Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Welcome to the IP Fieldwork podcast. Today, we will be discussing Perimeter Solutions. Why now, Will? Well, when I say why now, to be clear, we have published a range of pieces over the last year, including a company profile last September. Let's delve into the context surrounding the timing of this piece.

I started following this from the beginning. It was probably one of the only SPACs I really looked into. Like many, I was initially put off by the compensation plan. It seemed unusual, and I think that's a common first reaction to this business. The structure of the board's compensation plan was set up when the business was sparked, and it was quite off-putting.

However, as I delved deeper, I took particular notice because I've followed TransDigm for a while. It might sound crazy to say TransDigm is underestimated, given the multiples it trades at, but my hypothesis is that companies like TransDigm and Constellation are underestimated in their ability to operate businesses, not just acquire them and raise prices. They excel at operating these businesses thoroughly.

I paid attention to this due to TransDigm's influence on Perimeter Solutions. As I researched more, I realized it fits many characteristics I look for in a niche industrial business. To summarize, these include mission-critical products for end customers. Perimeter is an aerial fire-retardant business, and their core product is Phos-Chek. If you remember the LA fires in January, it was the red dye dropped from airplanes to suppress the fire. It doesn't extinguish the fire but suppresses its growth.

This business has been around since the 1960s or 1970s, owned by various large chemical companies, and has been a non-core asset for them. Now, it's a listed company. It fits certain characteristics, such as mission-criticality, which is self-explanatory. The Forest Service needs to suppress fires, especially near residential or commercial properties.

High switching costs or sole source agreements are also important. This business has been a sole source for a while, despite periods of competition. The switching cost comes from a regulatory moat, similar to aerospace suppliers with FAA regulations or Danaher with FDA-backed equipment. Perimeter supplies retardant underpinned by the Forest Service's Qualified Product List, a regulatory framework allowing vendors to sell to the Forest Service. It takes years to pass through various stages, not as strict as the FAA or FDA, but close.

Other characteristics include the product cost being a small percentage of the final cost to the customer. Like TransDigm, which focuses on sub-$5,000 unit parts rather than big engines for Boeing or Airbus, the retardant cost is only 3% to 4% of the total cost per year for the Forest Service. It's insignificant but critical in fire suppression.

Additionally, OEMs with proprietary IP are important. The Phos-Chek formulation is hard to replicate. While it's tricky to understand the proprietary nature of the IP, especially since I'm not a chemist, we can discuss the operational moat Perimeter might have. Other factors include a slow product lifecycle and an installed base. Perimeter fits many of these characteristics.

Although initially put off by the compensation plan, as I researched further, it ticked many boxes, prompting me to spend more time on it.

Could you take us through the process leading up to the company profile being published last September? We've had a series of interviews published on the platform before the company profile. How did that come together?

You're asking me to explain things that are sometimes unconscious.

A lot of it is indeed unconscious. Let me make it easier. You've spent a couple of years getting closer to the filings, reading about the business and the industry. You reached a point where you were ready to start making calls, which was probably more than a year ago, around 18 months ago. Could you walk us through how you set up these questions? It's all available for our subscribers to read, but the context of how you approach this kind of work is quite interesting.

The characteristics I mentioned are fundamentally what I'm looking for at a high level. I'm unconsciously consuming information and evaluating businesses based on those frameworks and points. It's not just about mission criticality, high switching costs, or product cost being a low percentage. These are intuitive concepts that people understand. However, having conviction in them and identifying when multiple factors overlap is particularly interesting.

Early last year, it became apparent that this might be the case. Additionally, there was an interesting setup with the company being domiciled in Luxembourg, relatively under the radar, and having been through a SPAC process. It wasn't well-covered in the US, and people didn't look at it much due to the compensation plan. There was also a couple of bad fire seasons a few years ago that hurt the stock, which deterred people since the company is highly correlated to the fire season.

In terms of the approach, a couple of things really matter for the business. It's about qualifying or building hypotheses around those moats. Secondly, it's crucial to consider whether another competitor will enter this market.

It's essentially a de facto monopoly, right? So, is there going to be another competitor? Why hasn't there been one? What could happen, when, and how? If another competitor does come in, what is Perimeter's moat, and how does that impact long-term earning power? I'm trying to understand how this business works by weaving in these core questions. I might be off with these questions, but various interviews on the platform explore these points.

Part of their moat is the operations around the products, not just owning the formulation. It's hard for me to validate the proprietary IP in a chemical product like this, or any industrial product, because whether it's mechanical or a chemical formulation, how much do I really know about whether a new product could be better than Phos-Chek? There's only so much work I can do on the product IP.

I spend some time understanding where there could be holes in their offering. I can understand how a chemical formulation is delivered to the customer, to the airbase the Forest Service owns, then into a tanker, and dropped onto a fire. What are the logistical and operational moats potentially around that? If a competitor were to come in, how would that work? Perimeter has potential arrangements, owning its equipment and airbase. Through this work, I've gotten to know a couple of firemen in the US that I chat with regularly.

But really, if this is a monopoly today, there's only one vendor in the US for dropping aerial retardant. You have to buy Phos-Chek because nothing else is approved. This isn't a novel idea. What's the risk? Another competitor entering the market. When you get into it, the decision or risk is really a policy question—a wildfire policy question.

Part of my work explores the history of Phos-Chek and why there hasn't been a competitor. The history of Fortress, which was the biggest competitor, is relevant. They came in, won some contracts, but messed up due to corrosion in the tankers. They also have another product called Qela, a Phos-Chek replica with the same formulation.

The nuance here is the policy from the United States Forest Service (USFS). I can't speak to a policymaker from the USFS due to compliance, and they wouldn't explore this with us. This information is crucial—how does their biggest customer think about adding another vendor? Do they want to be sole source? I couldn't validate this by speaking to someone from the USFS, but I can try to understand how the USFS thinks about policy by exploring the history of Fortress entering the market.

Why did the USFS bring on Fortress after 20 or 30 years? How did they establish their contracts? What was the plan if they didn't corrode the tanks, which they did? This research provides insight into how the biggest customer is thinking. It also highlights how difficult it is to enter this market, at least on any significant scale.

If I'm being critical, I hear you talk about characteristics that attract us to certain industrial businesses and products. How do I know you're not just running a giant exercise in confirmation bias, trying to fit available information into predetermined structures? How is what we've done not just cherry-picking information that validates what the management team says about their moat, competitive advantage, and competition?

Confirmation bias is always a risk for everyone. The way to combat or approach it is to understand how the industry or business works. If you look at our work on Fortress, I'm not overly concerned about why Perimeter might have a moat or switching costs. I want to understand how you work with the USFS to get your product qualified, which involves the QPL process, the regulatory framework in the industry.

There are many nuances in bringing the product to market that favor Perimeter at this point. The biggest question is that this is effectively a sole source agreement, and it's logical for a customer not to want a sole source vendor. It's a question of when, not if, there's another competitor. That's another exploration of what may happen.

How can Fortress bring a product to market operationally? We explore how the bases work. Winning a contract is one thing, but you must be able to distribute it. How does the airbase work? The equipment in the airbase? Suppose you have an existing base in LA dropping Phos-Chek with all the mixing units and logistics set up. If you want to switch to Fortress's product or another competitor, when Perimeter is running the base and potentially has capex in the ground, how will they co-mingle the formulations? What's the bargaining power of Perimeter?

What was the original plan when the USFS brought in Fortress? These questions bring to life how the industry and business work on a ground level. But yes, confirmation bias is always a risk.

Well, it is, but I think what you're saying is to really emphasize that a lot of the risk in our experience is mitigated by walking through step by step how things work. Actually, asking questions, even if they seem basic or dumbed down, is important. Some analysts might consider it embarrassing to ask them.

Right.

So, that's one thing—really confirming by asking straightforward questions, which has been a staple of yours for well over 10 years.

I'm not sure what that means, but I don't know how these things work. Like, I mean, what's an airbase like? It sounds good, but I've never been to one.

Well, this is it. Walk me through it. There's that line from Steve Blank that we've loved for a long time, which is, there's no facts inside the building. So get out of the building, hang out with some firefighters, find some stakeholders and try to get them to explain to you how things work. Now that's one thing.

I think the second thing is not being under pressure to have an opinion or, maybe put differently, is allowing the insights to reveal themselves should they arise at all, as to how this stuff actually works, whether it's this business or an industry we're studying. It's not like we're trying to figure this out in six weeks. What I would love people to understand is that this company profile is several years in the making. And it starts with actually studying TransDigm and understanding TransDigm. And then it continues with this process of getting over biases that you had. I think one of the main things I hear when Perimeter is mentioned is comp and management compensation; that aversion is overcome. And I don't want to talk too much about that today, I think.

But it is real, though, because it's something that I looked at and kind of dismissed immediately. I was probably just behaving like everyone else. Maybe they are right, and who knows what happens going forward. But I think there's a lot more to it.

Well, I think there's a great debate to be had around that. We've done fieldwork on the business, focusing on its quality, earnings power, durability, and competitive risks. The editorial questions here are interesting for people to understand how a piece like this is set up. It's a window into our thought process. With so much information out there, why should anyone care about what we've put together after a couple of years of work, including at least six to seven months of intensive work on this business?

Discussing the editorial choices is important. We have a segment on product litigation and one on management compensation, although we've agreed not to delve too deeply into that today. There's a section on competitive risks and the qualified supplier list, exploring how it works. I'm curious about what makes it into this list and what doesn't, and on what basis you choose what to highlight.

If I'm looking at intellectual property as an existing customer, trying to figure out what to focus on, or if I'm considering whether your work is worth my time, can I trust you to surface relevant information efficiently? This is a synthesis piece, drawing on fieldwork, readings of filings, and years of work in specific industries and verticals. Take us into the editorial journey for this piece.

I believe it ties back to what we've discussed about understanding how the business operates. It's crucial to weave in the most important questions and make a judgment on what those are. I might be wrong, but analyzing and exploring these questions openly while learning about the business is key. For instance, discussing competition or switching costs within the context of the QPL can reveal part of the strategic perimeter. Understanding what it takes to get through the QPL, identifying decision-makers, and learning how policy-making works are essential.

It's important to know how a new product gets approved, which could threaten or take volume from Phos-Chek by Perimeter Solutions. The potential advantages of any business, in my view, come from answering these critical questions through an open-ended exploration of the business's fundamentals. This is what most of this piece is about, like running an airbase. Explain how you manage one, what an airbase is, how it operates, and the different types of airbases and the QPL.

It gets tricky with some aspects, like product litigation, which provides informational value and incremental information about product risk. For example, Phos-Chek is a chemical formulation qualified into U.S. policy. However, it has issues, like killing wildlife, leading to environmental lawsuits against Perimeter Solutions. Competitors are pushing for the EPA's safer choice, a water-based option safer for wildlife. I don't have insights into whether these products are real threats, but I present the current state of product litigation.

There are various issues with Perimeter Solutions regarding product risk, offering incremental information for people to form their opinions. If a better product emerges, we need to understand how it gets approved on the QPL. We explore how Fortress was approved, the contracting process, capex, scale, and dollars required by vendors, and how to operationally bring it to market. This includes the necessary equipment, personnel, logistics, and scale to compete with Perimeter Solutions.

While nothing is impossible, if the USFS wants another vendor, which is rational, regulation requires two vendors for mission-critical products. Fortress claims there's a legal requirement for two vendors, so it's a matter of when, not if. I aimed to explore how a new competitor would enter the market and assess the associated risks.

Hopefully, it's clear to our listeners, but I'll make it explicit. IP research is a form of, or arises out of, a process of a number of investors learning in public. There is no pitch to this work. There is no finish date to this work. This is a work in progress. This piece was published last September as part of an effort that you undertook to aggregate what you had learned over a couple of years of work on this business. But I think it's come across, certainly to me and hopefully to our listeners, that this is provisional, that it's what we have so far, that it was enough in our opinion. There were a number of areas that we've touched on that we feel were incremental, that some of this material we believe is incremental to existing shareholders, but also that this is a work in progress. Certainly, we'd be the last to say that this is any kind of definitive opinion on the business. Yes, it does contain the fruits of a few hundred hours of work and tens of hours of conversations with people in the field on areas that hopefully are pretty relevant.

Right.

If you want to own this business for any period of time, I think that's all well and fine. I don't know if you want to comment on any of that or draw anything out, but maybe we'll end on why pay attention to this right now. Let's talk a bit more about the setup and give people a window. Part of the subtext of my question is because many people ask us why we are covering this now or how we filter. There are hundreds of great businesses out there, hundreds of compounders. We all have similar lists in this community of what might look like quality, right? Might stand the test of time. Let's look at that question specifically through the setup on Perimeter now and why we might care about this more than other things on our list right now.

Well, I thought it was cheap, and I might be wrong, but that was the original intent. Last year, in Q1, they lost Fortress, which was their only competitor. Last year, they had corrosion issues, and this year they effectively closed the business down. What got me interested last year was the whole corrosion issue, which made it particularly interesting because it became, objectively, a monopoly. I thought it was, for the business quality, fairly valued or pretty cheap. That's what really bumped it up the list.

So I think that's a wrap for today. Thank you to our listeners for checking in. You'll find a lot more on Perimeter on the platform. At the end of the learning journey of the company profile, we've listed a number of further research questions that we're investing in.

As always, this is for informational purposes only and should not be relied upon for investment decisions. Please do your own research.