The first is Oklahoma-based AXH air-coolers, which is being sold to Windjammer Capital. Oklahoma isn’t quite the midwest, but this is classic direct lending: Bain Capital Credit is providing a roughly $100m term loan to finance the buyout, advised by Lincoln. 

The second is a sale process for KwiKool, which is based in Houston. Still not the midwest, but close enough. The company, which makes portable cooling systems, is being marketed on $15m EBITDA in a process run by Lincoln. Direct lenders are all over it, as we reported last week. 

A bit like gardening, the HVAC space is fragmented. That makes it an ideal target for private equity roll-ups, often financed by direct lenders. 

“HVAC roll-ups are white-hot right now,” said one of the private credit executives we spoke to for this article.

Indeed, there have been a ton of deals in the HVAC market lately, some involving large strategics, but most involving PE firms in some way:

• Daikin, a literal household name in the HVAC space, is buying Williams Distributing, a privately-owned distributor in the Great Lakes region.
• In June, Ace Hardware purchased a portfolio of 12 companies from PE firm Grove Mountain Partners, which included numerous heating and air companies. 
• In the same month, sponsor Kian Capital acquired Team Air Distributing, an HVAC distribution company based in Nashville.
• Sila Services, which was acquired by Morgan Stanley Capital Partners in 2021, recently acquired Ohio-based HVAC contractor Jackson Comfort Services.
• Last week, Carrier Global sold its security business to Honeywell for $4.95bn as part of a pivot to becoming a “pure-play, global leader in intelligent climate and energy solutions”; as part of the pivot, Carrier is buying German HVAC provider Viessmann Climate Solutions for €12bn.

The Carrier transactions are pretty huge, and are unlikely to involve private credit. But smaller HVAC deals, particularly roll-ups, are catnip for private credit firms — especially because they’re likely to be a gusher for much-needed incremental loan origination.

You are / my sup-plier

Professional investors have been interested in HVAC for a long time, and clearly still are. But that’s not to say it’s been an easy few years for the industry.

In October, a report from S&P analyzed 200 downgrades caused by supply chain disruptions between 2020 and 2022. Around 15% of them were at equipment and capital goods companies, the second largest cohort in the sample (the full data set is on page four of the report).

Supply chain problems have affected all of the industrials sector, said Eric Ause, a senior director at Fitch, in an interview with 9fin. The HVAC industry sits in the middle of the supply chain and such businesses can be affected by all of the broader issues still plaguing the supply chain.

“Where the supply chain issues stabilize remains to be seen,” Ause said. “We'll see some more improvement next year, but it will continue to be a challenge. Some of those issues just don't go away.”

Supply-chain issues are generally more acute for companies that source components from abroad, or have manufacturing facilities in other countries. On this note, the HVAC space is increasingly globalized — some readers may be old enough to remember when Donald Trump campaigned on forcing Carrier to manufacture within the USrather than Mexico.

But there are exceptions! KwiKool, for example, has a hyper-local supply chain. 

According to its own website, the company’s 54 products are all manufactured and assembled in not just the US, but within the state of Texas. The domestication of the firm’s supply chain shielded it during the Covid pandemic, helping it grow EBITDA even as competitors struggled, according to a source familiar with the company.

Am I industrial (yee-aah) 

Playing in less cyclical areas of the market can help mitigate some of these supply chain risks.

Both AXH and KwiKool have large commercial use cases for their products. 

AXH is focused on industrial-scale cooling for natural gas producers and oil refineries, an area of the economy that has experienced a boom lately, partly due to the impact on oil prices from the war in Ukraine.

KwiKool caters partly to the consumer market but also has plenty of commercial customers, including hospitals, aircraft hangars and data centers.

Commercial contracts are generally seen as stickier than consumer demand. Given the state of the commercial real estate market at the moment, and the fact that demand for HVAC systems is quite closely tied to construction and renovation activity, this is perhaps less of a given than it used to be — but there is cause to be optimistic on that front. 

Specifically, the industrial real estate market is creating a tailwinds for HVAC demand. Generally owned by more sophisticated real estate investors, examples of properties in this sector are warehouses focused on e-commerce fulfillment or storage. In recent years, the growth of private capital in real estate has also led to more niche property types like cold storage for food or even pharmaceuticals.

Those facilities are navigating a period of change: ESG concerns, changing temperature patterns, and a need for greater efficiencies due to power shortages are all now part of the equation, said Clark Machamer, senior managing director in the industrial group at Crow Holdings, a real estate investment firm.

Getting enough power for a large HVAC system is a big issue these days, he told 9fin: “In my market [the Northeastern US], the utility company is not going to give you enough power to generate a cooling system on a speculative basis. They're going to want to know someone's going to be using that power within the building.”

In terms of tailwinds, one big (and scary) driver of HVAC demand is climate change. Machamer noted that in the Northeast, cooling never used to be something property developers needed to provide, at least compared to the South where temperatures are higher.

No more. The summer of 2023 summer was the hottest on record in New York — and even if building owners aren’t rushing to upgrade their HVAC systems just yet (the 9fin office being a good example), the trend is clear. 

The resultant increase in demand for cooling is putting strain on the power grid. HVAC requires a lot of power, so energy efficiency is becoming increasingly important, and this is driving a push towards digitization within the industry. 

This means companies with scale and capital to develop more efficient machines are in higher demand than ever. Smaller companies don’t necessarily have the capacity to invest in the technologies that allow for data collection, analytics, and smooth networks to run it all. 

“All of those trends probably provide a little more relative benefit to larger companies,” said Ause at Fitch.

Rolling in the heat 

This is all bullish for roll-up strategies, so the FTC’s crackdown on roll-ups may upset some market participants: it could add regulatory barriers for sponsors, and threaten the add-on pipeline for direct lenders. 

But for now at least, the deals keep coming. Many smaller HVAC companies are still owned by families or small teams of partners; Windjammer will be AXH’s first PE owner, for example. And as we’ve covered in the past, private credit firms are increasingly fond of non-sponsored businesses.

“There’s a lot of these small businesses that are getting sold right now because it’s not clear who’s going to take over the business,” said the private credit executive we quoted earlier. 

Even at today’s higher borrowing costs, the economics of an HVAC roll-up are strong.

According to the head of origination at another private credit firms, PE sponsors can buy a “premier” HVAC platform at 8x-10x EBITDA or a smaller one for 3x-4x, and find debt financing at 3x “all day long”:

“If I can buy a platform 8x-10x and create a 5x equity cushion on everything I buy because I'm paying all debt for it, it's a really good business,” they added. “That’s why I think the attraction has picked back up.”