Trading at just 5x this year’s earnings guidance and 3x forward earnings 18 months from now, IEAM is exceptionally undervalued for a company with very little debt, a new shareholder base of sophisticated activist investors, a fully funded business plan, a pattern of recent insider buying around current levels, net income that approximates free cash flow (as per management) and numerous near-term catalysts. The bottom line is that the average investor cannot appreciate the tremendous opportunity that IEAM represents because any understanding of its potential has been obscured by a reverse merger into a public shell, 3 major acquisitions in the past 2 quarters, a recent ticker change, an absence of research coverage, a recent reverse stock split and a complex capital structure that includes various tranches of convertible debt and warrants.  However, this will all change over the next few quarters as the reported financials become cleaner, the acquisitions begin to generate substantial cash savings and revenue synergies (already occurring) and the Company lists its shares on the NASDAQ (later this month).  Based on management’s $12m net income guidance for the fiscal year that just began on July 1, we believe that IEAM’s shares are worth at least $12 (88% upside) in the near-term (10x $1.20 EPS in FY2007) and will reach the $25 range (nearly a triple from current levels) over the next 18 months if results approach management’s 2-3 year net income guidance of $20m (12.5x $2.00 EPS in 2008/9, with a 15%+ growth rate longer-term).

 

 

 

IEAM is a roll-up of small, regional businesses that previously lacked efficient manufacturing or sales force utilization, purchasing leverage, sophisticated management or adequate financing.  Yet they are all in a stable industry (primarily low-end, after-market automotive supplies) with a steadily growing recurring revenue stream (consumables), no foreign competition (raw materials, not labor, are the largest portion of COGS) and virtually no low-end national competition (due to the prohibitive costs of freight over distances of about 250 miles).  This particular version of the concept is the brainchild of the current CEO, John Mazzuto – an executive we believe seems to have robust commercial instincts and a strong background in both operations and finance (former corporate finance MD at Chemical Bank).  A brief overview of IEAM’s current primary entities follows:

 

 

 

Accretive Roll-up Story.  In this highly fragmented regional industry, there is no shortage of under-scaled, fatigued regional operators with a lack of access to working capital in a rising input cost environment that are now amenable to being acquired at relatively low multiples.  For instance, IEAM acquired Unifide for $3.75m (less than 4x earnings – before synergies – according to management).  The Company then bought Pitt Penn’s estimated $1.4m of stand-alone earnings for just $4m (less than 3x).  However, IEAM then sold off Pitt Penn’s underperforming Springdale bottling facility for $2.5m (bringing the effective purchase price to just $1.5m) and estimates that the sale will actually save the Company about $500k per year in artificially high bottling costs – so, IEAM effectively paid just 0.8x earnings for this business (before accounting for substantial additional synergies that are expected to result from the combination of Pitt Penn with IEAM’s other holdings.  Management has communicated to us that they are evaluating a portfolio of similar regional acquisitions in the range of just 3-4x earnings (before synergies from revenue enhancements or cost savings).  In fact, just 2 weeks ago, the Company announced the acquisition of another regional automotive products manufacturer that is expected to double IEAM’s geographic base (with very little overlap).  Our understanding is that this business was also acquired for roughly 3x earnings.  Notably, as a result of previously issued warrants, no additional equity or debt financing will be necessary.  Most importantly, the Company announced that, “This regional combination will immediately increase our manufacturing capacity, national distribution, and purchasing power while growing revenues and net income by at least 20 percent during our 2007 Fiscal Year which begins on July 1, 2006.”

 

Massive Operating Synergies.  In addition to the bottling savings described above, the purchase of Pitt Penn has also recently allowed the Company to close 2 finished goods warehouses (and consolidate in Pitt Penn’s larger underutilized storage facility) for an additional $2.8m in annual savings (on rent, distribution, labor, etc.).  The greater purchasing power of the combined entities has also allowed for a renegotiation of bulk raw material purchases – the Company is now getting an incremental 4% discount on rail shipments and 6% on barge deliveries, for a blended 4.3% discount on approximately $60m of COGS (an additional $2.5m in annual savings).  Perhaps most importantly, prior to IEAM’s Pitt Penn purchase, that company’s manufacturing operations sat virtually idle for most of the year, running at an estimated 40-50% utilization rate (most of Pitt Penn’s products were seasonal in nature – antifreeze, wiper fluid, etc.).  Now with the addition of Unifide’s year-round chemicals and additives as well as EMC’s refrigerants business, the facility can now operate at a more reasonable utilization level, better leveraging a reduced level of fixed manufacturing costs.  Management estimates that the current facility can support at least $150m in revenues, which they anticipate would equate to more than $20m in annual net income as incremental volumes are expected to yield a greater than 15% margin due to fixed cost absorption.

 

Extremely Cheap.  As a result of the most recent acquisition, IEAM’s guidance now calls for $12m in net income for FY2007 (ending in June).  Based on a fully diluted share count of approximately 10m shares (using the treasury stock method) provided by management, this guidance equates to $1.20 EPS, revealing that IEAM currently trades at just 5.3x this year’s earnings guidance.  Looking to the 2-3 year guidance of $20m ($2.00 EPS), implies that at the current share price, IEAM will be trading at just 3.2x forward earnings 18 months from now.  With an expected growth rate of 15%+, these trading levels are absurdly cheap.  We believe that if management executes on its strategy over the next 18 months and the operating results even approach its current medium-term guidance, IEAM’s shares will trade to the $25 range.

Sophisticated Investor Base.  A number of well-known hedge fund investors have very recently become meaningfully involved with IEAM, a fact that we believe underscores the tremendous upside opportunity here, especially given the small size of the Company relative to the size of the funds currently taking positions.  Jeff Feinberg (JLF Asset Management) provided $5m in the Company’s first quarter 2006 convertible offering.  Just 3 weeks ago, Dan Loeb filed a 13G, indicating that Third Point had purchased a 400,000 share stake (IEAM’s share price was $7.43 at the time of the filing).  Together, we estimate that these 2 funds represent at least one-third of the economic ownership of IEAM, giving us comfort that we are in good company as investors.

Insider Ownership.  In addition to the funds listed above (and the many others involved in IEAM’s previous financings), the CEO has also expressed that his adult children hold a substantial interest in the Company as well (approximately 15%).  Additionally, Mazzuto himself has spent over $200,000 personally to acquire additional shares over the past month (at a weighted average price of about $6.25, according to filings) and we expect to see more of the same with the stock price at these attractive levels.

Under the Radar & Misunderstood.  Very few investors actually understand the tremendous upside potential here given the state of the public information currently available.  IEAM’s historical financials are not representative of the current operations as they do not pro forma for the operations of recent acquisitions or the tremendous revenue and operating synergies that management indicates are already immediately apparent in the ongoing business.  The share count is completely misunderstood by many due to a reverse share split and the existence of in-the-money converts and warrants (Bloomberg, for instance, lists Third Point’s stake at 40,000 shares, when it is in reality 400,000 shares or more than 7% of the current common shares outstanding).  The ticker has also recently changed and will do so again very soon.  There is no analyst coverage and the shares currently trade only on the OTC Bulletin Board.  We view all of the above as creating opportunity by having kept the share price artificially low.

Fully Funded Business Plan.  Although IEAM expects to make a number of accretive acquisitions going forward (in order to reach its net income guidance of $20m within 2-3 years and maintain an earnings growth rate of 15%+ after that), the Company has already secured the financing for these transactions through the issuance of warrants in previous financings that are ineligible for cashless exercise (representing an eventual $17m of proceeds).  As such, shareholders should expect no further equity dilution or increased financial leverage for the Company to be able to achieve these targets.  Additionally, IEAM currently has only approximately $7.5m of non-convertible debt outstanding (just 0.6x this year’s net income guidance).

Pending NASDAQ Listing.  IEAM has announced that it is seeking a NASDAQ listing, which should increase the visibility and liquidity of its shares.  According to management, the Company is currently in compliance with all listing requirements and expects to receive approval as early as the end of this month.  Although the common shares currently represent a market value of less than $40m, the fully diluted market capitalization is more like $65m (using the fully converted share figure provided by management).  Furthermore, for a company of this size, liquidity has been pretty decent, with an average of 104,000 shares ($675,000) trading daily over the past 2 months.

 

 

Execution Risk.  Plant & logistics rationalizations tend to be easier said than done and will certainly cause some disruptions and potential loss of customers in the short-term due to delayed deliveries, etc.  However, much of this rationalization (aside from the recently announced acquisition) has already occurred over the past few months.

Commodity Risk.  Raw material purchases (various chemicals, primarily) represent approximately 70% of IEAM’s operating costs.  As such, there is some risk that the value of raw materials held in storage could fall before being resold as finished products.  To combat this risk, management has negotiated consignment relationships with some of its key suppliers.  Additionally, the Company prices its products based on an input cost pricing matrix, to ensure that it maintains margin.  Unlike higher-end products in the sector, there is little wholesale manufacturing margin to play with, allowing IEAM to insist upon a full pass-through of any raw material price increases.

Naked Short Interest.  There seems to be some fairly substantial level of short interest in IEAM, although based on the Company’s recent recurrent appearances on the Regulation SHO Threshold List, it seems that much of this is illegal naked short selling.  Given this high level of Failure to Deliver notices, these are likely retail investors and day traders left over from the public shell company that IEAM effectively merged into in October 2004, as opposed to sophisticated institutions making rational investment decisions.  Although such activity can increase the near-term volatility of the stock, we view this as an opportunity as these shorts are forced to cover once they realize that this is no longer a shell company, but has quickly become a highly profitable NASDAQ listed entity with strong growth prospects and a sophisticated investor base.