Description

Description

Belden is a cabling and connectivity company that serves two primary end markets: Enterprise and Industrial.  Within the Enterprise market the company provides cabling and connectors for non-residential construction and residential construction / service installation, as well as media production equipment for live sports and news production.  Within the Industrial market the company provides similar cabling and connectivity products as the enterprise segment, as well  as some networking and software products, primarily for discrete manufacturing automation.  The Enterprise segment is roughly $1.5b in revenues and the Industrial segment is roughly $1b in revenues.  The company’s largest distributor is Anixter (12% of revenues in 2018), and the company’s main Enterprise customers are MSOs like Comcast, and main Industrial customers are automated discrete manufacturing solution providers like Rockwell and Siemens.  The company is headquartered in St. Louis, Missouri.

Executive Summary

The short thesis on Belden is that while the company pitches itself as a high quality connectivity company powered by strong secular trends, it is in fact mainly a copper-based cabling and connectivity company with no growth / secular headwinds.  Additionally, I think there is an underappreciation for a) the poor quality of earnings, and b) how the company has had to steadily add leverage in order to grow the company at just a LSD-MSD inorganic rate over the past several years.  While Belden would like to be compared to companies like Commscope and Amphenol, I believe that the differences in growth rates and margins results in a significantly lower deserved multiple.

 Business Quality

In their marketing materials, Belden pitches themselves as being exposed to positive secular trends like Industrial Automation, Smart Buildings, Bandwidth, and Video Consumption, and suggests these trends have been the forces behind their >6% revenue CAGR and increase in reported EBITDA margins.  I believe this is a disingenuous representation of the company.  I believe the strongest headwinds for the company are in the Enterprise segment.  In that segment the company breaks down their “key markets” to the attractive-sounding segments of “Smart Buildings”, “Final Mile Broadband” and “Live Media Production”.  The reality is that the company is primarily providing copper-based cabling and connectivity equipment to these markets which is in secular decline.  For example, when you talk to them the company admits that their “Smart Buildings” growth has under-indexed non-resi construction spend because copper-based products that connect phones and desktops to jacks in the walls are in secular decline.  There is a similar discussion to be had regarding the “Final Mile Broadband” segment where the company will admit that the fact that fewer set-top boxers are being installed in homes, as a result of cord-cutting, is a headwind.  Lastly, in the “Live Media Production” market customers are being pressured by cord-cutting and OTT services, in the context of a competitive environment full of private sub-scale players; the company is exploring the sale of this business but given that competitive landscape, this sounds challenging.

Re: copper exposure, while the company suggests in public that it has substantially diversified away from copper through acquisitions and divestitures, one can look at the 10-K’s over the last decade to see that the level of copper purchase obligations has been a slow and steady bleed and is still substantial; i.e. much of this business is copper-based cabling and connectivity products that are in secular decline.  The result is that the organic growth rate of Belden has substantially lagged that of both it’s largest distributor Anixter, as well as its peers like Amphenol, Commscope, TE Connectivity, etc.  In the table below you can see that in a strong economic environment over the past three years, while the peer group has averaged 5% YoY organic growth each Q, BDC’s average rate is barely above zero and lags the competitive set in >80% of the last 12 Qs.  I think that a quote from the recent 10-K sums up BDC’s growth rate perfectly: “Since 2014, we have grown revenues by 12%, from $2.3b to $2.6b in 2018, representing a 2.3% compounded annual growth rate for that period.  The majority of our revenue growth has been the result of our inorganic initiatives”.  Basically, the company has no organic growth, has grown more recently at rates less than half of peer organic growth, despite that all being generated by substantial spend on M&A.

Margins have also been a disappointment.  In the table below, you can see that BDC’s margins have lagged COMM, TEL and APH in every one of the last 12 quarters.

Furthermore, that margin performance is with the benefit of consistent restructuring charges at the company being excluded.  As you can see in the table below, the margin gap grows wider when including the restructuring charges in EBITDA, and more importantly the restructuring charges are fairly consistent in terms of timing and size, vs sporadic M&A, suggesting they should be considered ongoing operating costs rather than one-off expenses.

One exercise that I think is useful to do to put BDC’s growth, margins and M&A in perspective, is to look at leverage over the last decade while the company has grown at a total (including M&A) compounded rate in the low to mid-single digits.  Including recurring restructuring charges and the company’s 2016 issuance of convertible preferred stock (realize this is mandatory conversion to equity this summer, but I include it in net debt in this exercise to see the “cost” to the company’s balance sheet of funding pretty mediocre growth), net leverage has gone from around 1x to 3.5x.  Going forward I believe the outlook for this business is that they have less capacity to do deals, those deals will continue to be expensive (they want to do small fiber deals, but admit the price tags are high), and that this business will become more clearly viewed as a mediocre, levered business facing secular headwinds.

Valuation

I look at BDC on their 2018 recurring/cash EBITDA – i.e. reported EBITDA with restructuring charges subtracted.  I think that on growth disappointments the stock can trade at 7-8x that number, representing ~20-35% downside back towards the 52wk low.

Catalyst

Disappointing top line performance.  Last quarter the company reported 6.8% organic growth, 6pts of which were a benefit from a revenue recognition issue a year ago.  That same issue will make the next two quarters tough comps.

Catalyst

Disappointing top line performance.  Last quarter the company reported 6.8% organic growth, 6pts of which were a benefit from a revenue recognition issue a year ago.  That same issue will make the next two quarters tough comps.