Why Cintas Is Facing Financial Stress And Its Fastest Growing Business Has Charged With Fraud And A Public Safety Risk

Report entitled “Uniformly Bad Business Practices” outlines how Cintas faces 60-75% downside risk to approximately $69.00 to $107.00 per share when accounting for its weakening fundamentals, aggressive accounting, regulatory and litigation risk related to the fire business, poor governance, and extreme valuation.

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Fundamental Challenges & Growing Signs Of Strain Following G&K Acquisition : Cintas acquired G&K for $2.1 billion in August 2016 after sweetening its offer three times. Based on industry research and expert discussions, we believe that G&K had a very poor reputation with customers and carried meaningful exposure to the challenged oil, gas and mining sectors. Despite this, the lofty acquisition was likely necessitated by Cintas’ slow underlying growth in its core uniform business and the accounting flexibility that the acquisition would afford. Despite analysts’ praise of Cintas’ performance following the acquisition, numerous signs indicate that the core uniform business is under strain. Cintas’ allowance for doubtful accounts, working capital requirements, and DSOs are all rising rapidly to record levels. Our concerns over a slowdown are further heightened by sluggish inventory growth, new disclosures around discounts and rebates, and a reliance on a poorly-disclosed investment gain. All of this has occurred while Cintas’ leverage – which, we feel, is underappreciated given the magnitude of its foreign-domiciled and other restricted cash – is steadily rising. In Spruce Point’s opinion, the attractive picture painted by Cintas’ management has been a product of its ability to spin a consistent “beat and raise” story. However, after adjusting for questionable initial guidance around intangible asset amortization, G&K revenue suppression, and share repurchases, we find that Cintas delivered no outperformance last year relative to initial 2019 guidance
Playing With Fire – Instance Of Fraud And An Outstanding Wrongful Death Suit : Recent changes in revenue disclosure reveal for the first time that Cintas’ fastest organically-growing business is fire inspection. Based on our research, this industry faces serious headwinds from a shortage of qualified labor. Cintas has used an “affiliate network” to expand its reach, but this approach poses serious hurdles to the challenge workforce monitoring, putting its quality standards and licensing practices at risk. Using a recent Freedom of Information Act (FOIA) request, we found that, following an Aurora, IL fire, Cintas was charged with fraudulent business practices after it was determined that 8 of Cintas’ 12 inspectors were unlicensed and unfit to carry out inspection duties for the 22 properties within Aurora’s jurisdiction. These inspectors consequently produced falsified inspection records. Based on our research, this may not be an isolated incident. We believe that Cintas may have breached its credit agreement by incorrectly representing that it holds all licenses necessary to conduct its business in compliance with the law. Further, a case is currently being heard in the Southern District of Indiana where a plaintiff is seeking damages against Cintas for the wrongful death of her husband because of purported negligence. In addition to the risks inherent in the business, waves of cash flooding into the industry could disrupt Cintas’ national market position. Fueled by cheap financing and the ability to leverage contractually-mandated inspection revenues, private equity players are creating regional platform acquisition vehicles to seize market share from disgruntled Cintas customers. Further, APi Group, a large national competitor, was recently acquired by a UK SPAC and will soon be listed on the NYSE, giving it broader access to public capital to compete against Cintas
Poor Governance And Extreme Valuation : Spruce Point has numerous concerns about Cintas’ Board of Directors, including a relatively slim level of separation between its Chairman and CEO, relationships which call into question the independence of Board members, dubious compensation practices, and an unusually close relationship between the company and its auditor. In fact, Cintas has been audited by Ernst & Young since 1968, and its E&Y engagement partner, Craig Andrew Marshall, was also the audit engagement partner at embattled Papa John’s International (Nasdaq: PZZA).
Inflated Valuation With A Poor Risk / Reward : Analysts and investors love Cintas for its ability to grow earnings consistently while returning capital through share repurchases and a modest dividend. As a result, analysts reward Cintas with the highest multiple among its publicly-traded peers in the commercial and safety space. Yet, Cintas’ average analyst price target of $255 already implies 1% downside to its current share price of $259, even before taking its underappreciated business headwinds into account. Analysts fail to critically evaluate each of Cintas’ business lines and apply proper multiples to reflect their dissimilar growth and risk profiles. The company as a whole trades at 4x sales and 18x EBITDA, but, in light of recent industry deals carrying far more modest multiples of 1x-2x sales, none of its individual business lines deserves such a rich valuation. Taken together, Cintas’ businesses are fairly-valued at $69 - $107 per share, implying 60% – 75% downside to current levels.

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Disclaimer

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To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of CTAS or other insiders of CTAS that has not been publicly disclosed by CTAS. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use.

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