Description

COBRA ELECTRONICS (NASD: COBR $8.10)

THESIS:
Cobra is a leading consumer products company that possesses significant growth potential, numerous catalysts for the stock to move significantly higher and limited downside, yet it trades at dirt cheap levels.

The company is #1 worldwide in radar detectors; #1 worldwide in CB radios (yes, people such as truckers and taxi drivers still use them); #2 worldwide in Family Radio Systems (FRS) (i.e. walkie-talkies), a rapidly growing market---have you been to the ski slopes lately or checked out their usage among retailers?; and recently announced that it will be introducing a hand-held GPS product in the 4th quarter this year which management expects to be a big winner—on a scale with their hugely successful FRS product— by 2004.

Notwithstanding the above, the stock is dirt cheap at 3.9x and 9.3x 2002E EBITDA and EPS, respectively; and 0.9x tangible book value and 1.0x net working capital. We believe that Cobra is worth at least $18 per share (up 122% from the current level) on several bases as discussed below.

VITAL STATISTICS:
3/31/02
Actual
Price $8.10
F-D Shares 6.46
Market Cap. $52.3
Net Debt at 3/31/02 ($0.6)
Plus "Permanent Debt" (expected year-end debt) $7.5
Cash Surrender Value of Life Insurance ($5.7)
Enterprise Value $53.5

Tangible BV [BV less Other Assets] $54.4
Net Working Capital $46.1
Market / Book (excludes Life Insurance) 0.9x
Market / NWC (excludes Life Insurance) 1.0x

FYE 12/31 2001A LTM 3/02 2002E 2003E
Revenue (millions) $153.5 $144.5 $155.5 $175.0
EBITDA $14.6 $11.0 $13.8 $18.0
EPS $0.86 $0.71 $0.87 $1.17

TEV / EBITDA 3.7x 4.9x 3.9x 3.0x
P/E 9.4x 11.4x 9.3x 6.9x


CATALYSTS:
There exist several potential catalysts any one of which should have a material impact on the stock price:

1) Fundamentals

Fundamentally the company is simply undervalued when taking into consideration actual earnings and FCF as well as its growth prospects. As mentioned above, the stock is cheap at 1.0x tangible BV, 4.9x a depressed LTM EBITDA, and 11.4x LTM EPS, adjusted for a charge related to a canceled acquisition in 2001.

Revenue has grown approximately 50% since 1998 and, notwithstanding an awful retail economy, revenue still managed to grow by a respectable 7% in 2001. This impressive revenue growth largely is a function of FRS which currently is a +$400 million domestic market that is expected to grow by greater than 15% annually over the next 3 years (Europe is expected to grow even faster) and within which Cobra enjoys 25% market share. Growth has come primarily from new customer accounts added: Best Buy and Costco were added in 2000; Wal-Mart (for FRS), Target, Radio Shack and Ultimate Electronics were added in 2001. The company is in a total of 31,000 storefronts today. Cobra will be in 3,000 Wal-Marts by the end of 2002, up from 900 at the end of 2001. Sales to K-Mart have been falling, and were only 7% of sales in Q4 2001, according to management. Additionally, credit losses from K-Mart were minimal.

EBITDA margins expanded from 6.2% in 1998 to 8.3% the next year and 10.1% in 2000; margins dropped to 8.3% in 2001 as the weakening economy combined with greater promotional spending drove SG&A expenses up as a percentage of sales. As the economy picks back up and revenue increases in both FRS as well as from the new GPS product EBITDA margins should rebound.

Further, Cobra should generate significant FCF as a result of modest capex (all manufacturing is done in East Asia) and very modest leverage at $0.02 million at Q1 2002, with the average debt balance throughout the year at about $7.5 million, or less than 1x EBITDA. Working capital requirements are in line with other consumer products companies with retail customers, and should improve as the number of Wal-Marts and Targets serviced increases to levels at which inventory can be more efficiently managed.

Finally, Cobra also has significant asset coverage (the stock trades below tangible book value) and has excess assets including $5.6 million cash surrender value of life insurance policy and its 93,000sq. ft. headquarters building and warehouse, which we value at $3.0 - $5.0 million.

The company reported a loss for Q1 2002 [versus a profit in 2001] on May 14, which spooked some investors, sending the stock down 13% from $9.15 to its current $8.10. Sales were down 30% from Q1 2001 as last year included 2 large orders from mass merchants running promotions which are normally Q2 events. Additionally, COBR experienced what every other consumer products company selling to the big chains experienced in Q1 – a shift to a lower-inventory stocking model coupled with a retrenchment in purchasing based on fears of weakening consumer spending. We know from Q1 results at these retailers [WMT, TGT, BBY] that the consumer slowdown expected did not occur, as spending has remained strong.

We believe the market overreacted, as Q1 is by far the smallest quarter in terms of annual EBITDA [17% of FY2001] and Net Income [13%]. Management attributes the quarter’s net loss to 1) discounting of prices on older detection and FRS models to make room for new products on the shelves and 2) a tougher retail environment, with retailers hesitant to add anything but new products to inventories. Overlooked were 1) the company’s $16.3 million in CFFO generated in the quarter, which the company used to pay down virtually all its $15.4 million in debt and 2) the CEO’s assertion that the first quarter’s performance notwithstanding, they expect “sales and earnings for 2002 to be higher than 2001”, even after backing out the non-recurring write-off in 2001.

Management believes the company is taking share in all its product markets, and in FRS, its largest product group, the company is closing the gap with market-leading Motorola by taking share from marginal players who are struggling such as Audiovoxx [VOXX] and Jensen, which is manufactured by Recoton [RCOT].

2) GPS

Cobra recently announced the introduction of a hand held GPS product which will hit the market in the 4th quarter of 2002. Management expects this product to be a big hit (similar to FRS) as the only public competitor is Garmin (GRMN). Garmin markets its products principally through the marine distribution channel and has had limited success in the consumer electronic arena within which Cobra excels. Management expects GPS to contribute $30 million in revenue in 2003 and to eventually generate at least $100 million in annual revenue. Obviously, the potential for a successful GPS product launch is not at all reflected in today’s stock price..

Note that Cobra’s stock tripled at the end of 1997 upon the introduction of the FRS product.

3) Strategic buyer

We are aware that several strategic buyers approached the company in the past year most prominent among them are Garmin and Beltronics (#3 worldwide in radar detection). Garmin is particularly interesting because Cobra’s new GPS product would fit perfectly with Garmin’s marine oriented product while rounding out Garmin’s weakness in consumer electronic distribution. Garmin could certainly afford to buy Cobra as it is sitting on over $350 million of cash and investments on its balance sheet and its stock trades at 15x EBITDA, triple Cobra’s multiple.

4) Management Buyout

Management has indicated that if the stock price doesn’t appreciate within the next 12 months it would look to take the company private. We are aware that several LBO funds have approached the company and are interested in pursuing a deal. At 5.0x - 6.0x normalized EBITDA of $15 million assuming that the deal is financed with debt equal to 3.0x EBITDA and the balance (approx. 33% of capitalization) with equity, the company could easily be taken private at $12 - $15 per share today (i.e., giving zero credit for the new GPS product).

PRIMARY RISKS:
Obviously greater dependence on mass merchants means lower margins and higher working capital requirements. However, this is the price of being on the shelves at high-growth chains that, in turn, drive the growth of the company.

As a consumer electronics company, a substantial portion of the company’s profits are derived from Q4 sales.

Motorola is the largest player in FRS and the biggest competitive threat faced by the company. While they occasionally get aggressive on pricing, Motorola has historically provided a generous [20%] pricing umbrella. Motorola could theoretically buy up all the retail shelf space around with heavy promotions, but that’s a loser’s game, since they’d be sacrificing profitability, and the retailers prefer having at least 2 brands to offer.

VALUATION:

If Cobra were NOT launching an exciting new product in the next six months, we would expect it to trade up to $12-$15 per share, simply due to a rebound in the retail environment and more normalized inventory stocking by the mass merchants. This is based on a 12x to 15x multiple on normalized EPS of more than $1.00. However, we expect that after the hand-held GPS product launch, Cobra’s prospects will look significantly better, with a large and growing portion of revenues coming from high-growth consumer electronics (GPS and FRS). More realistically, we base our 2003 estimate on $30 million of revenue from GPS and flat revenue from all else (an highly conservative assumption) yielding $180 million in revenue and $18 million of EBITDA (assuming a return to historical 10% margins). The emerging growth potential should justify at least a 7.0x multiple (comps trade at significantly greater multiples such as Garmin at 15x and Universal Electronics (UEIC) at 10x). A combination of FCF and the asset value of the insurance policy are expected to reduce net debt levels to about $5 million, producing an $18 TARGET PRICE in the next twelve months.

Catalyst

Very cheap and introducing an exciting new comsumer electronics product this year.