Description

Despite a mediocre business, continued losses, and recent violation of loan covenants, Exide appears to be quite a bargain with a market cap of $180MM, equal to 0.06x sales and 0.35x book -- particularly in light of multiple factors suggesting that its reported results and balance sheet will look much prettier in the near term, likely producing a nice run-up in the stock over the next 12-24 months:

* The company is writing down the carrying value of its inventory (exact amount to be announced in todays' conference call at 4PM), depressing margins in FY2005; but this will also have the pleasant effect of boosting reported gross profit (and therefore EBITDA and net income) in the very near future. In short, the company's new CEO, Gordon Ulsh, is doing what many “turnaround CEOs” often do: take a blood bath so as to make future results look better.

* The company has $750+MM (!) tied up in working capital, of which about $250MM is likely to be released in the near term via A/R securitizations. During bankruptcy, Exide repurchased $117.5MM & $124.8MM of securitized A/R when it terminated its U.S. & European securitization programs, respectively, and is now in a position to replace these A/R programs with new ones. In short, the balance should look prettier by $250MM in the near term.

* During bankruptcy, Exide was not allowed to hedge its exposure to lead prices, which represent the single biggest component of costs of good sold. Now that the company is out of bankruptcy, it can hedge its exposure, likely reducing the impact of the biggest contributor to depressed gross margins over the past 12 months.

* The stock is under selling pressure today following yesterday's announcement that Exide is in technical violation of certain loan covenants; but lenders are extremely unlikely to force the company into bankruptcy given the relatively clean balance sheet, the prospects of near-term A/R securitization, the appointment of a new CEO only two months ago, and the the fact that only a year has transcurred since emergence from bankruptcy. I expect lenders to grant the necessary waivers.

These factors should help create conditions for a nice run-up in the stock over the next 12-24 months.

For an overview of the business, the industry, the emergence of bankruptcy, and the impact of lead on gross profits, please see last year's writeup and Q&A at http://www.valueinvestorsclub.com/value2/Members/view-thread.asp?id=1461&more=dtrue.

POTENTIAL DOWNSIDE

Downside risk appears very limited at the current price, as book value is about 3x greater than market cap, and net working capital alone exceeds outstanding net debt by almost $200MM. In short, Exide is selling in the stock market for less than its liquidation value, thus providing a measure of downside protection while one waits to see if the company, as I expect, reports prettier results over the next 12-24 months.

POTENTIAL UPSIDE

Potential upside appears to be considerable at the current price. In an optimistic but still realistic scenario, Exide:

1) reports about $200MM of EBITDA in the coming fiscal year (an amount comparable to prior years' reported EBITDA figures), thanks in some measure to lower COGS resulting from the recently announced write-offs and better hedging of lead prices;

2) shows reduced net debt of about $300MM, thanks to the monetization of about $250MM in A/R (the securitization would reduce reported net debt by the same amount); and

3) reports positive operating cash flow (and therefore positive FCF), thanks to the reduction in working capital.

Applying a 6x multiple to EBITDA of $200MM would yield an EV of $1.2B; subtracting $300MM of net debt would give a market cap of $900MM, equal to 4.8x the current market cap, for a 380% gain within the next 12-24 months.

Evidently, other, less optimistic upside scenarios are very possible. For practical purposes, I think of this opportunity as offering downside protection in the form of hard assets and likely potential upside between 150% and 300% over the next 12-24 months.

Catalyst

* New CEO has taken blood bath to make results look better tomorrow
* Higher margins within the next 12-24 months thanks to recent write-offs.
* Net working capital release of as much $250MM from A/R securitizations.
* Reduction in net debt by the same amount
* Better ability to hedge lead costs
* Lenders grant waivers