Description

Thesis

Arising from the hedge fund graveyard from whence it was banished in mid-2007, GN Store Nord ("GN") now offers 50-150% return over the next two years driven by a) significant management-driven cost savings, b) a new transformational product launch, and c) two probable litigation wins driving a material cash infusion and a major strategic opportunity.  GN is comprised of two distinct, standalone businesses.  GN's ReSound is the fourth largest hearing aid player - a business fortified by incentivized audiologists controlling distribution.  GN's Netcom is the #2 player in the B2B headset duopoly (Plantronics is #1), characterized by >60% gross margins.  After missing the previous innovation wave within audiology, which resulted in four years of decreasing margins and poor earnings at ReSound, the market incorrectly projects continued ReSound weakness.  From speaking with the two largest distributors in Europe and the three largest competitors in the industry, we are confident that the new product offering is highly successful, enabling margin recovery to peer levels.  If we are correct, the result would be >100% share price appreciation, assuming peer multiples.  Additionally, we believe shareholders will receive significant upside from two potential "jackpot" opportunities.  First, a long-awaited court award recently announced should result in up to one third of the current market cap.  Second, ReSound is potentially for sale following an April 2010 ruling by the German Supreme Court, which overturned a previous anti-trust ruling that prevented GN from selling ReSound to competitor Sonova for 145% of the current entire enterprise value of GN (including Netcom).

Description

GN Store Nord operates two standalone businesses, GN ReSound (61% of 2010E Sales and EBITDA) and GN Netcom (39%).  Each company has a CEO that reports to the Chairman.  Management throughout the Company have been aggressively purchasing stock.  The new CEO of ReSound comes from GE Healthcare.  The Chairman joined in June 2008 and controls the strategy/decision making for the group.

GN ReSound is a manufacturer of personal hearing aids and diagnostic equipment. The global market is around DKK 26B and growing at 5-7% per annum.  ReSound has a global market share of ~12.9% down from ~14.1% in 2007. The three largest members in the space include William Demant (~23%), Sonova (~24%) and Siemens (~21%).  Historically distributors have been very loyal to their brands, so the new products are likely to reclaim the market share lost.

GN Netcom produces communications headsets for the CC&O (Contact Center and Office) B2B market (63% of sales and 100% of 2010E EBIT) and the consumer B2C mobile market (38%).  In the CC&O market, Netcom is one of two global players.  GN Netcom's market share is 31% versus Plantronics with 64%. The market is predicted to grow at >20% per annum.  Margins are high due to the importance/stranglehold of global distribution.  The consumer mobile market is highly fragmented, and characterized by low margins.  The mobile headset market is growing at 5-8% per annum.  

Investment Merits

• Business quality: ReSound and Netcom's CC&O businesses possess strong structural growth drivers and high barriers to entry, which should generate significant growth and a rapidly expanding ROIC over the next several years.
  • Hearing aid producers maintain a rational oligopoly characterized by captive distribution and price insensitive consumers. From speaking with several distributors and hearing aid manufacturers, >90% of hearing aid customers walk into the store with no concept of brand, price point or product differentiation. The audiologist becomes the key decision maker/thought leader in the process. As a result, audiologists are incentivized to push price points higher in order to generate higher absolute profits. For example, the largest global distributor of hearing aids, Amplifon, generates gross margins of over 75% (producer gross margins range between 60%-75% as well!)! As a result, market share rarely changes hands unless a producer misses a product cycle (happened to GN), but even then, the share loss is very contained due to the loyalty of distributors/audiologists (<2% market share lost despite the lack of wireless product). Additionally, hearing aid penetration is <25% globally, generating 4-7% annual demand growth as a result of increased product awareness and better technology leading to less conspicuous/externally visible equipment (fashion stigma of being seen with a hearing aid is the #1 reason the >75% of people in need of a hearing aid forego them). Demographics are favorable as well as the baby boomers enter their golden years
  • Similar to hearing aids, distribution is key in the B2B headset market. Netcom and Plantronics control global distribution for CC&O products. Many competitors have attempted to enter the market over the past several years and have failed. Given that nearly 100% of the globally installed base is made up of Jabra (Netcom's brand) or Plantronics, churn is minimal (razor/razorblade). Due to the rapid adoption of "Unified Communications," market research firm Frost & Sullivan expects the value of the CC&O headset market to triple by 2014. Unified Communications is the industry nomenclature for the integration of computing and telephony. Many companies are beginning to abandon their office phones entirely in favor of a digital solution. Thus, many companies are choosing to create hands-free telephony environment where the company eliminates its need for fixed lines. The result is a dramatic increase in demand for headsets.
• Cost restructuring: Within ReSound, DKK200mm of costs have been structurally removed with no impact to capacity. Meanwhile, Netcom has nearly completed its restructuring, removing DKK500mm of costs. This has largely been under the direction of Chairman Per Wold-Olsen who led a series of successful restructuring and growth initiatives at Merck. Netcom volumes fell by 30% in 2009 due to the global downturn. Gross margins, however, increased. As volumes return, the operating leverage will be significant.
• Major product launch and market share gains at ReSound: The new premium segment, top of the line "Alera" hearing aid range was released in the summer of 2010. It introduces a new wireless connectivity not seen before in the industry, seamlessly integrating everyday audio devices (phone, TV etc) with the hearing aid. This COULD reintroduce GN ReSound as a market leader and will certainly help close the 1,800bps margin gap between ReSound and Sonova. Margin products in the premium segment offer contribution margins of >90%. ReSound has not participated in this product category (about 1/3 of the market) over the past several years due to the lack of a wireless product. From speaking with the two largest global distributors who tested and are now selling the product, we are convinced that Resond is currently gaining significant share in the premium segment, which will disproportionately benefit margins. Additionally, in November 2009, ReSound became a supplier for the Veteran Affairs, which accounts for 18% of the market in the US. ReSound has already doubled its share from 3% to 6% in Q1 2010.
• Litigation provides significant upside optionality.
  • In 2006, Sonova made a bid of DKK15.5bn for GN ReSound (>45% higher than the current enterprise value - and the bid EXCLUDED Netcom). The transaction was declared anti- competitive by the German authorities and never completed. In April of 2010, the German Federal Supreme Court overruled this decision, and made it clear that the door was open for a similar transaction to occur. Both Sonova and William Demant previously made bids. With a depressed share price and significantly improved product offering, it should come as no surprise if one of these players makes a bid for ReSound in the relatively near future. In 2007, Sonova assumed DKK500mm of synergies, suggesting the deal would be massively accretive at current levels.
  • In 2001, a dispute arose between DPTG (owned 75% by GN Store Nord) and what later became TPSA relating to revenue share of a fiber installation in Poland. On Sept 3^rd 2010, after 9 years of legal battles a ruling was issued by the Arbitration Tribunal in Austria for "Phase 1" of the claim for the period 1994 to mid 2004, GN's pre-tax share was DKK2.2bn including interest and principle. "Phase 2", from mid 2004 - Jan 2009, using the same rationale, is estimated to be an additional DKK750mn. The total settlement figure is ~ 26% of GN's market cap post tax. TPSA has yet to pay the Phase 1 and has made public statements that the decision is outrageous and they will use all legal means available to them to reduce the amount. Our external checks with legal experts familiar with EU and international law have determined that there are no further legal avenues open to TPSA to dispute the ruling and they must pay or face asset seizure and jail time for executives. GN can proceed with enforcement proceedings 90 days following the settlement. It is our belief that TPSA is simply posturing as a negotiating tactic for the amount of Phase 2. In their 2010 Q3 results TPSA has announced a DKK4.2bn provision to settle the claim with DPTG. We believe that the payment, for at least Phase 1, will be made within the next 1-2 months.

Investment Risks

• Execution risk: Management has made many internal changes over the last 12 months. The cost-cutting may have been too deep, suggesting that it could be difficult for the company to grow market share.
• Failure to innovate: All business units are in markets with 12-24 month product cycles, meaning that most products are only competitive in their market for 12-24 months. Competition could innovate faster and gain a competitive advantage putting pressure on pricing and reducing market share, while increasing costs to catch-up. ReSound is a clear example of this. In recent years we have seen the major competitors make technological jumps that held ReSound back for four years and is only now finally catching up.

Catalyst

• TPSA check receipt and commensurate buyback for >30% of GN's market cap
• ReSound is sold to Sonova or William Demant
• Earnings results showing improving sales and margins from ReSound
• Earnings results revealing structural growth at Netcom from unified communications