Description
INTRODUCTION
Lowrance Electronics is a manufacturer and marketer of products used in sportfishing and boating. LEIX is the world leader in its field, with 50% market share in worldwide annual unit sales of sportfishing SONAR (also known as fish finders). LEIX is trading at only 4.3x trailing EBITDA and 6.5x trailing EPS of $.89. LEIX is 50.6% owned by its 64 year old founder and CEO, Darrell Lowrance, who has entered two different definitive merger agreements to sell the company in the past four years. Both deals fell apart. While LEIX is a microcap, it is not a roach motel. Over the past three months, average daily trading volume has been nearly 9,000 shares, and it is not uncommon to see five-digit volume trading days.
BUSINESS & PRODUCTS
The Company designs, manufactures and markets sportfishing SONAR and marine global positioning systems (GPS), as well as related accessories. Fishfinders are used by sport fishermen to detect underwater surface structures, schools of fish and individual fish as well as to determine bottom depth/composition and display water surface temperatures. Boaters also use the Company’s products as critical navigational and safety devices in navigating waterways. Most of the company’s fish finders use LCD screens in monochrome grey scale or 256 color and are marketed under the "Lowrance" and "Eagle" trade names.
The Company is also a leader in marine navigational products, including GPS, and also has a number of units that combine SONAR and GPS.
Products retail from $79 to the least expensive fishfinder to $2,499 for the top-of-the-line color 10.4" mega-screen, combo SONAR/GPS+WAAS unit.
Rather than go into excruciating detail on the products here, I will point the reader to the Company’s websites: www.lowrance.com, www.eaglesonar.com, and www.lei-extras.com. The Company even has SONAR and GPS tutorials on its website. Additionally, products from the Company as well as its competitors can be seen at www.westmarine.com. Information on sportfishing can be found at www.asafishing.org, the website for the American Sportfishing Association. The major industry trade show, and where Lowrance introduces its new products every year, is ICAST, held every July.
In fiscal 2002 (fiscal year ended 7/31/02), sales were derived as follows: SONAR and SONAR/GPS combos - 76.2%; GPS - 9.2%; Other (accessories) - 14.6%. International sales comprise 21% of total sales. Products marketed under the Lowrance trade name comprise 54% of sales with the Eagle trade name accounting for the balance. Lowrance brand products are sold primarily to boat manufacturers, wholesalers and retailers having the requisite level of skill to install and instruct fishermen and boat owners on their use. Eagle brand products are sold primarily through mass merchants, mail order and retail stores that do not provide technical assistance to consumers.
Up to 1994, all manufacturing was done in the Company’s factory in Tulsa, OK. In 1994 the Company began shifting production to Mexico. The transition to Mexico was completed in 2000. Now all the Company’s products are manufactured in its low-cost manufacturing facility in Ensenada, Mexico, south of San Diego.
BUSTED MERGERS
On March 11, 1999, LEIX executed a stock for stock merger agreement with Orbital Sciences Corp (ORB), which at the time of the announcement was worth $6.41 per LEIX share. On August 26, 1999, the merger agreement was amended to change the terms to $7.30 cash per LEIX share. This price represented an LTM EBITDA multiple of 9.0x. As anyone who has followed ORB knows, its business and stock price suffered a protracted decline during 1999. Because of the debt load they were already carrying and the additional debt the LEIX acquisition would entail, ORB’s bankers declined to fund the acquisition and the merger agreement was terminated as the walkaway date passed without ORB’s funding in place. ORB sold its Magellan business (the business with which LEIX would have been combined) to Thales Group in July 2001.
On January 5, 2001 LEIX entered into a merger agreement to be acquired by Cobra Electronics (COBR) in an $8.25 cash tender offer. This offer was conditioned on Cobra obtaining financing. The deal price represented an EBITDA multiple of 6.8x trailing EBITDA. On April 25, 2001, the parties announced they were lowering the deal price to $7.50 because LEIX’s fiscal Q2 2001 sales were below plan, even though they increased 11% over the prior year. On May 2, COBR announced they had terminated the offer and merger agreement due to LEIX missing April 2001 sales targets, although Cobra’s weak financial position made satisfying the financing condition difficult.
FINANCIAL & OPERATIONAL
LEIX has been investing heavily in R&D and has seen a strong uptick in sales over the past few quarters as sales of newly introduced products have taken off. The Company’s fiscal year ends on July 31. Sales for the most recent two quarters ended January 31, 2003 were up 16.3% over the prior year while gross margin improved by 440 basis points. In the first six months of the fiscal year EBITDA swung to positive $334 thousand from negative $1.2 million in the same period of the prior year. On March 13, the Company said in its Q2 earnings release, "The third quarter is off to an excellent start, as evidenced by Lowrance’s 245% increase in backlog as we enter the seasonally strongest selling period."
Lowrance introduced 25 new products in the current fiscal year compared to 11 last year. The success of these products has been behind the strong sales results to date. R&D is close to 4% of the Company’s $84 million in sales.
It is important to note that the business is highly seasonal, with sales peaking in the third fiscal quarter (ending April 30). The fiscal second quarter is the next busiest quarter. Inventory levels tend to peak at the end of fiscal Q2 in preparation for the sales peak in fiscal Q3. The company draws on its revolver to fund the inventory peaks. So the debt level of LEIX varies greatly throughout the year, and usually peaks at the end of fiscal Q2.
The Company’s outstanding recent financial performance can best be illustrated by looking at trailing-twelve-month (TTM) EPS over the past number of quarters. Using TTM EPS smoothes out the impact of seasonality for our trend analysis purpose (Fiscal quarter end: TTM EPS):
FQE TTM EPS
Q2 2003: $.89
Q1 2003: .73
Q4 2002: .61
Q3 2002: .28
Q2 2002: -.32
VALUATION
At a price of $5.75, LEIX trades at 4.3x trailing EBITDA and 6.5x trailing EPS. As highlighted above, debt level varies with seasonality. Debt peaks at the end of fiscal Q2, where it stood at $18.1 million on January 31, 2003 compared to debt of only $8 million at the end of Q4 02. This compares to an average total debt of $14.4 million over the past 4 quarters. Using the average debt in our TEV/EBITDA calculation instead of Q2’s peak debt would yield a multiple of only 3.9 times trailing EBITDA instead of 4.3 times.
In any event, the stock appears very cheap. Trailing EBITDA is $9.0 million, versus capital expenditures of $1.5 million. So TEV to free cash flow (EBITDA less CapEx) is just 5.3x. EBITDA per share is $2.40, so a one-point increase in the multiple translates into a substantial increase in the stock price. Below are the closest public comps to LEIX I have found: (Name, Bloomberg ticker, LTM EBITDA trading multiple; LTM EPS multiple):
Garmin – GRMN – 17.6xEBITDA; 25.6xEPS
Cobra – COBR – 6.2xEBITDA; 24xEPS
Furuno – 6814 JP – 21.5xEBITDA; 83xEPS
Teleflex – TFX – 6.4xEBITDA; 12.6xEPS
From the fairness opinion in the aborted merger with ORB, I found the following additional companies that were included as comparables for purpose of the opinion (with current trading multiples):
Brunswick – BC – 5.8xEBITDA; 15.7xEPS
Trimble – TRMB – 12.5xEBITDA; 22.8xEPS
Novatel – NGPS – 4.9xEBITDA; 22.3xEPS
Compared to Lowrance currently:
Lowrance – LEIX – 4.3x EBITDA; 6.5xEPS
And LEIX busted deal multiples:
Aborted ORB merger multiple: 9.0x EBITDA (equates to $16.88 per share today)
Aborted Cobra merger multiple: 6.8x EBITDA (equates to $11.62 per share today).
While some of the above comps trade at high multiples for obvious reasons (Funuro is Japanese, Garmin is a leader in GPS with consistent strong growth), the overall multiples serve to highlight how undervalued Lowrance is. And it is not because it is the smallest cap of the bunch. Novatel has that distinction. Cobra’s market cap is similar to that of LEIX, yet sells at higher multiples despite having horrible year over year numbers in the latest quarter (15.6% sales declines compared to 26% sales increases for LEIX).
CONCLUSION
If you’re one of those value investors who thinks a good value stock is one that is still attractively priced at twice the current price, consider that LEIX at twice the current price would be at 6.75x EBITDA and 12.9x EPS. Compare that to the comp multiples above and it is in the ballpark, especially considering the earnings trend highlighted above. With LBO firms flush with cash, I wouldn’t be surprised to see a financial buyer emerge for LEIX, especially in light if its strong free cash flow generation.
LEIX practically invented the fishfinder 45 years ago. With 50% market share, it has maintained the "moat" around its business. Ignoring the possibility of a sale, it is an attractive stock. But if you consider the CEO’s age and past attempts to sell the company, it is hard to see how the Company does not get sold eventually. As Lowrance’s CEO and 50.6% shareholder approaches retirement age, I expect to see one more attempt to sell the company, and who knows, third time may be a charm.
Catalyst
CEO/founder, who is 64 years old, owns 50.6% and clearly has selling the company on his mind evidenced by two sale attempts in past four years. Meanwhile, you own a cheap-cheap stock with strong operating performance.
Newly introduced products drive strong sales, EBITDA and earnings growth.