word, fossil fuels are a  dirty word.” Expect to see utility companies investing more in alternative energies for the long-haul. I could  say, without hesitation, that the long-term impact, you can’t eliminate fossil fuels, but you could see a shift as  much of 25-50% of the business that went to fossil fuels moving to alternative energies. In the long term it’s  going to be a very challenging position for Cleaver-Brooks to maintain in the combined-cycle, in the heaviest  end of its industrial boiler business.

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4.
Can you assess Cleaver-Brooks’s boiler market positioning? What do you think are its strengths or unique boiler technology competencies?

SP: Their strength is their market footprint, they’ve been around a very long time, it’s a well-known brand.  Again, I’m going to say more at the larger end of the spectrum, they are an established leader in the market  place. If you are considering some industrial project of scale, and I’m talking about a power plant, I’m talking  about an airport, I’m talking about a hospital, if that is the scale of the project that you’re considering, your  engineering team and your architects, Cleaver-Brooks is one of the first names they come across in their  Rolodex. That puts them in a really enviable position in terms of market presence. However, there is  increasing competition and you cannot really rest on your laurels. It doesn’t really matter what the industry is  or who the player is, you have to do things differently, you have to evolve, and the evolution that Cleaver Brooks has chosen as far as directional is vertical integration. Originally, they were a large domestic, so  apartment buildings and large industrial, and really what they’ve done is they’ve actually integrated by  acquiring and integrated by providing additional services within the various segments that they currently  serve. For example, would be they now remarket and rebrand a boiler that they purchase in Europe and sell to small commercial buildings, let’s say a four-unit or as much as a 10-unit apartment complex. They won’t go  much bigger than that, but that’s what that product segment was brought on board to do, they have a  marketing relationship with this European company. 

Something else that they’ve done is, if you look at the demographics associated with the baby boomer  population getting ready to retire, what it’s generating is there is a lack of skilled technical resources within the  industry. It’s very difficult, if you’re running a complicated system, to keep it online and to do the maintenance  and to keep it compliant with environmental regulations which include smokestack monitoring. The number  of people that are capable of doing that is in short supply, and so Cleaver-Brooks’s response to that was they  acquired a couple of companies that have those service capabilities, one in Texas, used to be called Holman  Boilers, now Cleaver-Brooks Sales & Service, a second company in Illinois. What they’re really doing is they’re  expanding their offering in order to generate, first, a greater degree of loyalty and, second, revenue streams  from other categories that they had not previously been able to participate in.

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5.
I believe Cleaver-Brooks’s broad portfolio breaks down into smaller firetubes and larger watertubes. Can you assess the key technological differences and Cleaver-Brooks’s positioning in each? Is it stronger in one than the other?

SP: The real difference between the two of them is, there’s a technical difference, but it’s almost meaningless  in this context. Firetube is you have something that is combusting fuel, and as the exhaust gases travel through  the firebox and then ultimately through the heat exchanger, the products of combustion, the energy is released  through small tubes, and on the exterior of those tubes you have water. That’s how you transfer the energy  from the exhaust stream that’s going up the chimney into the water that’s circulating past it. That’s firetube.  Watertube is different, and that is basically everything around the firebox is immersed in some type of a heat transfer medium, typically water. It doesn’t have to be water, but that liquid absorbs the heat right off the  firebox. It’s more efficient, it’s much more expensive to manufacture, it is much more technically demanding.  What I’m saying in a somewhat roundabout way is they have a whole lot less competition in watertube than  they do in firetube. In firetube the barriers to entry are very low, the margins are very low. The number of  suppliers across the globe is, I’m going to say, at least 10-fold higher because it doesn’t require a whole lot of  technical expertise or large manufacturing facilities, whereas watertube, your boiler is as large as a bus and not  everybody has the facilities to be able to manufacture that or the engineering to support it. 

Even better than that, on that scale your customer is going to buy something, they’re going to give you a  deposit for that, but it’s going to be 10, 11, 18 months before it’s finished. Your capital position really  determines how much of that business you can get because very few companies can afford to finance that kind  of a purchase, and so that keeps a lot of the smaller players out of larger industrial end. By the way, based on  the ownership and the access to capital, that puts Cleaver-Brooks in a good place in that segment. 

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6.
Are condensing boilers taking share from traditional firetube boilers? Is that a trend? Is it deflationary for the package boiler industry?

SP: That’s a really good question. Let me be technically precise. A condensing boiler, as you make the fire and  the temperature is, say, 2,000 degrees at the point of combustion, as it travels through the heat exchanger,  that energy is absorbed by the boiler and transferred somewhere else where it’s being used. At a certain  temperature the combustion gases have cooled so much that it begins to get wet, that’s when the condensation  comes from. Really what you’re talking about is condensing boiler is not a different kind of boiler. What it is, is  it the capability of wicking heat from the combustion process more effectively, more fully than a traditional  boiler does because you’re just sucking every bit of heat out of those combustion gases before they go up the  chimney. As they go up the chimney they cool so much, just like the air conditioner on your automobile, that any moisture in the atmosphere begins to precipitate out and that’s what’s condensing. That’s what the  condensing boiler is, it’s an extension of an existing boiler with greater efficiency that leads to a phase change  of the gases from a gas to a liquid. 

Clarification, yes, the industry is moving to condensing boilers fast and furious. You could not get an architect  today to specify a boiler in an apartment complex that wasn’t condensing, because a non-condensing boiler  suffers an efficiency disadvantage of as much as 20%. If I don’t care about condensing, I can only get up to  about 80% efficiency. If I want condensing, then I can take that all the way up into the high nineties. You’re  losing fuel, you’re polluting and it’s the way the world is going. 

Third Bridge (TB): Is that trend deflationary for the package boiler industry? 

SP: No, actually it’s not. The problem is that the industry is experiencing deflation, it’s not because of  condensing boilers. You asked a great question, what you asked was thought-provoking. There is some  deflationary pressure, I’m going to change my answer to that, but explain why there’s deflationary pressure. If  I had a boiler 10 years ago that was 80% efficient and I’m replacing it with one that’s 100% efficient, I don’t  need as large of a boiler, I don’t need as many boilers to heat the same space, and so what you’re seeing is a  significant reduction in unit demand across the entire boiler industry. There are fewer boilers being sold  because the ones that are being sold, I don’t need them to be as big and I don’t need as many of them. That’s  creating deflationary pressure in that market, leading to smaller demand in terms of quantities being  produced. Also, because of that increase in efficiency, again efficiency upgrade as a result of being able to  really cool the exhaust gas temperatures and transfer that energy into something else that you can use,  because of that you have smaller boilers that are capable of doing things that in the old days, however you  measure the old days, 10 years ago, 20 years ago, they’re much smaller boilers that are now capable of  delivering that same kind of heat output on demand, but they’re commercial grade not industrial grade.

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7.
Is there a good way to assess boiler demand across new constructions vs replacements?

SP: Yes, that’s a really important question. It’s not that hard of a question, it’s a really important question and  it’s actually very easy to answer. It presents, again, another headwind for the industry. I’m going to answer the  question in the context of what’s happening in New York City. New York City is the oldest housing stock that  uses boilers in the United States, it’s the oldest and largest. There are a couple of things that are going on in  New York City. One of the things that’s going on in New York City is the value of real estate is so high. By the  way, this is the single biggest geography that consumes boilers and it’s really particularly because New York  City is old housing stock. If you are building newer housing stock, there are a number of things that are likely  to happen in a new apartment complex that can’t happen in New York City or didn’t happen in New York City  at the time that they had to make a selection of how you were going to heat that facility. 

Alternative energy, or alternative technologies, for example, furnaces or independent heat-generating plants  that are the size of a single apartment vs a boiler room in the basement that heats the entirety of the building.  This is that trend that I wanted to get to. In New York City, the real estate values are so high that we’re seeing a  competitor to Cleaver-Brooks, a company by the name of Navien has really been championing this, but all the  others in the industry are starting to catch on, and they’ve figured it out and are copying it. When a tenant  moves out of an apartment in a larger complex, instead of just moving somebody else in, they’re typically  sending in a heating and ventilation company who will install, either under the cabinet in the kitchen or in a  closet next to the bedroom, the technology is called a tankless hot-water heater. It’s capable of generating heat,  and it’s capable of generating domestic hot water. It’s actually the size of a mini fridge. It’s quite small. I can tie  a gas meter to that device and tell you, as the next tenant who is about to move in, that you are responsible for  heating. If I’m the landlord, and I’m tired of standing outside my building, looking up and seeing, in the  middle of the winter, while the boiler is running, that half my tenants have their window open, it’s very  wasteful. 

The icing on the cake is, when I’ve done this in every apartment that I have for rent in my complex, then I don’t need the boiler downstairs in the cellar anymore, and I’m going to actually dismantle it, I’m going to  chop it up and move it out in pieces. I’m going to refinish the basement and then I’m going to build individual  storage units in the basement, and I’m going to tell my tenants, “If you would like to rent additional space for  all your stuff, you can rent a cage downstairs in the basement.” What we’re seeing is a tremendous move away  from this monstrous machine that used to occupy the basement, and landlords figuring out, “I control my  costs, as far as heating the building, I can increase my rental footprint and I don’t need an industrial boiler  maintenance company,” very few of which there are available, to come in and take care of these. “I can get any  old plumbing and residential heating company to come in and service that tankless hot-water heater.” I’m not  running all the time. I’m only running when the person actually needs heat and turns it on for hot water or a  shower or comfort heat. Big change in a geographic market, depending upon changes in the industry. Refocus.  What was the question, specifically? 

TB: Is there a good way to assess demand driven by boiler replacements vs organic growth from new fittings? 

SP: Boiler replacement has always been as much as 70-80% of the market. I’m not sure if that’s data that  you’ve ever heard before, but it is the vast majority. Primarily because if your heating system in your, it’s not  really a home, but in your business, in your apartment complex, is based on the boiler, you’re not really  substituting a different type of heating plant because you don’t have places to run ductwork. You are confined  to a boiler once all of the pipe has been installed in the building. If you are a new building, if you’re brand new,  the chances are that you’re going to use fewer boilers. You may not even use boilers. You may use either a solar  or partial solar or even wind, but you also have the opportunity to break the boilers down to something much  more commercial. Your industrial boiler market is diminishing because even the replacement market is  impacted by higher-efficiency, lower-cost alternatives to what we used to do 50 years ago.

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8.
The barriers to entry are much higher for larger boilers and buildings, requiring more sophisticated technologies. Can you assess the competitive landscape of this top end of the market, highlighting key competitors? Cleaver-Brooks is often positioned as a leader for large-scale industrial or commercial boilers. Which other competitors should we be aware of? Are there any key points of differentiation?

SP: I want to answer that question in two ways. Again, the boiler itself is only a portion of the equation. The  burner is also a significant element. Remember, the boiler is just a vessel. One of the bigger players that  Cleaver-Brooks has been competing against all along is this company called Hurst. Hurst, actually they’re not  all that far. They would trade employees, as a matter of fact. Very much the same profile of product. There are  a couple of other boiler manufacturers in that same category, many of whom are migrating upwards. Weil McLain is one of the companies I used to work for, and they specifically made a decision to move from boilers  in 150,000 Btus up to the five million and 10 million Btu range. They’ve introduced a whole line of products,  and they’re also very well-established, for a very long time, like Cleaver-Brooks. The issue is, and this is a  double-edged sword, and has been for Cleaver-Brooks, if you have a particular preference for a boiler, the  chances are more than not, it’s at least a 50% chance, you own more than one boiler. If I were a university, for  example, I can’t run a university on a single boiler. I have to have five or six boilers. I have to be able to flex up  in peak demand. I have to be able to take units offline to do maintenance. I have to have room for failure  because boilers, they do get hot and cold, and hot and cold, and hot and cold, and that expansion and  contraction destroys the machine, so you rebuild them over and over again. 

If I have multiple boilers, what I want is I want this boiler that I already have with this burner. There’s a great  deal of value in being able to stay with what you have when you go to replace. What Cleaver-Brooks did, right  or wrong, was they made a decision that if you purchased a Cleaver-Brooks boiler, it would come with a  Cleaver-Brooks burner. That was some of the vertical integration we talked about. They acquired two  companies, one a company by the name of Industrial Combustion out of Monroe, Wisconsin, and then another  company by the name of Natcom out of Montreal, Canada. If you have a Hurst boiler, if you want to buy a  Hurst boiler, Hurst will ask you, “What burner do you want on it?” You can choose a Coen boiler, and Coen is  owned by the Koch brothers, big, major player in the marketplace. They’ve acquired quite a few of the players  in the combustion services end of our business. You will have a choice. You can put whatever you want on it, and your buyer is interested in keeping one burner and all five of his boilers so that he has one set of  mechanics that know how to work on them all. 

It’s not just the boiler, but you do have some major players. You have Zeeco, you have Hurst, you have the  Koch brothers, you have Weil-McLain. I’m just trying to think, it’s been a while since I’ve run through the  names, but I’m going to say that, based on how many players there are in that market space, you have about  five major players, Superior, Hurst, Cleaver-Brooks. There’s one that just eluded me. It will come to me when  I’m not trying to think of it. There are approximately five really big players doing that industrial boiler. Indeck,  that’s the name of the company. That’s who they’re competing against, and they’re quite a bit larger. Cleaver Brooks is quite a big larger than those guys. That’s both good and bad. The strength of their position is you  have local representation. By the way, we didn’t talk about that, but I think you need to, if you haven’t asked  One of the strengths of Cleaver-Brooks’s market position is boilers are maintenance-intensive. You may have  your own staff, but in a typical hospital the staff is able to read the dials and the indicators and understand  that everything is in the green, but when things get ugly, when they stop working, being able to diagnose the  problem is frequently very challenging. Cleaver-Brooks’s model for going to market is they have either aligned  with, or in fact acquired, major distribution points across the US, companies that are capable of not just selling  the boiler but also doing the maintenance, and selling parts and doing the service on boilers that are already in  place. 

That is a significant advantage over Indeck or Miura or many of the other companies, who their coverage is  really haphazard, very regional, because these distributors are the leftovers, the second-tier distributors. All  the really powerful, influential players in that marketplace are typically Cleaver-Brooks. If you’re Kellogg’s or if  you’re Kraft, you don’t want to deal with 19 different companies. You want to deal with one company. I can call  Cleaver-Brooks at their corporate headquarters and say, “I have a cheese factory in Atlanta, and I need  somebody in there right away because it’s not working.” Cleaver-Brooks can handle the entire activity on your  behalf, and there are very few companies that can do that. There is a strength there that insulates them, at the  higher end, from some of the other companies that can manufacture a boiler for less money. Significantly less.  We found ourselves, on a number of bids, anywhere between 30% and 20% higher than everybody else. If you  have a competent technician on-hand or a staff capable of managing and running boilers, you’re actually not  going to pay that premium.

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9.
Have there been areas in which competitive pressure has increased for Cleaver-Brooks? You mentioned an element of increasing competition. Were you referring to the larger-scale segment or something on the lower end?

SP: Yes, absolutely. Where you see it the most acutely is in the smaller products, because the volume and the  absorption typically come from producing a boiler that is about the size of your sofa. Anybody can build those,  and there’s a lot of smaller players. A lot of the competitors that are out there actually were, in one way or  another, formerly associated with Cleaver-Brooks. They’ve taught many competitors how to be in this business.  The smaller you go, the more intense the competition. It’s impractical to import a boiler that is the size of a  truck. You can’t do it. You can’t put it in a container, put it on a cargo ship and take it through the Suez Canal.  The competition for things that are smaller, it’s far easier for competitors to enter the marketplace and  establish themselves. It’s highly fragmented, lots of very small players with exceptionally spotty penetration. It  just happens to be where they happen to be, and two-thirds of the country are uncovered for that brand. 

On the higher end, as I said, the strength that Cleaver-Brooks has is, first of all, the logistics of moving a  massive boiler across the country are hard enough without trying to do that from an overseas location. Then,  second of all, if you’re looking for all of the infrastructure that supports the sale of something that is USD 5m  and takes you 28 months from the time you order it to the time that it’s actually commissioned, that strongly  favours a company like Cleaver-Brooks.

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10.
How tight is labour capacity in the US boiler market, especially in technician roles?

SP: It’s horrible. It’s really interesting that you say that because if you look at my resume, I’m very much an  industrial guy. Because I worked on heating equipment as a kid, I’m very attuned to that segment, but the  other business, the other industries that I’ve served are all experiencing the same thing. There is a shortage of  qualified welders, to the tune of 300,000 individuals in the United States. The number of technicians that are  graduating the trade schools and are capable of becoming boiler makers, is down almost 50% over prior years.  One of the most critical paths that used to spit out qualified steam generation technicians was the US Navy,  because all those boats used to be steam-powered by a boiler, and none of them are now. Now they are using  something that is far more similar to what you would find on a jet aeroplane. You have far more sophisticated  appliances that are far more efficient. They are turbine engines, and nobody that works on a turbine-powered  destroyer comes out of the Navy and knows how to work on a steam boiler, so you have a tremendous shortage. 

In the next 10 years, it’s actually supposed to get worse, of people not entering the trades. You see that across  any trade you can imagine. You see that even in truck driving. There’s a shortage of truck drivers to the tune of  60,000. The problem is we’re not graduating people with technical skills nearly at pace with demand. To  exacerbate the problem, the products that we need them to work on are far more sophisticated, more  technically complex than anything that we used to work on 25 years ago. It is something of a perfect storm.

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11.
Has Cleaver-Brooks attempted to mitigate any labour challenges or future risks around labour constraints? Is there anything to be done? There is only so much players can do with labour dynamics, especially with some of the headwinds you just mentioned, but the company’s labour and technician capacity seems well positioned, perhaps due to some acquisitions.

SP: It’s very challenging to do something about that. You have to have a pool of candidates that are willing to  learn. I’ve seen things done at other companies that were more proactive than what I’ve seen at Cleaver Brooks. For example, one of the manufacturers, again heavy steel industry that I was associated with, had  partnerships that they were engaged with in local trade schools. They would offer, for example, to pay tuition  with a fixed-period payback. “If you went to welding school, we’ll pay your way.” As long as you stay on as an  employee for a period of time, your debt for that training will be forgiven. That was something that I thought  really needed to be brought into Cleaver-Brooks. For whatever reason, it wasn’t in the cards. It’s now three  years since I was last connected, so I don’t know if they’ve done anything different about that. 

That said, what I would also say is the shortage of qualified welders has led to opportunities for competitors,  because where you may want to do business with Cleaver-Brooks, their lead times are significant. Anywhere  between 16 and 26 weeks was common, which means, first of all, there’s very little being built on speculation,  so there is no inventory. I do know, from when I worked with United Technologies, when you have lead times  that are that dramatic, for a product that might be considered a critical infrastructure piece, if you’re a hospital  and a boiler goes down, you might want Cleaver-Brooks, but if that is one of just two functional machines or  three functional machines, the risk of waiting for another half a year to get product is too great for many to  wait and they’ll go to a second-tier supplier. 

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12.
Is there anything else you would like to mention or expand on?

SP: There is one thing that I think probably needs to be, if you want to understand their position in the  marketplace. I will tell you that I’m a pretty technical person. I understand how the products work, but that is  not my greatest strength. My greatest strength is understanding distribution models. That is, for me, one of the things that I’m most concerned about, not just for Cleaver-Brooks but for many other market participants  across a wide range of industries. In particular, what I’m talking about is the vast majority of Cleaver-Brooks’s  go-to-market model is dependent upon independent businesses that are typically family-owned. They are out  there promoting Cleaver-Brooks products. The analogy that comes to mind is the hardware store or the auto  parts store. If I dial back the clock 30 years, there was an auto parts store in every town. It was quite small. It  was privately-held. Same thing with a lumber store. If you fast forward, the Home Depots and the AutoZones  have pretty well, through consolidation, wiped out all the independent players. 

Cleaver-Brooks’s model is dependent upon approximately 30 families, with, I’m going to say, one exception,  and that’s Cleaver-Brooks Sales & Service. That was the former Holman Boiler company that they bought and  staked out a position in Illinois and Texas. If you then look outside those two territories, quote, unquote, what  you’ll see is, again I’m using broad strokes, you will see several groups of greybeards, men who are 50 or 60 or  maybe even a little bit older, who are milking it but they’re not growing it. If they could sell it, and they found  somebody who would pay them what it was worth, they would probably sell it and ride off into the sunset, but  based on the margin profile, the lack of human resources and technical resources that are required to create a  profitable model for that, many of these players do not have an exit strategy. If my distribution model is  dependent upon 30 companies across the United States, most of whom are owned by very close-to-retirement age individuals, I’m a little concerned. By the way, this is not limited to Cleaver-Brooks. This is an observation I’ve made in a number of different industries that I’ve served, but I think Cleaver-Brooks is especially  vulnerable to it because if you do a distributor profile and you look at how it’s owned, who are the principals,  there’s not a lot of them who have a succession plan. They don’t have succession plans, with very few  exceptions. 

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13.
Is there an alternative to Cleaver-Brooks’s distribution model? Have there been competitors or similar industries with other models that the company could transition towards?

SP: Yes, there is in fact an evolution that you should expect, and it’s very predictable. The purpose of the sales  organisation, from a theoretical point of view, is they are diffusers of innovation. We’re here to tell you about  something you don’t know about, that you should know about. Once a market reaches maturity, then  competitive advantage accrues to the companies whose logistics profile is the most robust. It’s going to be  more price-sensitive because there’s more competition, and you have to shed overhead. In this case, you could  talk about the distribution channel as overhead. They take anywhere between 30% and 50% margin on what  they buy from Cleaver-Brooks onto themselves, and it leaves huge gaps, geographically, throughout the  country. Ultimately, the most efficient logistics platform for Cleaver-Brooks would be some kind of direct  selling routine. 

They’ve migrated that way a little bit. If the sale gets made to an electrical plant, a power plant in a  distributor’s territory, Cleaver-Brooks will hold the paper. They’ll write the invoice, and when everything is  done they’ll credit the distributor for their active participation, and that that is the hook that keeps you  involved and servicing that customer for a good long time, because I’m paying you to be engaged. That  Cleaver-Brooks distributor couldn’t have done that job if they wanted to. They just don’t have the cash  reserves. Very rarely would they have access to capital on that scale. The problem is, as these guys reach  retirement age, there’s nobody to come in and acquire their businesses. When I say nobody, I mean most of  them don’t have that in place. The only alternative that I see for Cleaver-Brooks is either acquisition, acquire  your distribution channel, or you lose it. If you lose it to somebody who sells another brand, that’s a bad play. I  think, ultimately, for Cleaver-Brooks to maintain their position over the long haul, they’re going to have to  figure out how to deliver not just a manufactured product but all of the infrastructure that supports that  product, from installation, service, to long-term parts availability and support. That will be challenging. Not  impossible, but that will be challenging.

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