Description

LoJack Corp. (LOJN) is an off-the-radar, uncovered micro-cap that is deeply undervalued based on virtually any fundamental valuation technique you choose.

LoJack's principle business involves the design, manufacturing, marketing, and wholesale distribution of its flagship, eponymous stolen vehicle tracking and recovery system (SVR). JoJack units are sold both domestically and overseas (sales mix is approximately 2/3 domestic and 1/3 international), basically to anywhere where the incidence of auto theft is high and populations are dense. LoJack's systems are sold as an aftermarket add-on product by auto dealerships both retail (i.e. optional add-on sold to end-customer in individual new car sale; average ASP of ~$600) and in bulk installations (i.e. installed wholesale in 100% of the vehicles on a dealership's lot; average bulk ASP of ~$200-$300 depending on dealership unit volumes, etc.) The LoJack system is unique and unmatched from both an efficiency and competitive standpoint vs. its traditional GPS competitors for several primary reasons:

1.) LoJack's SVR system operates on an isolated telecommunications radio spectrum frequency band allocated specifically for national emergencies and auto thefts by the FCC. This is significant as its signal is much stronger, consistent, and has much better propagation characteristics (i.e. can freely penetrate inside buildings and/or even underground) relative to GPS, which means that the authorities are able to locate stolen vehicles regardless of how remote and hidden they may be. In contrast, GPS signals have poor propogation characteristics and are often unreliable and ineffective in penetrating buildings and/or warehouses, which is precisely where most stolen cars are immediately taken after being hijacked as the vast majority of auto theft today is done by professionals that quickly hide stolen cars in scrap warehouses where the cars are then stripped and sold for their parts (typically overseas). If you can't locate a stolen vehicle, then it can't be recovered. LoJack delivers a very valuable service offering on this front and sports an enviable 95%+ recovery rate in 24 hours as a result of its dramatically superior technology (head and shoulders above the national average and competition).

2.) LoJack's SVR system is tightly integrated with local police forces and their stolen vehicle databases and police cars/motorcycles/helicopters as LoJack hardware is installed in every unit. This is a distinct competitive advantage and a key driver of LOJN's impeccable recovery rate, because once a car is reported stolen and a police report has been filed, the LoJack system activates automatically and transmits a direct signal to local police patrol cars that they can then follow and use to track down stolen vehicles. GPS has no such relationship with the police. LoJack supplies the hardware for free to the police in exchange for long-term commitments/contracts from local police forces to endorse and use their products.

3.) GPS is installed uniformly in the same exact location in every vehicle by make and model (typically on the front overhead console near the windshield on the ceiling). This is a fatal design flaw because the professionals are naturally very aware of this fact and hence immediately rip out the GPS as soon as the car is stolen, thus rendering the GPS useless. However, the LoJack unit is very small (about the size of a playing card deck) and can be hidden in upwards of 30 locations (i.e. non-uniform) inside a vehicle during the installation process. Furthermore, LoJack never places any stickers on the windows or anywhere else on the car so that thieves are unaware of its presence.

4.) LoJack customers receive discounts on their insurance premiums (vary by state, but typically in the range of 10-30%) which helps offset the initial cost of the system and create a favorable investment proposition for buyers. Insurance companies do so because they know they are saving big on payouts for stolen vehicles due to LoJack's impeccable track record of a 95% recovery rate in 24 hours. GPS can offer no such discounts and has a much lower % recovery rate and average timeframe of recovery.

5.) LoJack systems offer an attractive value proposition to dealers at the same time that they are making less and less per car due to intense price competition from the internet and the secular downtrend of decreasing expenditures on service. The LoJack system is a high margin, after-market add-on sale for dealers at a time when they need all the profits they can get. This drives increasing loyalty and adoption rates as dealers are economically incentivized to push the product, thus driving stable unit volume growth as well as high brand recognition for LoJack. GPS systems are typically manufactured at the OEM level (i.e. Chevrolet's OnStar), which keeps profits in-house at the OEMs as opposed to with dealers.

6.) LoJack charges no monthly recurring subscription fee to consumers for its services after the one-time, upfront hardware sale (flagship system typically retails for $600 and is good for the lifetime of the car), as opposed to GPS which generallly charges subcriptions fees in the neighborhood of $10-$20 per month. Additionally, the $600 one-time cost for the hardware is typically financed and just rolled up into the auto loan thus making it a non-cash upfront, negligible additional charge added on to your monthly car payment.

Due to the former, LoJack essentially has no direct competition and is simply competing vs. non-consumption as well as for wallet share of the relatively fixed consumer budget pool designated to aftermarket add-ons when purchasing a new vehicle (e.g. warranties, 4 wheel-drive packages, premium tires, heated seats, Bose sound systems, etc.) This means that LoJack unit volumes should roughly trend with new vehicle sales in the United States (i.e. conservatively assuming constant attachment vs. its historical rate of ~8%) and be relatively insulated and unaffected by any competitive forces. Given the auto industry's forecast for healthy double-digit auto sales growth through 2015 as sales volumes rebound after falling off a cliff in 2008/2009, LoJack's unit volumes and sales should grow proportionate to the US SAAR for at least the next two to three years. This will likely mean double-digit unit growth through 2015 for LOJN domestically, and assuming ASPs remain flat (i.e constant retail/bulk mix going forward), translate to consistent high-single-to-low-double-digit revenue growth. This is significant because LOJN's business model has inherently high fixed costs and is currently operating at a sub-scale level, meaning profits should expand at a far faster rate for LoJack the next few years as it leverages a recovery in unit volumes that pushes it above break-even scale leading to accelerating, positive EBITDA and cash flows.

On top of the robust outlook for US vehicle sales due to the pent-up demand post recession and an average US vehicle fleet age of 11 years vs. the historical average of 8, low interest rates, easy financing and consumer credit, and growing demand for more fuel-efficient vehicles accelerating the replacement rate, LoJack has lagged the broader domestic auto market and its peers in terms of a rebound in growth and profitability due to its heavy exposure to the big 3 Japanese OEMs (e.g. Toyota, Honda, and Nissan; estimated at 2/3+ of units). Due to its overindexing in Japanese brands, the Japanese tsunami and resulting supply chain disruptions and inventory shortages in 2011 really held back LOJN's unit sales and growth in 2011 (units were actually negative) at the same time that broader auto sales were experiencing a sharp rebound in demand. This has artificially clouded the future growth potential for LoJack and creates a very nice tailwind for 2012 as Japanese brands are forecast to regain lost market share and grow at a faster rate than the overall double-digit industry pace. YTD sales trends confirm this and the trend appears to be picking up steam.

In addition to the previously described positive outlook for LoJack's primary end market, the company recently hired and brought in a new CEO and CFO with vast auto industry experience at industry heavyweight Ford as well as proven turnaround experience (under Allan Mullaly) to streamline the company's operations, rightsize its cost structure to a post recession operating environment, expand its sales and marketing channels/distribution/reach, and revive and return LoJack to consistent profitability following a dramatic fall from grace post 2007. Furthermore, both the new CEO and CFO have been buying stock recently and have significantly increased their stakes on a % basis. The new LoJack management team wasted no time and immediately re-implemented its stock repurchase program in Q411 which should serve as an additional catalyst for the foreseeable future given LOJN's excess cash, zero leverage, and positive FCF. The new management team has completely overhauled the company's strategy and, due to their valuable relationships gained over the years at Ford and elsewhere, aims to broaden and extend the sales mix more towards American manufacturers (e.g. LOJN historically has had very little exposure to GM and none to Ford, etc.) as well as increasing LoJack's unit attachment rate and volumes through new and expanded relationships with the largest US dealers which sell a majority of all cars today (e.g. in conjunction with the trend of increasing scale and consolidation at the dealership level). If at all successful in their endeavors, LoJack should become a much more stable, diversified, and higher growth company in the future.

Some of LoJack's greatest and most valuable assets are its brand (which boasts over 90% brand recognition in the US) and its patented, proprietary technology with a heavily entrenched leading market share position due to its close relationship with and support from local police forces. Nonetheless, the company's current public market valuation ascribes zero (and arguably negative) value to its brand and/or superior technology considering LOJN's market capitilazation is a measly $59mn and its Enterprise Value is just $24mn ($35mn in net cash). This compares to LoJack's peak sales, EBITDA, EPS, and FCF flow of $223mn, $45mn, $1.13, and $30mn respectively in 2007 at the top of the last cyclical upturn in auto sales and last year's trough sales and EBITDA of $141mn and $9mn. I see no reason as to why LOJN cannot get back to 2007 profitability levels long-term and they could possibly surpass them if the new management team is successful in executing their new strategy. For reference, LoJack was a $300mn+ market cap company and its stock price peaked near $35 back in 2007. Moreover, LoJack has a strong growth backdrop domestically while its international business (though admittedly extremely weak in Europe today) has room for significant expansion to new geographies and should finally bottom and return to growth in 2013. Finally, LoJack's technology extends beyond autos to motorcycles, heavy construction equipment, important documents transportation, cargo, stolen laptops, and the missing persons markets (e.g. Alzheimer's patients) - all of which are nascent markets and a very small piece of the business today but with lots of potential runway for growth.

Thus, with the stock currently trading at just $3.30 (or ~0.3 EV/Sales and 2x EBITDA based on 2011 trough results), LoJack represents a high-quality, market share leading technology company that is being valued as if it is going to go out of business despite its dramatically improving fundamentals, its valuable brand name and technology, and a new management team with significant turnaround experience at the helm that is properly and closely aligned with shareholders (via compensation in stock that is tied to future performance and hitting growth targets/goals + significant recent insider buying). This begs the question, where is the massive disconnect coming from? To begin with, LOJN's tiny market capitalization and illiquidity inherently limit institutional buyers' access and ability to hold the stock, not to mention the fact that it being totally uncovered on Wall Street has helped keep this story a well-hidden secret. However, most importantly and the much more likely cause, the market is assigning a large discount due to the fact that LoJack is currently being sued in a Massachusetts arbitration court by its largest international licensee in Brazil (accounts for ~10% of total sales) for upwards of $50mn. Thus, in a potential settlement and though perhaps unlikely, LOJN's current net cash of $35mn could conceivably be wiped out. However, LoJack is defending these claims vigorously and believes it has a good case as I have spoken with the CFO numerous times and he expects this lawsuit to be resolved within the next 6 months or so. While I have no reasonably certain estimate for what this settlement may ultimately prove to be, even assuming its full cash balance goes away, the stock is still cheap at 0.5 EV/Sales and 7x trough EBITDA on an adjusted basis for a 25 year old company with a leading market share position and valuable brand that is certainly not going away and should see a dramatic rebound in growth and profitability over the next few years. I believe the stock conservatively holds 100% upside (and perhaps much more) assuming its prospects strengthen alongside the overall growth in the US auto market's SAAR and as its sales/profitability begin to ramp and approach 2007 levels gradually over time. Finally, and virtually irrespective of the ultimate settlement's price tag, once the lawsuit is finally resolved and closed (ongoing since March 2011), I would expect the stock to rally substantially because a gargantuan overhang and uncertainty will have been removed meaning investors can begin to value the stock on normalized profitability going forward.

Catalyst