Description

Automodular is a liquidation-like stock that I estimate should return 40% over the next year.  This return should have little fundamental correlation to overall market returns or the macro economy, and I believe that the probability of permanent capital loss is reasonably low.

Business Description:

I will be brief here and spend most of my time on valuation as the going business is currently set to end by December 23, 2014.  Automodular is based in Canada and is a sequencer and sub-assember of modules that go into vehicles assembled by North American auto OEMs.  Currently, the only customer is Ford, which has a contract that is set to end in December of next year.  Work for GM concluded in 2012.

The company also successfully completed a small project for subassembly on wind turbines during 2012 for Vestas, a large player in the wind energy space.

Valuation:

We have financial statements through the third quarter of 2013, so there are five quarters left on the current Ford contract.  I believe that the potential sources of value are as follows and will go through each in more detail:

1. Cash currently on the balance sheet
2. Five quarters of cash earnings from doing work for Ford
3. Working capital and PP&E
4. GM litigation
5. New businesses

Cash – As of September 30, 2013, the company had $34.8 million on the balance sheet.  The company paid 16 cents of dividends in November 2013 including a 10 cent special dividend.  There should be about $31.7 million of cash left over after that.  This is $1.63 per share of value.

Five quarters of cash earnings – I estimate that cash earnings excluding closing costs will be about $22 million over the next five quarters.  Subtracting $5 million of provisions currently on the balance sheet and another $4 million to come in 2014, we get $13 million of cash earnings.  This represents another $0.69 per share of value.

Working capital and PP&E – As of September 30, 2013, current assets excluding cash totaled $13.6 million while current liabilities totaled $6.2 million.  The company currently has a $0 allowance for doubtful accounts.  This seems reasonable as all of the receivables should be from Ford.  Liquidating this working capital would get us $7.4 million, which is $0.38 per share.  Furthermore, there is about $5.5 million of PP&E.  My base case assumes that the company can get $3 million out of this resulting in $0.15 per share.

GM litigation – Back in 2010, GM terminated a contract with Automodular for the sequencing and sub-assembly of components and modules for the Chevrolet Camaro.  Automodular alleges that GM wrongfully terminated the contract and is suing for $20 million of due to breach of contract and another $5 million for punitive damages.  Examinations for discovery are expected to happen early in 2014, and it is possible that a settlement could come soon after.  I do not have any particular insight into the process but think that a base case of $5 million from this litigation is reasonably conservative.  This would be another $0.26 per share.

New businesses – As noted earlier, Automodular has already successfully completed work in the past on wind turbines for Vestas.  The company mentions in the shareholder letter issued in Q213 that it continues to “have discussions with Vestas and other wind-based OEMs regarding opportunities in Canada and overseas”.  To be conservative, I assign $0 in value to new business opportunities in my base case, but the potential for upside here could be large.  Every $1 million of ongoing profit at a conservative 6x multiple would add $0.30 per share of value.

In summary, we have the following:

Risks:

Given the nature of this investment, I believe that the primary risk is bad capital allocation.  There are a couple of factors that make this less of a risk than it could be.

First, the company has stated that it plans to keep the dividend in place.  Shareholders should get a healthy 10.8% yield over the next year, which means that there is a little less cash that management could potentially waste.

Second, Parsa Kiai, a value oriented hedge fund manager, was recently added to the board of directors on November 26, 2013.  He and his fund appear to be allied with Bo Shan of Gobi Capital, another value hedge fund.  Together they own 6.9% of the outstanding shares and should be instrumental in ensuring that shareholders retain value.

Catalysts:

I believe that the shares will trade up as cash continues to accrue on the balance sheet over the next year.  Additionally, any positive development from the GM litigation or sign of a viable ongoing business should take the shares materially higher.

Additional Considerations:

It is worth noting that the amending agreement with Ford, in which Ford extended the contract another half year, states the after July 1, 2014, the piece price will be adjusted.  The amount is redacted, but given that Ford made other concessions such as paying for all of Automodular’s incremental closing costs, the amount should be higher.  While the magnitude probably won’t make or break the investment, every 5% price increase for the latter half of 2014 should increase value by $0.08 per share.  My estimate above does not include any of this benefit.

Catalyst