Description

EVENT:

On March 18th, CTBC announced they had retained Bear Stearns, CSFB, and George Baum to advise the company on developing strategic alternatives designed to enhance shareholder value. CTBC trades at 4.1x EV / Trailing EBITDA and, at an equity price of $15.10, has an enterprise value of $151mm. Bear Stearns, CSFB and George Baum are handling the assignment. What the release doesn't say is that the Chairman, Chris Chocola, who owns 6% of the company is running for Congress. Additionally, CTBC's largest holder American Security Partners (with a 37% stake), has been involved with the company for seven years and is likely looking for an exit. CTBC makes integrated systems for the poultry, hog, egg production and grain industries.

INDIANA CONGRESSIONAL ELECTION:

CTBC Chairman Chris Chocola (R) is seeking the Congressional seat in the Indiana's 2nd District in this year's election. This is Chocola's second attempt at running for Congress, having lost narrowly (52% to 47%) in 2000 to six-term Democratic Rep. Tim Roemer, who recently announced he won't be seeking re-election. Chocola spent over $1mm in the 2000 campaign, including about $500,000 of his own money.

Chocola is leading in the early polls and his chief potential Democratic rival is former Rep. Jill Long Thompson, who lost her seat in the 1994 Republican landslide (Thompson held a position in the Clinton Administration's Agriculture Department after leaving Congress after 3 terms). In late January, the leading candidates in the district reported their campaign funds:

Chocola (R) $193,621
Long Thompson (D) $121,230
Alexa (D) $36,485
Meissner (D) $8,329
Farrand (D) $3,048

Given that Chocola spent a million dollars on his 2000 campaign, and the fact he holds 700,000 CTBC shares (a 6% stake), it is not unreasonable to assume that the announcement of a review of strategic alternatives at CTBC has been influenced by Chocola's need to fund his political aspirations and a desire clean up his holdings prior to leaving the company. Chocola's CTBC stake, at $15 per share is worth $10.5mm (pre-tax) and each $1 increment in the equity price results in a $700,000 benefit to Chocola.

House Majority Leader, Dick Armer (Texas-R), was in Indiana in late February campaigning on Chocola's behalf and its clear that Chocola is the GOPs candidate. Despite the fact that the election was very close in 2000, Chocola has to believe he stands a very good chance of winning. Admittedly, the loss of the Chairman could pose a problem for potential buyer, but I believe there is enough depth in the management team to fill the void if Chocola wins a Congressional seat. Chocola's web site is located at:
http://www.chocolaforcongress.com/

WHAT DO THEY DO:

CTBC is one the world largest providers of poultry production systems, hog production systems, egg production systems and grain storage bins. Product line details are as follows:

Poultry: integrated feeding, watering, ventilation, heating, cooling, nesting and control systems
Egg: egg production systems including feeding, watering, egg collection and cage systems for laying birds
Hog: feeding, watering ventilation and control products
Grain: feed and gain conveying, feed storage and commercial grain storage

CTBC divides their product line into three primary segments: the Protein Group (equipment for the production of poultry, hogs and eggs), the Grain Segment (products for the storage, handling and conditioning of grain), and the International Segment (all product lines). http://www.ctbinc.com

price $15.10
shares 11
cap 167
cash 53
debt 37
EV 151
Trailing
EBITDA 36

EV / EBITDA 4.1x
EV / EBITDA - capex 4.7x

This is a seasonal business with poultry, hog and purchasers buying for construction in the spring, summer and fall. Grain producers typically install storage bins in the late spring and summer to prepare for fall harvesting. As a result, revenue and net income are higher in the 2nd and 3rd quarter. Historical spreads are as follows:

FY01 FY00 FY99
Revenue:
Protein group 84 93 -
Grain 62 86 -
Int'l 87 80 -
Total Revenue 233 259 273

EBIT:
Protein group 15.5 17.8 -
Grain 11.4 19.3 -
Int'l 14.0 7.8 -
other (15.1) (18.9) -
total EBIT 25.8 26.0 25.2

Depr. & Amort. 10.0 10.2 8.0
EBITDA 35.8 36.2 33.2

Revenue growth
Protein group -9.3%
Grain -28.7%
Int'l 8.8%
Total Revenue -10.1% -4.9%

EBIT Margin
Protein group 18.5% 19.2%
Grain 18.4% 22.4%
Int'l 16.0% 9.7%
Total EBIT 11.1% 10.0% 9.3%

EBITDA margin 15.4% 14.0% 12.2%

Revenue has been declining, reflecting weakness in the U.S. poultry markets, lower shipments of farm bin sales and commercial grain bin shipments. Internationally, however, CTBC has benefited from strength in its European operation and in Latin American. Despite the decline in the top line, CTBC has done an excellent job at controlling costs and has improved its EBITDA margin over the past several years.

2001 REVIEW:

Revenue was down 10% to $233mm in 2001, with notable weakness in the Grain segment where revenue was off 29% over 2000 results. The weakness was attributed to a slowdown in commercial bin orders, lower levels of farm bin sales, and reductions in feed bin revenue. Protein group (poultry, egg and hog) revenue declined 9% in 2001, reflecting the continued weak conditions in the U.S. poultry market. The top line highlight was the improvement in CTBC's International operations (protein and grain), where revenue increased 9% to $87mm (the largest contributor to 2001 revenue of the three segments). International revenue benefited from strong European sales, and exports to Latin America. Despite the 10% decline of top line revenue (and a 5% decline in 2000 over 1999 results), CTBC has improved their EBITDA margins by 320 basis points since 1999. The improvement is attributed to operational improvement and cost containment efforts. Specifically, raw material costs, improvements in the sales mix and reduced profit sharing and warranty costs of $1.1mm in 2000 that did not recur in 2001.

Looking forward, the company stands to benefit from the following:

1) animal welfare concerns in the poultry and egg businesses. Animal rights groups are intensifying their focus on growing conditions in the poultry and egg business. In the egg business, cages are approximately 16 inches x 18 inches and hold five to six hens (each with a wingspan of 32 inches). "Broilers" and "Fryers" are bred to produce a profitable chicken and these birds tend to suffer numerous health problems from being "meat heavy". People for the Ethical Treatment of Animals (PETA) has been calling for larger cages for the nations poultry population (refer to http://www.peta.org/mc/facts/fsveg7.html for a summary). Any inroads they make on expanding existing cage sizes will benefit CTBC.

2) Biotech grains - value enhanced grains and larger grain varieties will require smaller bins and increase the importance of grain separation in the future. Kellogg, for example, was forced to shut down a plant last October because it couldn't guarantee corn used in cereal production would be free of genetically modified grain approved only for animal consumption. Similarly, in September, Kraft ordered a nationwide recall of Taco shells after tests confrrmed the presence of genetically modified corn that hadn't been approved for human consumption.

RISKS:

1) If the advisors can't find a buyer you'll be stuck with it. In the three months prior to announcing the development of strategic alternatives designed to enhance shareholder value, CTBC averaged 4,500 shares a day (with some double counting). This name is illiquid and if no buyer turns up you'll be holding this name.

2) Russian US Chicken Import Ban Resolution - The U.S. exports about 15% of U.S. chicken production. Amazingly, 50% of all U.S. poultry and poultry product export sales worldwide are to Russia. Effective March 10th, the Russian Agricultural Ministry banned U.S. poultry imports over concerns related to salmonella, antibiotic drug levels in American chicken, and the use of chlorine to kill bacteria on chicken carcasses in slaughter plants. 20% of all U.S. exports to Russia are chicken-related. I think its unlikely the ban isn't lifted but there is a risk that the already depressed U.S. poultry market is faced with increase supply as a result of an extended Russian ban. Negotiations are continuing.

CONCLUSION:

3 advisors for a $151mm EV company implies that the M&A business really is that bad or that management really wants this company sold. CTBC's largest holder, American Security Partners (37% stake), has been involved with the company for seven years and is likely looking for an exit. American Strategy's exit motivation, in combination with Chocola's campaign funding needs, a low valuation reflective of trough industry conditions, and solid cash flows despite the weak operating environment suggests this company will be sold. A 5x trailing EBITDA multiple gets you $18 and a 6x multiple results in a $21 equity valuation. At these levels, I believe there will be interest from both strategic and financial buyers and think its fair to assume CTBC gets sold at a 30% premium to current prices. I'm looking for a sale price in the $20 range.

Catalyst

Undervalued up-for-sale. The company's EV / trailing EBITDA is 4.1x and Bear Stearns, CSFB and George Baum are handling the assignment. 37% holder, American Security Partners, who helped buy the company in 1996 and take it public at $14 in a DLJ-led offering in 1997, is presumably looking for an exit. Additionally, CTBC's chairman, Christopher Chocola, is running for Congress and likely needs to monetize his 6% equity stake to help finance his campaign. Values are in the $20 range.