Nortek (NTKS) emerged from bankruptcy in December 2009 and currently trades at about 6x normalized free cash flow.  NTKS is putting the finishing touches on a comprehensive debt refinancing that both extends maturities and significantly lowers the cost of debt capital.  NTKS stock currently trades OTC and will likely move to the NYSE this year, which is a potential near-term catalyst for the stock.  We think that the stock could easily double in the next two to three years.

Business:

Nortek manufactures branded building products for the both the residential and commercial markets.  Sales are spilt 50/50 between new construction and repair and remodel.  The company has four segments:

·         Residential Ventilation Products (~ 1/3 of sales) – kitchen range hood and exhaust fans; #1 market share in North America (50% share) with brands such as NuTone and Broan.

·         Home Technology Products (~ 20% of sales) – audio, video, security & access control products; brands include Niles and HomeLogic

·         Residential HVAC (~25% of sales) – air conditioning and heating systems (license brand name from Frigidaire, Maytag and Westinghouse)

·         Commercial HVAC (~20% of sales) – custom designed air conditioning and heating systems

Balance Sheet:

·         Nortek ended 2010 with about $1.1 billion of debt (including about $100mm of bank debt, $750mm of 11% sr sec notes due 2013, and $250mm of 10% sr notes due 2018). 

·         Last week, Nortek priced $500mm new Senior Notes 8.5% (due 2021) and is currently in the market with a new Revolver and Term Loan.  Net proceeds from these transactions will be used to tender for the company’s 11% Senior Secured Notes (and to call the remaining notes for anyone that doesn’t tender).   This transaction both extends the maturity of the debt and lowers the cost of capital.

·         Proforma for the refinancing, the company will have gross debt of about $1.2 billion of debt and cash interest expense should be around $90mm.

·         EQUITY: Nortek has 15.0mm shares outstanding, 0.8mm warrants (expires 12/21/14 at $52.80), 0.7mm restricted shares, and 0.8mm options (at $18/share) - - so at $44 – the equity cap is around $700mm

Cash Flow:

·         In 2010, which is looking like a trough year for the company, net sales totaled $2.1 billion, EBITDA was $200mm, maintenance capex is ~$35, interest proforma is $90 and cash taxes are $20 - - - so the company in the trough year is doing about $55mm for free cash flow or around $3.50 per diluted share.

·         Proforma for acquisitions EBITDA peaked around 2005-2006 at about $330mm and we’re currently in the trough at about $200mm during the 2009, 2010, 2011 time frame. 

·         In a “normal” year for housing, it seems reasonable that Nortek’s sales could reach $2.4 billion.  Given the cost cuts over the past two years, EBITDA margins should increase from around 10% currently towards the peak margin of 14%.  Our normalized estimate is around 11.5%, which would be $275mm EBITDA.

·         Our normalized free cash flow estimate: $275 EBITDA - $35 capex - $90 interest - $40 taxes = $110 or ~$7 per share.

Thesis:

·         Calling the exact turning point in the housing market is nearly impossible, but we don't think you have to do that to make a lot of money in NTKS stock (or warrants if you’re really bullish).

·         With the recent debt refi, NTKS will make it to the housing upturn; Buffett said we're less than a year away - I guess we'll see. Clearly the situation is leveraged (both operational and financial), but the company has bought itself a lot of time at a cheap cost of capital and significantly extended the optionality of the equity.

·         The long-standing management team has done a good job of right sizing the business and will participate in upside with both restricted stock and options.

·         At $44, the company is trading at around 6x our normalized earnings estimate and could easily double in the next two to three years.

Disclaimer:  We own shares of NTKS.  We may buy or sell these shares at any time without notice.  The information in the write-up is believed to be correct as of the date written but VIC members should do their own verification of this information and analysis of this potential investment.  We undertake no obligation to update this write-up if new information arises at a future date.