Description

FTV

Summary

Fortive (FTV) is a diversified multi-industrial company that was spun out of Danaher (DHR) on 7/5/2016. It composes 6 platforms and 17 distinct businesses.  I believe the stock is worth ~$62 and offers ~15% upside in the next 6-12m. My thesis centers on 3 main points:  

1. Near term growth opportunity in their Gilbarco Veeder-Root due to EMV (Europay, Mastercard and Visa) regulatory liability change for outdoor fuel dispensers (pumps). I believe this opportunity is worth $1.70 for the FTV stock or ~3% upside

2. Fortive’s M&A upside – The Company committed to do $2-3bn of deals in the next 2 years. Given FTV’s expertise in deal making and improving businesses – I believe M&A should add $4 to my PT or ~7%.

3. Fortive is undervalued given the quality of its business, its margins, investment in the business and quality of internal processes (Fortive Business System) and its management team. I think multiple expansion can add ~$2.70 or 5%

Business Description

Professional Instrumnetaion

• 2016 Sales ~$2.9bn, Gross Margins >50% , Operating margins ~23%

• Consists of 3 platforms:

Industrial Technologies

• 2016 Sales ~$2.3bn, Gross Margins ~45% , Operating margins ~21%

• Consists of 3 platforms:

Company Highlights

• There are 17 companies under the Fortive umbrella and the majority of them are small in size. Therefore, I am highlighting the larger more significant parts of the business ~$4.01bn/$6bn in sales)

Fluke ($1.2bn in sales)

• Fluke designs, develops, manufactures, and sells commercial electronic test and measurement instruments for scientific, service, educational, industrial, and government applications.  For example - Fluke's measurement tools help measure pressure, temperature, insulation, vibrations, and power quality.

• Market size: ~$5bn

• Growth Drivers: Industrial Production

Global IP - correlation:0.82   R2: 0.67 EU IP - correlation:0.87   R2: 0.75

• Customers: Industrial maintenance professional, electricians, contractors, engineers, medical technicians and Scientists

• Product Lines: Industrial (electronic test tools and software): 58%, Calibration (precision calibration instruments) 15%,  Networks (solutions for installation and maintenance of networks): 14%, Biomedical (biomedical test and simulation products): 8%

• Growth Opportunity: Fluke Connect – Largest portfolio of wireless SAAS enabled test and measurement tools. ~50 tools.

• Allows for automatic sync, storage, visibility and analysis of critical data in a cloud environment

• Current installed base of 20m handheld tools  (less than 5% fluke connect enabled)

• By 6/30 $100m of connected tools sales > total 2015 connected tools sales

• Active user base triples in the last 18m

• Allow company to reduce opex (reducing maintenance labor and downtime) and capex (through partnerships with ERP and Automation to optimize asset replacement schedule)

Tektronix ($850m in sales)

• Tektronix manufactures test and measurement devices such as oscilloscopes, logic analyzers, and video and mobile test protocol equipment. They mainly serve the communication, computer, semi, aerospace & defense, education, consumer electronics and education industries. Tektronix is recognized as the world leader in the sales of oscilloscopes.

• Market size: ~$4bn

• Growth Drivers: Industrial Production

Global IP - correlation:0.78   R2: 0.61 EU IP - correlation:0.83   R2: 0.69

• Customers: Computer & consumer electronics, military/government, education, broadcast/cable

• Product Lines: Oscilloscopes (40% of sales), Video – Waverform monitors/rasterizers/media analysis (10% of sales), high performance electrical production testing – SourceMeters, Power supplies, digital multimeters (15% of sales), Specttrum analyzers (5% of sales) -

• Growth Opportunity: Tektronix will be launching a new platform for its products by the end of 2017. The new platform will transform allow much more commonality among the different products and a great software component vs. hardware. This will allow reducing manufacturing costs but more significantly it will allow for a new market for software applications, add-ons, online services etc.

Gilbarco Veeder-Root ($1.5bn in sales)

• Gilbarco Veeder Root is a global provider of integrated technology solutions in the retail petroleum and commercial fueling industries. They supply fuel dispensers (pumps), POS systems, payment systems, merchandising and support services

• Market size: ~$7bn

• Growth Drivers:

• Global environmental, safety and security regulations

• Increasing sophistication of convenience store format

• Larger fueling networks requiring control and automation

• Fleet managers looking to improve costs and efficiencies

• Customers: Major and regional oil companies, convenience store owners, hypermarkets, truck stop owners

• Products: Dispensers (fuel pumps),POS, tanks, sensors, vapor recovery systems, mechanical & electronic meters, fuel management services

• Growth Opportunities: Automation of fueling stations in HGM (20% to  55% by 2020), SAAS service opportunities,  service growth due to share gain of installed base

Matco ($500m in sales)

• Manufacturer and distributor of professional automotive repair tools, diagnostic equipment and toolboxes. It operates in a franchisee model and sells the products in white Matco trucks. 99% of sales are in NA. It is a direct competitor to Snap-On (SNA) and Stanley’s (SWK) Mac Tools.

• Market Size: ~$3bn

• Growth Drivers:

• Franchise expansion

• Shift to open platforms, lowers cost of ownership for diagnostic scanners

• Car model sophistication expands aftermarket diagnostics

• Have grown MSD for 25/27 quarters

• Customers: Professional mechanics and  automotive aftermarket

Thesis

My thesis centers on three main points:

1. Eurocard, MasterCard and Visa (EMV) opportunity

• Background:

• EMV is a technical term for smart payment (credit/debit) cards that use a smart chip technology. The technology is named after the firms that created the standard. The cards EMV store data on an integrated circuit in addition to magnetic stripes. The new cards allow for better security and lower fraud alongside a better control of “offline” cards. The new standard has been implemented in parts of EU and other parts of the world but only in the past couple of years was implemented in the US. In fact, the indoor implementation date was October 2015. What this date symbolizes is that a retailer who did not have a POS system compatible with the new cards was liable for any fraud committed in his location. While if the retailer had a compatible POS system the credit card company would be liable. Thus far 70% of convenience stores that operate fueling stations have converted their in-store POS systems. Fortive’s Gilbarco Veeder-Root (GVR) sells internal POS systems for fueling stations but has a small market share. In 2015 these internal POS systems accounted for less than 1% of sales.

• October 1st 2017 is the outdoor implementation date in the US. Meaning that gas stations that will not convert their dispenser payment systems will be liable for fraud.

• GVR has 60% market share in the outdoor POS / dispenser market in the US. Its largest competitor is Wayne (~40% market share) who was purchased by Dover (DOV) for (~12x EBITDA). The acquisition is expected to close during Q1 2017.  

• There is a wide debate on the size of the market opportunity. Fortive is extremely conservative and are sizing it as $500m. Dover assumes it is $1.5bn, ML $3.0bn and Bloomberg recently wrote an article that sized the opportunity at $7bn.

• Sizing The Opportunity

• My base case assumption is that the Market opportunity is ~$3.05bn out of which GVR has a 60% share. Assuming 50% incremental margins and an adoption of 70% by the end of 2019 – this opportunity should be worth $1.70 to FTV or ~3% upside

• My bull case assumption is that the Market opportunity is ~$4.4bn out of which GVR has a 60% share. Assuming 55% incremental margins and an adoption of 80% by the end of 2019 – this opportunity should be worth $2.80 to FTV or ~5% upside

• My bear case assumption is that the Market opportunity is ~$1.8bn out of which GVR has a 60% share. Assuming 40% incremental margins and an adoption of 60% by the end of 2019 – this opportunity should be worth $0.90 to FTV or ~1.6% upside

2. M&A Expertise

• Danaher was formed in 1984 by Steven and Mitch Rales. They recruited George Sherman as their CEO and started acquiring companies. Over the years DHR acquired more than 400 companies making Danaher into a large conglomerate. Over the past ~10 years Danaher focused its M&A on the life sciences sector where management saw better returns. In the meantime the Industrial portfolio was “starved” for M&A. This was the main reason for spin of Fortive from Danaher.

• Over the years DHR created more value than any other industrial company for shareholders and this was mainly attributed to its core M&A strategy and its unique operating system.

• FTV announced during their spin that they will deploy $2-3bn in the next 2-3 years. I am assuming that 2bn will be deployed in the next couple of years – which will contribute 38c to EPS. To be on the conservative side I give them 50% credit for the accretion and I apply a 21x multiple – I get potential upside of $4/share or 7.5% upside

3. Valuation – What is the right multiple?

• I believe the right comps for FTV are high quality industrial acquisitive companies with high gross margins. Based on the following metric – I see no reason why FTV shouldn’t trade at an average multiple:

• Gross Margins: 49% vs. Peers at 43%

• EBIT Margins 20% vs. Peers at 20%

• EBITDA Margins 23% vs. Peers at 24%

• R&D as % of Sales 6.2% vs. Peers at 2.8%

• FCF Conversion 110% vs. Peers at 109%

• Organic Growth 2.5% (2015) and 1% (2016) vs. Peers at -2.6% (2015) and -2% (2016)

• Comp set includes: ROP, AME, IEX, ITW, CFX, and ROK

• Therefore I am using a 5% discount to ROP, IEX and AME 2017 multiple to value the company

Valuation

• EMV = $1.70

• M&A = $4.0

• 21.2x * 2017 EPS (with 3% GVR Growth) = $56.50

Total: ~$62 or 16% upside

Catalyst

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