August 29, 2017 - 8:46am EST by
2017 2018
Price: 39.80 EPS 1.50 1.67
Shares Out. (in M): 37 P/E 26.5 23.8
Market Cap (in $M): 1,490 P/FCF 0 0
Net Debt (in $M): 22 EBIT 69 74
TEV ($): 1,511 TEV/EBIT 21.8 20.5
Borrow Cost: General Collateral

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I am recommending a short of Fox Factory Holding Corp (“FOXF” or the “Company”). 

The core tenets of my short thesis are as follows:

  • ·     Although FOXF occupies an admirable premium-category position, the perception of its relative advantages in the marketplace have declined as competitive alternatives have improved coupled with a premium price that might not be sustainable given the decline in the perception of relative advantages.
  • ·         Growth from advantages of FOXF with suspension systems across premium priced mountain bikes will likely moderate because of the significant growth developing from the electric mountain bike (“e-MTBs”) category.  The critical component of the suspension system of a mountain bike is marginalized by the increased importance of the motor and battery in an electric mountain bike, thereby causing OEMs to invest accordingly.  Although FOXF is positioned within the e-MTBs, evidence of a lower mix of bike models versus the conventional mountain bike is demonstrative of a lower relevance being accorded by the OEMs.  One specialty bike retailing expert said, “FOXF has greatly benefitted from its marketing approach tailored to the racing crowd and since the e-MTB category is not tailored to the racing crowd, the FOX brand is not as meaningful.”
  • ·         Unsustainable growth ascribed to its off-road midsize pickup customers.  The substantial growth in powered vehicles ascribed to the Ford F-150 Raptor and Toyota Tacoma TRD is likely to moderate given limited production mandates coupled with competition from the Chevrolet Colorado ZR2.  Powered vehicle growth is subject to new vehicle introduction timing and will not be linear between quarters or years.
  • ·         As evidenced by an erosion of CFFO less net income, quality of earnings have eroded as described more below.
  • ·         The stock is “priced for perfection”.  On an LTM basis, FOXF is trading at 18x Adjusted EBITDA, 38x GAAP EPS, and less than a 3.5% FCF yield.  One year ago, when FOXF was ~$20, on an adjusted non-GAAP basis, the stock was trading at 17.5x ‘16E EPS and 15.6x ‘17E EPS.  Today, the stock is trading at over 26x ‘17E EPS and ~24x ‘18E EPS.  Therefore, the current P/E on both current and next year estimates has expanded by over 50%.  When compared to a peer group of auto parts and equipment companies that are each forecasted to grow earnings by double-digits next year (note consensus for Fox Factory is 11.3% EPS growth in 2017-2018), FOXF’s ‘17E P/E is at more than a 65% premium on a median basis and more than a 75% premium on an average basis.  Using consensus for 2018, FOXF’s ‘18E P/E is at ~75% premium on a median basis and over an 80% premium on an average basis.  For additional valuation context, note that Canadian-based Dorel whose largest revenue segment Dorel Sports markets bicycles such as brands Cannodale, Mongoose, and Schwinn, is trading at less than 12x ‘18E EPS despite similar EPS growth anticipated this year and more EPS growth currently anticipated next year relative to FOXF.  Helsinki-based Amer Sports, a sporting goods company that includes the Mavic brand of bike ride dynamics components, is trading at ~16x ‘18E EPS despite EPS growth that is 60% more than current consensus growth at FOXF.

o   Based on a moderation of growth, I anticipate the stock will re-rate accordingly.  If FOXF were to trade at 19x ‘18E EPS (a 40-45% premium to selected peers and a 20% expansion to the Company’s P/E multiple from a year ago), implying 13x ‘18E EBITDA (a ~45% EBITDA multiple premium from early March 2016 when consensus growth was higher than currently), the stock would be priced at $31.75, providing a 20% return.

  • ·         Insiders have been significant sellers of stock.

Founded in 1974 by Bob Fox, the Company designs, engineers, manufactures and markets performance ride dynamics products for customers worldwide.  FOXF’s main product category is high-performance suspension systems designed to enhance ride dynamics for mountain bikes and powered vehicles.  As described in their 10K, “these products dissipate the energy and force generated by bikes and powered vehicles while they are in motion.  Suspension products allow wheels or skis (in the case of snowmobiles) to move up and down to absorb bumps and shocks while maintaining contact with the ground for better control.”  In other words, a suspension or shock absorber system on a mountain bike is engineered to provide improved control, traction and comfort on rooty, rocky single-track or potholed roads to soften the impact of rough terrain by compressing and rebounding.

In 2008, the Compass Group acquired a majority interest in Fox Factory for ~7.5x EBITDA based on an enterprise value of $85M and took the Company public in 2013 at ~$14.  I was happy to own some of the Company historically at a much lower valuation level through a long position in Compass which exited its remaining position this past March at $26.65 pursuant to secondary sales during 2014-2016 at $14.67-20.51.  Founder Bob Fox remains a Director of the Company and retains 1M shares after selling almost a third during the same secondary when Compass exited.  Insiders have sold over $44M of stock in the past two years.  The CFO who was a significant seller in 2014 at prices ranging from $13.60-17.50 has reduced his ownership by over 40% since the beginning of 2017; the CEO reduced over 30% of his position in May at ~$32.50; and the bicycle division leader reduced his stake by approximately half in May and June at ~$33.  

The Company’s products are generally sold at premium prices and are primarily used on bicycles, Side-by-Sides, on-road vehicles with off-road capabilities, off-road vehicles and trucks, all-terrain vehicles, snowmobiles, and motorcycles.  In biking, the Company competes for specification primarily on bikes with retail price points of at least $3,000.  FOXF’s suspension products carry retail price points that generally range from $400-1,800.  In 2016, 56% of sales were generated from bike-related products and 44% from powered vehicles.  The Company has diversified its mix from what was 67% bike-related products in 2012.  In 2016, 60% of sales were generated from OEM customers and 40% from more than 5,000 retail dealers and distributors for resale in the aftermarket channel (this is up from ~20% in 2012).  Sales to the ten largest OEM customers accounted for ~42% of total sales (down from 56% mix in 2012).  Domestic mix comprised 47% of 2016 sales mix but the 53% of international mix includes sales attributable to countries outside the U.S., based on shipment location for bicycle assembly, that are then shipped back to the U.S. for purchase by end users.  Taking this into account, the Company estimates at least two-thirds of the end-users of its products reside in the U.S.

The Company sells to more than 200 OEM customers including Giant, Scott, Specialized and Trek in bikes, and BRP, Ford, Toyota, Yamaha and Polaris in powered vehicles.  In 2016, Giant accounted for 14% of sales which included both sales to Giant as a branded bike OEM as well as to Giant as a contract manufacturer used by certain of the Company’s other bike OEM customers.  During 2016, ~87% and ~82% of the Company’s complete suspension forks and shocks, respectively, were manufactured at the Taiwan bike suspension component facility that FOXF completed in 2015.  The facility in Taiwan enabled a more efficient supply chain and especially since the Company’s largest customer Giant, the world’s biggest bicycle manufacturer, is located there as well.

For bicycles, modern suspension forks come in almost as many flavors as ice cream, from 100mm travel XC forks to trail-worthy forks with 140mm travel.  Bicycle manufacturers don’t make their own suspension products and instead have sought to incorporate brands such as FOX, RockShox, SR Suntour, Marzocchi (recently acquired by FOXF), Manitou, DT Swiss, and X-Fusion into their bikes.  Almost all bikes are equipped with front suspension.  The most common type of front suspension is the “fork” comprised of two struts connecting the front wheel to the frame’s head tube.  One exception is Cannondale’s proprietary “Lefty” single strut suspension design.  Rear suspension is only found on full-suspension mountain bikes, and is commonly referred to as the rear shock.

For mountain biking enthusiasts, the website is an important source of credible input and insights.  The Company’s FOX Rhythm series fork was a beneficiary of winning the best suspension fork from MTBR in 2016.  The Rhythm series is a new entry level model that “offers premium performance at a budget price.”  It is only available on complete bikes that retail for approximately $1,500-2,500.  The Rhythm series is a slight deviation for the Company which historically has focused almost exclusively on the higher-priced category but the pivot by management is to try and expand its addressable market and the validation from MTBR is notable.  The 2016 runner-up was the RockShox SID which has won a gold medal in every Olympic game since 2000.

As noted below, the Company competes with numerous providers across a variety of segments.  Share data is not available although management believed during 2013 that its aggregate share (within its addressable market) based on an estimate of OEM specification position for front forks and rear shocks was greater than 60%.  However, that does not seem to be the case anymore when evaluating numerous premium models, reviewing surveys of most popular suspension systems, and speaking with specialty bike retailers.  Nevertheless, FOXF is currently either the first or second in suspension systems in its premium category. 

Management has positioned FOXF as a premium provider through an emphasis on innovation and engineering (R&D is ~4.5% of revenue), and by tailoring its marketing through professional athletes that influence purchasing habits of consumers seeking high-performance products.  The Company’s products are used by athletes who endorse the product when using them at competitive events such as the Union Cycliste Internationale Mountain Bike World Cup and the X Games.

Competition within the market for bike suspension components includes RockShox (SRAM sub), X-Fusion Shox (A-Pro sub), Manitou (HB Performance Systems sub), SR Suntour (largest within the $1,500 and below retail bike segment), DT Swiss (Vereinigte Drahtwerke AG sub), Crane Creek Cycling, DVO Suspension, Bos-Mountain Bike Suspensions (“BOS”), and Ohlins Racing AB.  Competition within the market for all other bike ride dynamics components includes SRAM, Truvativ, and Zipp (all part of SRAM), DT Swiss, Mavic (Amer Sports Corp sub), and Shimano. 

SRAM is the world’s second largest bike component manufacturer with an estimated share of the global bike component market at ~15% (second to Shimano) as described when SRAM planned to go public in 2011.  It is estimated that SRAM generated ~$615M of revenue and $30M of FCF in 2016 and is highly levered at 6x EBITDA.  On sales that were ~35% less than SRAM in 2016, FOXF’s margin of 15.4% was above SRAM’s of ~15%.  SRAM and FOXF are in litigation as described more below.  There are some industry experts with whom I spoke to who believe SRAM is willing to compete more on price with FOXF to win OEM share.  Given the perception of relative equal quality among the hard-core mountain biking community, this is a potential looming risk for the Company.  It’s notable that the Company’s operating margin is essentially flat in spite of more than $130M of revenue since 2013.

During 2016, in a survey from over 9,000 respondents conducted on Vital MTB, a site that caters to mountain biking enthusiasts, 33.3% selected SRAM’s RockShox as most preferred fork to buy with FOXF a close second at 33% and almost 41% selected FOXF’s as most preferred rear shock to buy with RockShox second at over 21%.  It is worth noting that during the last survey by Vital MTB in 2013, FOXF’s fork was most preferred and by 700 basis points more than RockShox so SRAM’s team has more than closed the gap, at least with the Vital MTB respondents.  In a direct comparison of the two leaders, an expert surmised the following:  “FOX is more complex and not as easy to maintain, is heavier than RockShox, and more expensive but can go longer intervals between services.”  When Singletracks conducted a survey of the ten most popular mountain biking forks for 2016, RockShox won 60% and FOXF won 40% of the votes.  According to the Company, based on a 2010 survey conducted by Leisure Trends Group, 67% of bicycle dealers believed that FOXF made the best suspension products.  However, the compelling lead that FOXF apparently once had over other industry participants has eroded and primary research is indicative of the Company’s premium pricing strategy lacking the perception of the requisite premium in relative quality to command the pricing power that was exhibited in the past.  Having read thousands of reviews and spoken with more than a hundred mountain biking enthusiasts, it is clear to me that both SRAM and FOXF have a strong position in the premium category.  Each company is continuously seeking to improve both the reality and perception of its front and rear suspension but there is not an unequivocal leader between the two and SRAM’s willingness to compete for share with price is an ongoing risk to FOXF. 

The potential resurgence of returning entrant from legendary brand BOS is another risk to FOXF’s growth prospects.  In the U.S., the suspension market is led by FOXF and SRAM but there are some other worthy offerings like X-Fusion, Formula, Magura, Crane Creek, and DVO but those don’t carry the same brand recognition.  However, in Europe, there’s a suspension company that those in the know speak of in deferential terms.  That company is BOS, once a premiere manufacturer of mountain bike suspension.  The brand won dozens of World Cups through the 1990s and early 2000s, but has been more focused on rally car suspension in recent years.  After a long hiatus from mountain biking, BOS aims to make a comeback with a new fork called the OBSYS.  This fork is scheduled to make its debut at Eurobike which takes place at the end of August so there are few details at this stage but much industry buzz and anticipation given the performance of the earlier 2017 launch of the DeVille 35, the latest all-mountain fork from “legendary” BOS.  The price on the DeVille is priced below that of its main rival the FOX 36.  As described in a review by Enduro Mountain Biking magazine, “We were expecting great things from the BOS DeVille and indeed the damper is one of the best on the market.  Once dialed in, the ride is supremely stable and confidence-inspiring…”  The same magazine review said in regards to the Fox Factory 36 Float that “the iconic racing fork now offers more support and control at high speeds.  The Fox Factory 36 Float is a powerful racer’s fork that gets better the faster you go, but like a supercar it needs speed and aggression to shine.”  The appeal to racers in using FOXF is not the issue, at least not yet, but whether enough non-racers are compelled to pay the premium in the future is a key consideration.  As further described by Enduro Mountain Biking magazine, the Fox Factory 36 Float “looks expensive—is expensive.”

The challenge that confronts FOXF is that its historical success with the racing community that enabled a premium price with the mountain biking enthusiasts is being confronted by competitors that have intensified their efforts to grab share, with an increasing ability to engineer similar quality but pricing such more economically to the OEMs and end-market.  When Singletracks recently reviewed best mountain bikes, they noted having tracked many excellent bikes at relatively affordable prices.  There has not yet been much deterioration across the OEM landscape for the Company but those design decisions take time and in speaking with some industry experts, they would not be surprised to see an erosion of FOXF’s OEM share as SRAM pursues a lower price for similar quality and returning companies like BOS with very strong brand equity also pursue a lower price for a quality suspension system that is perceived to be equal or better quality.  This is among the reasons some industry experts think that FOXF is trying to expand its addressable market with a lower price point but there’s a delicate balance to avoid eroding both its premium brand and price point as the Company tries to also tailor its business to a lower mountain bike price category.

Competition in the market for off-road and specialty vehicle suspension components includes Multimatic, Thyssen Krupp Bilstein, King Shock Technology, Icon Vehicle Dynamics, Sway-A-Way, Pro Comp USA Suspension, and Tenneco’s Rancho.

Competition within the market for powered vehicle suspension components in the snowmobile segment includes Kavaba Industry’s KYB, Ohlins Racing AB, Walker Evans Racing, Works Performance Products, and Penske Racing Shocks/Custom Axis.  In the ATV and Side-by-Side markets, outside of captive OEM suppliers, the Company competes with ZF Sachs, and Walker Evans Racing for OEM business, and with Elka Suspension, Ohlins Racing AB, Work Performance Products, and Penske Racing Shocks/Custom Axis for aftermarket business.  In the market for lift kits, competition includes TransAmerican Wholesale/Pro Comp, Rough Country Suspension, Tera Flex, ReadyLIFT, Tuff Country EZ-Ride Suspension, and Rusty’s Off-Road.

Within the U.S., electric mountain bikes are a relatively new trend and one that stirs much controversy among the mountain bike enthusiasts but in spite of much resistance, the trend is growing and some believe that the category will become similar to Europe where the e-mountain bike revolution began and now ~20% of mountain bikes sold in Germany is an e-bike.  The trend in mountain biking is evolving more towards e-MTBs and this could marginalize the Company’s growth relative to expectations.  The Company’s EVP of the Bicycle Division said that e-MTB is “definitely a bright spot in the industry” and they believe that there’s incremental units coming by the way of the e-bike but “it does do some cannibalization to the standard pedal bike portion of one’s product line.”

From my research surveys, it is clear that many mountain biking enthusiasts detest pedal-assist bikes, some on principle, some because they fear these bikes could lead to trail access issues, and some from what I will call mountain biking puritanism.  The most common negative feedback is simply that e-MTBs are not bikes.  Regardless of the criticism among the “purists”, this industry segment is growing and all the major brands have introduced e-bikes.  This is an issue that FOXF is confronting as the Company’s historical success, largely driven by engineering and astute marketing, has been tailored towards the premium category of which many mountain biking enthusiasts are likely among the “purists”.  As much as 30% of a premium suspended mountain bike’s cost might be tied to the suspension components which has worked towards the Company’s advantage historically as OEMs invest to drive performance and marketability.  However, the brand equity that FOXF has well-established across traditional mountain biking has not transcended as being as relevant to the e-MTB category where other bicycle components (like the motors from Bosch, Brose, Yamaha, and Panasonic) are more integral to the product.

When comparing four of the highest-rated 2016/2017 e-MTB models manufactured by Specialized, IZIP, and Magnum, FOXF was specified on only one of the eight suspension systems (i.e., fork or rear shock of each model).  Specifically across the four top-rated models, FOXF was integrated as the frame rear of just the Specialized Turbo Levo FSR Expert but not the frame rear of the other Specialized top-rated model nor either the IZIP or Magnum models.  Furthermore, across each of the four top-rated models, the Company’s frame fork was not specified at all but instead its competition RockShox across three models and Suntour in one.      

The manufacturer most focused on e-MTBs is Haibike with 42 different models.  In regards to forks and dampers (i.e., the suspension system), SRAM’s RockShox and SR Suntour are each integrated into over 27% and 26% of the Haibike models, respectively.  FOXF is third at less than 18%, a meaningful difference from its disproportionate higher mix of traditional mountain biking models in the premium category.  As one specialty bike retailer said, “The fact is the importance of the suspension system is not the focal point as is the motor and battery in the e-MTB.”  A product manager said, “FOX is not a meaningful distinction in the marketplace in the e-MTB category as it has been in the more traditional mountain biking segment and particularly in the premium price category.” 

During 2014, Giant Bicycles was selling e-MTBs in Europe but had not brought the product to the U.S.  Giant’s then senior product marketing manager Andrew Juskaitis said he would “do whatever he can to keep the bike away from U.S. riders.”  Nevertheless, Giant as well all major OEMs have embraced the e-MTB trend that is growing in the U.S.  In regards to Giant, the Company’s largest overall customer, which had eleven 2017/2018 e-MTB models, FOXF is specified in only two models for its fork and only one model for its shock.  Giant has selected Suntour and RockShox each to be specified on five and four forks, respectively, and each on three shocks.  Giant’s specification of FOXF in its e-MTB is significantly lower than the specification in its traditional suspended mountain bikes in which approximately half of Giant’s mountain bikes (models above $1,000 price point in 2017/2018) are equipped with a RockShox suspension system compared to 35% from FOXF.  In short, the fork and shock are not driving purchasing habits as much as the motor and battery and therefore OEMs are selecting other suspension brands of comparable quality but at a lower price point. 

The Company’s brand and reputation is primarily derived from its innovation in mountain biking suspension systems and the brand visibility from its mountain biking racing sponsorships and endorsements.  However, management appropriately diversified its business from being overly dependent on just the bike category.  In fact, it is the powered vehicle category to which one can ascribe a majority of recent top-line growth.  During the first half of 2017, sales increased by 24.4% which was generated from bike products increasing by 8.2% and powered vehicles increasing by 48%.  Based on estimated 2017 revenue for each category, the two year CAGR for the bike category is ~6% and ~20% for the power vehicle category.  I believe the market (evidenced by the substantial premium earnings and EBITDA multiple), and despite management’s attempt to temper expectations, is discounting far more growth potential from the powered vehicle category than is likely to materialize next year.  The fact is powered vehicle growth is more volatile and subject to new vehicle introduction timing and will not be linear between quarters or years.  As the CEO said on the most recent earnings call, “We are having a great year based on some of the introductions.  Next year…it might be a bit lower…it could be the same or it could be a little higher…we don’t know.” 

Although it is not broken out within the power vehicle category, the substantial growth this year is primarily based on the Company’s suspension systems supporting both the Ford Raptor and Toyota Tacoma.  The Company’s shocks have been featured on the Ford F-150 SVT Raptor since 2010.  The first-generation Raptor was a commercial success but Ford halted production of that model in 2014 to accommodate a full redesign and relaunch of the base F-150.  Ford reignited its business with FOXF for the Raptor last year for the Company to begin shipping its patented internal-bypass shocks for the 2017 model.  It is estimated that the first-generation Raptor generated annual sales of ~$20-25M for the Company.  Given the vehicle’s absence from the market for two years, William Blair Research estimates the Raptor might sell at least 25,000 units this year, representing ~$38M of revenue to FOXF.  The success of both of these off-road models and their respective impact to FOXF this year are indeed impressive but the pattern of such growth is not sustainable.  The CFO said, “We would tell you that, clearly 2017 growth was above our long-term projected growth and so, we would not expect a similar growth profile next year.”  The CEO said that “both of these vehicles are designed to be…relatively smaller run vehicles.”     

Among off-road pickup vehicles, the main participants are the Ford Raptor, the Toyota Tacoma TRD, the Jeep Wrangler Rubicon, and Colorado ZR2 from Chevrolet.  A competitive threat to FOXF’s customers, both the Raptor and Tacoma, has recently come to market (this past May) from Chevrolet and the Formula 1-style shocks make the difference.  The 2017 Chevrolet Colorado ZR2 comes equipped with shock absorbers from Multimatic which uses dynamic suspensions spool valve (“DSSV”) technology.  Multimatic DSSV shocks are only on a handful of vehicles, including the Colorado ZR2, the Camaro Z/28 and ZL1 1LE, Mercedes-AMG GT, and Aston Martin One-77. 

As described by Murray White, Multimatic’s technical director of vehicle development, “The DSSV has been known in racing circles for at least 20 years…The first application was in the Aston Martin.  Then GM came to us and said (they) would like to do a technology demonstration project with the 2014 Camaro…then they came back and said we have the next application for the spool-valve dampers:  a truck.”  Conventional shock absorbers like those made by FOXF can only offer one damping profile for compression and rebound.  The shocks on the Colorado ZR2 offer six distinct damping curves on the front axle, four at the rear and each acting on a different portion of the truck’s suspension travel.  As recently described in Motor Trend magazine, by using Multimatic’s DSSV shocks, engineers were able to give the ZR2 more suspension travel than they might have with traditional shocks, better cooling for high-speed off-roading, and better control over each wheel’s movements.  In other words, the Chevy’s suspension adapts to street driving, technical rock crawling, and high-speed off-roading.  These attributes are appealing to a majority of surveyed end-users.

The bar for off-road versions of modern trucks has been set by the Ford F-150 Raptor.  As described by The Detroit News, “The 2017 Colorado ZR2, targeted at buyers with a taste for Baja-style adventure, has won raves from media for its versatility in conquering the outback…the shock has given Chevy a leg up in the off-road pickup wars.”  Compared to the F-150 Raptor, the ZR2 is narrower by two feet, shorter by eight inches, and lighter by 1,000 pounds which means the Chevy can go places the Ford cannot.  Having read hundreds of reviews, the most compelling attraction of the Raptor relative to the Colorado ZR2 is more power and there is certainly a market segment for that but that comes at a price point of ~25% more than the ZR2.

Another component of the short thesis is that the Company’s quality of earnings have been deteriorating.  At year-end 2016, FOXF had the highest DSOs, the highest days of inventory, and the highest days payable since 2011.  Among the reasons that DSOs could be rising is because of the challenges being incurred by Giant, the Company’s largest customer, which accounted for 17% of FOXF’s receivable balance at year-end 2016, up from 16% in 2015.  Another customer accounted for 14%, up from 8% in 2015.  Giant’s challenges are evidenced from its recent results—a decline of 7.4% in revenue and a decline of 29.5% in net income during the first half of 2017.  Giant’s sales in both Europe and the U.S. have recently been growing but Giant has been challenged in China because of soft demand which can partially be ascribed to the popularity of bike sharing. 

Another red flag from an earnings quality perspective is the Company historically depreciated information systems, office equipment and furniture at 3-5 years but during 2016 management chose to separate a component that is now characterized as “internal use computer software” and apply an estimated useful life of 10 years to it which enables FOXF to report a higher EPS than would have been reported applying the preceding year accounting policy.  From 2012-2014, adjustments to GAAP EPS ranged from just 20-25% but in the past two years have ranged from 31-51%, a large component ascribed to a fair value adjustment of contingent consideration and acquisition-related compensation.  Those accrual issues primarily pertain to Sport Truck and Race Face/Easton, two acquisitions completed during 2014 with total contingent consideration of $29.3M and $19.5M (in Canadian dollars), respectively.

Management has noted its operating expenses are currently running below target and that planned investments in research and development, sales and marketing, and ERP systems, as well as changes related to FOXF’s status as an emerging growth company will result in higher spending in 2018.  The SOX 404 requirements will lead to higher audit fees and higher internal costs to be SOX compliant. 

The Company has achieved an attractive tax rate from changing its international tax structure to achieve a tax rate in the mid-20% range or less partially through tax incentives in Switzerland that are effective through March 2019 but these incentives are provided such that the Company meets specified criteria.  I have not been able to identify such criteria but at the beginning of 2016, FOXF sold the net assets of its Taiwan branch operations and its shares of Fox Factory IP Holding Corp to Fox Factory Switzerland GmbH.  Fox Switzerland and its Taiwan branch own a portion and license the remainder of the Company’s non-US intangible property to generate earnings that are not subject to US income taxes so long as they are permanently invested outside the US.  Therefore, the Company has not recorded a deferred tax liability of over $3.7M (as of 2016) related to taxes on almost $21M of unremitted earnings of Fox Switzerland.  I am not able to appropriately frame this risk but after speaking with a couple of tax structuring experts who opined that this structure seemed “vulnerable” to them, I think it’s worthy of highlighting since the tax rate, expected to be at the low end of 18-20% this year, has been a significant recent benefit that might not be sustainable.   It’s notable that FOXF is already getting a relatively attractive tax benefit and so what might ultimately be favorably legislated by the Trump administration in tax reform would have less impact to FOXF (all else being equal).  The Company’s tax rate last year was just 17.2% and is only 16.5% YTD although part of the recent benefit is further ascribed to the excess deductions on the exercise of stock options and vesting of RSUs.  When management was asked during the Company’s Q4’15 earnings call in February 2016 about the sustainability of a low tax rate, the CFO said he thought the rate would be sustainable “at least for the next couple of years” but this would depend on FOXF’s mix of international versus domestic business. 

The Company has spent over $4.5M since 2016 in several lawsuits against its competitor SRAM.  In suspension, the Company’s FOX and Marzocchi brands compete with SRAM’s RockShox brand.  The Company’s Race Face and Easton brands compete with SRAM’s drivetrain, wheels and cockpit products, including those sold under the SRAM, Truvativ, Zipp and Service Course brands.  The suits originated over SRAM seeking to protect its “wide-narrow” chainring patent in late 2015 against several companies.  While the others settled or worked out licensing agreements with SRAM, FOXF has not and this is specifically over its Race Face brand.  The litigious issues escalated when SRAM alleged that FOXF infringed on its trademarks, as well as its patent, by engraving “SRAM” and “GXP” on its chainrings to indicate compatibility.  But FOXF got the trademark claim thrown out by highlighting that SRAM had not specifically trademarked the terms for use on chainrings.  In January 2016, FOXF filed suit against SRAM in California alleging patent infringement over some RockShox forks and rear shocks.  Then in May 2016, SRAM filed another suit against Race Face, for infringing on a very similar patent for narrow-wide chainring technology, which SRAM had been granted in March 2016.  FOXF then followed in July 2016 with two more patent infringement suits over thru-axle technology.  For the time-being, it seems like only the lawyers have garnered any benefit.  Although I don’t have a very well-informed perspective to frame the risk or any potential benefit to FOXF from the pending litigation, based on comments from SRAM’s vice president of corporate development who claimed FOXF’s suits are just “retaliatory” and “they could have licensed the X-Sync product many times over for what they’ve (i.e., Fox Factory) spent in legal costs”, I am not ascribing this as a significant risk to FOXF.  Nevertheless, I think it is worthy of communicating as it’s a relatively small industry and the pending litigation attracts industry attention and the company isolates these legal costs as a non-recurring item.      

Selected Risk Considerations

Management has not been overly promotional in regards to a similar pattern of growth being exhibited in powered vehicles next year.  The Company’s longer-term growth target is for mid-to-high single digit growth in the mountain bike category and low double-digit growth in the power vehicle category.  Management also believes another 200 basis points of EBITDA margin expansion is achievable.  Based on my research on the bike category, much of it summarized above, I don’t think a high-single digit growth target is likely without margin degradation.  The powered vehicle category could grow double-digits again but I think it will be a difficult anniversary year in 2018, but the market multiple is discounting a pattern of accelerating growth.

Although I deem the Company’s stock price as being “priced for perfection” and discounting a growth trajectory that is overly ambitious in the near-term, the stock’s momentum begets momentum and that is clearly an ongoing risk and especially in the current market.  I do believe the Company has engaged in some quality of earnings issues to mask deterioration in the core business but I don’t think there is product-related fraud nor am I questioning the Company’s premium brand and quality in the marketplace.  The fact is the marketplace trends are shifting, the competitive landscape is intensifying, and FOXF’s stock price fails to adequately discount these and other risks.   ROIC is still attractive at over 15% (on average) in 2015-16 but has deteriorated from 24.5% (on average) in 2013-2014.  I do not believe management is oblivious to the industry challenges (particularly those insiders who have been selling their FOXF stock) but I recommend a short because I don’t think the market adequately discounts those challenges.  As for additional growth prospects, management has communicated an intent to expand into additional markets that could include military, RVs, on-road motorcycles, commercial trucks and “performance street” cars.  There is a possibility that one or more such opportunities materialize but I view the current multiple as more than discounting this potential risk.  The fact that FOXF has expanded its addressable market with the Rhythm series to a lower-priced segment is a risk given the potential to penetrate increased volumes but I also deem this strategy as being potentially detrimental to the overall price premium that FOXF gets from the higher-end.       

FOXF has a relatively strong balance sheet and could pursue additional tuck-ins (e.g., performance wheels and cranksets) that are accretive.  In response to a question during the Q1 earnings call regarding M&A, the CFO said, “We’d like to get an acquisition that would meet our strategic and financial requirements…it is a frothy market out there, and we’re going to continue to be disciplined.”  It’s possible that his notion of “frothy” also pertains to his perception of how the market is valuing FOXF since he reduced his stake since that call by almost 45% at ~$34.25.   

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


  • Market recognition of moderating growth profile driven by anniversary of unsustainable powered vehicle growth
  • Inability to achieve higher margin profile as envisioned by management given pricing degradation in core bike category
  • Challenges emerge across distribution channel and/or OEMs with e-MTB trend, causing more quality of earnings issues
  • Competition intensifies from product quality perception, brand equity perception, and willingness of industry participants to price more for share 
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