Description

In our opinion, Artesyn Technologies (ATSN) is an intriguing value + catalyst investment, with an exclamation point on the catalyst. ATSN is a manufacturer of power conversion and communication devices. The company’s blue chip customer base includes Dell, Nortel, HP, IBM, etc. ATSN has preferred supplier status with most of its customers. The investment thesis in a sentence is that ATSN is (a) reasonably valued; (b) has significant cost-saving opportunities; and (c) is likely to engage in a significant strategic transaction in the near term. Taking the three parts of this thesis in turn…

Valuation
ATSN has approximately 52 million fully diluted shares outstanding (includes convert shares that have a conversion price of $8.04). Thus, at today’s stock price of $9.80, the market cap is just north of $500 million. Assuming conversion, there is about $100 million in cash and no debt (i.e., about $2 of net cash per share). ATSN has had great success on design wins over the past year (e.g., designs wins for 2005 through September are $760 million vs. $360 million for the same period in 2004) giving good visibility into future revenue growth. Furthermore, the margins of the design wins are higher than what the company is currently experiencing. Net of the cash, the company trades at about 14x our $0.55 2006 EPS estimate and roughly 6.8x our $60 million 2006 EBITDA estimate. The business is not especially capital intensive, so earnings approximate free cash flow, providing a free cash flow yield of about 7%.

Cost Savings
While ATSN is reasonably valued on the surface, the valuation becomes all the more compelling when one looks just a bit deeper into two key aspects of the company’s cost structure – (a) corporate overhead and (b) research and development spending. To put it bluntly, we think that ATSN’s corporate overhead is somewhere between bloated and completely unnecessary. As one anecdote, ATSN’s headquarters are in Boca Raton, FL, while the company has no operations anywhere near Florida. Our analysis indicates that a strategic buyer of ATSN could eliminate $10 million or more of overhead. Looking at research and development, ATSN spends 10+% of revenues on R&D. This compares to the roughly 5% of revenues spent by competitors. Given that we expect in the neighborhood of $500 million of revenues in 2006, bringing ATSN’s R&D expenditures into line could yield as much as $25 million in incremental profits. Thus, factoring in potential savings for these two items potentially raises 2006 EBITDA by as much as 50% to the $90 million zone. At that level of profitability, the company would be trading at 4.6x EBITDA and 8.1x EPS (net of cash). We believe this is how a strategic buyer would view the company, which brings us to the next section of this write-up.

Strategic Transaction
As noted in the introduction above, we believe ATSN is likely to engage in a significant strategic transaction in the near term. Our confidence is driven by a number of factors – (a) industry observations and conversations; (b) prior bid; (c) retained investment banker; (d) activist shareholder; (e) severance packages; and (f) management’s public comments.

(a) As to ATSN’s industry, we believe it is ripe for consolidation, with a few large players, a couple handfuls of mid-size players (including ATSN), and dozens of smaller companies. Conversations with numerous management teams throughout the industry confirm an expectation that the industry will consolidate.

(b) With regards to the prior bid, late last year one of ATSN’s competitors, Bel Fuse, bought 5% of ATSN’s outstanding stock and made an offer for the entire company. Using the then proposed exchange ratio and today’s Bel Fuse stock price would imply an offer of roughly $9 today. The offer was rebuffed by ATSN’s Board. Bel Fuse still owns its ATSN shares. Conversations with Bel Fuse, as well as with other industry players, confirm that Bel Fuse remains interested in ATSN, is willing to pay meaningfully more than its original offer, and that ATSN continues to give Bel Fuse the Heisman.

(c) In the middle of this year, the company announced that it had retained Lehman as a financial advisor to review various strategic alternatives. We believe that Lehman has been actively engaged on the process.

(d) The largest shareholder of ATSN is activist hedge fund Jana Partners, shown on Bloomberg as owning nearly 11% of the outstanding shares of the company. Based on an agreement between ATSN and Jana announced in early July, Jana appointed a representative to the Board of Directors and obtained the right to participate in discussions concerning strategic alternatives. We believe Jana’s involvement will help to keep the strategic process moving forward.

(e) ATSN’s management team has arranged quite nice severance packages for themselves in the event of a change of control. Most recently, on October 27th, ATSN promoted its interim CFO to a permanent role, and as part of the promotion gave him a nice deal as well. It sure does look to us like the management team is “prepared” for a change of control.

(f) Finally, the company’s recent earnings release and management’s recent comments confirm that the strategic process continues and is getting close to a conclusion.

While the outcome of the strategic process will not be known with certainty until a final announcement is made, our due diligence indicates that the most likely result is a sale of the entire company. Other possibilities include a sale of part of the company and/or a significant dividend or buyback. In the case of a strategic sale, we believe the most likely range of prices for ATSN is $12.35 to $15.35 (7-9x $77.5 million of EBITDA, derived by splitting the synergies 50/50 with a buyer; equates to 5.7-7.3x to the buyer). Conversations with industry participants confirm an interest in ATSN by a number of companies in the space. Even if the strategic process does not result in a sale of the company, we feel that ATSN is still of some interest at current prices given its roughly 7% free cash flow yield, strong balance sheet, significant revenue growth opportunities, and ability to engage in an accretive recap. We expect the strategic process to reach the finish line in the near term.

Catalyst

Conclusion of the strategic process underway.