Hardinge, Inc. (HDNG) is a manufacturer of precision lathes, mills and grinding equipment (precision meaning that their equipment cuts and shapes metals to tolerances of one millionth of an inch). At $9.98/share, the company may be purchased for 0.8x tangible book value, 4.4x trailing EBITDA. This is remarkable in light of the following:

 

1. The company typically makes money; median annual earnings over the last twelve years were $6 million; median EBITDA was $21 million. 
2. HDNG manufactures and sells its products globally; just shy of  80% of revenue is from sales outside of the U.S.
3. The company’s assets are probably understated, e.g., they maintain a $26 million reserve against the value of their inventory (12/31/10) and have a $54 million valuation allowance (12/31/10) against their tax assets. Their gross property, plant and equipment is $157 million, while their net PP&E is $57 million.

 

Valuation

The following table shows HDGN’s current capital structure and valuation:

 

(000 except share price & dividend)
Shares outstanding, 9/30/11	11,659
Options, 12/31/10	60		0.5%	WASP= $6.64
Restricted shares/units, 12/31/10		248	2.1%
diluted share count	11,719
Share price, 11/14/11	9.98
Market capitalization	116,952
Cash, 6/30/11	24,216
Operating lease obligations, 12/31/10	7,266
Debt, 6/30/11	10,805
Enterprise value, net	110,807
Dividend (annualized)	0.080
Dividend yield	0.8%

 

Background

Founded in 1890, HDNG is headquartered in Elmira, New York.   HDNG is known worldwide for its precision metal turning lathes. In the 1970s, HDNG began producing computer numeric control machining centers and in 1995 HDNG acquired Kellenberger, a manufacturer of precision grinders based in Switzerland.  HDNG’s specialty is making machines that cut and shape metal to very close tolerances, measured in millionths of an inch.  These machines are used in a broad range of industries including aerospace, defense, automotive, electronics and medical equipment. HDNG’s largest customer in 2010 accounted for 11% of revenue. Typically, 25% of revenue is from collets and parts; the balance is from new machines. The company has manufacturing facilities in Elmira as well as in Switzerland, Taiwan and China.  The following table summarized HDGN’s revenue by country.

 

Revenue by Country

 

In China, Germany and the U.K., HDNG sells its products through a direct sales force.  Historically, HDGN used distributors in the U.S. In 2007, however, the company fired its distributors and built a direct sales force for the U.S.  Coincidentally, we listened to the Q108 HDGN earnings call and management’s explanation of why they were changing their distribution channel in the U.S. As with other industrial equipment business, HDNG’s distribution channels are a key competitive barrier. At the time, we were concerned with management’s lack of sensitivity to the effects of dickering with their distribution channel, both from an overhead standpoint (a direct sales force is a fixed cost while distributors are a variable cost) and a customer service standpoint (distributors often form close bonds with customers over many years). This, along with valuation concerns, were reasons we did not pursue this investment in 2008.  As it turned-out, HDNG’s board of directors fired Patrick Ervin, chairman / CEO, on 5/22/08.  HDNG’s new management team recently announced that they have signed-on three distributors to cover the U.S. and have laid-off the U.S. direct sales force.  Of course, this is risky, but the risk is already priced into the stock.  Also note that the directors asserted their authority by firing Ervin and splitting the job of chairman from that of president – we infer that HDNG’s directors are serious about corporate governance.

 

Why HDNG, why now

The table at the top of this report shows that HDNG may be purchased for just slightly more than its current assets less all of its liabilities.  This gives zero value to the company’s property, plant and equipment (gross value of $144 million, net value of $55 million).  It also gives zero value to the company’s U.S. tax assets (approximately $45 million), zero value to the $24 million of inventory write-offs (which depressed gross margins by $8 million in 2009 and $7.6 million in 2008) and zero value to the company as an ongoing business. That is a lot of upside optionality that we don’t need to pay for.  Here is a summary of HDNG’s earnings since 1998.

 

	Earnings GAAP	Earnings Adjusted	FCF	EBIT	EBITDA
9 ME 9/30/11	8,744	8,729	1,094	12,938	18,823
2010	(5,234)	(5,289)	(1,975)	(2,786)	4,256
2009	(33,309)	(32,081)	(25,414)	(28,422)	(18,577)
2008	(34,305)	(18,512)	(13,345)	(14,035)	(4,175)
2007	14,926	14,034	18,186	23,371	33,105
2006	13,950	13,950	16,904	23,097	29,642
2005	9,472	9,472	12,967	15,560	23,869
2004	6,825	6,825	9,944	12,494	21,474
2003	(11,284)	(11,284)	(4,150)	5,800	14,468
2002	2,000	2,000	8,630	4,614	13,581
2001	(21,853)	(562)	3,867	(7,660)	3,062
2000	7,532	7,532	14,233	12,317	22,189
1999	6,041	6,041	11,054	10,273	20,731
1998	20,283	20,901	12,305	34,258	43,282
Totals	(16,212)	21,756	64,300	101,819	225,730
Mean (ex 2011)	(1,920)	1,002	4,862	6,837	15,916
Median (ex 2011)	6,041	6,041	9,944	10,273	20,731
Current mrk. capitalization			116,952
Current enterprise value			110,807

 

 

The table shows that 2008 – 2010 were abysmal and 2011 will be a good year. Going forward, we have no idea of how HDNG’s business will develop.  What we do know, however, is that they have been producing equipment for the last 12 months full out, and their backlog continues to be strong.  HDNG builds equipment that is used by customers around the world to make everything from planes, to artificial femurs, to iPods.  The company is well financed and is able to produce and sell its equipment profitably in most years. 

This is not a spcieal situation, hence there is no particular catalyst other than it is very modestly valued and it is a real business making real products.