Date: 9/04/2007

Price: $20

Average trading volume: $1.5mm

 

[Noble very recently closed the acquisition of Arcelor Mittal’s North American and European laser welding operations. All numbers discussed below include stock and cash issued in the transaction.]

 

Shares Outstanding: 24.9mm (fully diluted)

Market cap: $500mm

Total Debt: $250mm

 

Summary: Noble has no direct public comps, operates a seemingly-complex business, and services an industry (auto manufacturing) that is under some distress. We understand why many investors would ignore it. We see an underfollowed company that is clearly the worldwide technology leader in its space, has dominant market share (nearly 50% in North America and >30% in Europe), is expanding and diversifying its business into new product lines and new geographies (both organically and through acquisition), and will grow EBITDA and free cash flow by 20%+ annually for at least the next several years.

 

We envision the company producing between $2.50 and $3 in free cash flow per share in 2008, with a moderately levered balance sheet (<2x 2008 EBITDA). Because of the projected growth, we think the stock is worth anywhere between 15x and 20x 2008 “all-in” free cash flow ($40 - $60 per share, or 100% - 200% upside). As of August 31, 2007, the date of the closing of the transaction mentioned above, Arcelor Mittal owns 40% of the company (9.375mm shares).

 

This is our first VIC writeup, and one of our best ideas. Our “edge” here is significant—we’ve spent many hours talking with industry consultants, customers, competitors, etc.—and we have high confidence that our numbers are achievable and maybe even conservative.

 

 

Noble was founded by current Chairman and 9% shareholder, Bob Skandalaris, in 1993. The stock is closely held by a few large shareholders: 17 million of 23.5 million shares after the Arcelor deal will be held by 5% shareholders and insiders. The stock trades >$1mm per day.

 

The company is the market leader in laser welding (and production of laser welded blanks) for auto manufacturers with 35% share in North America before the Arcelor transaction, 45 – 50% after.

 

The production of a laser welded blanks involves:

 

1)       blanking: cutting two or more pieces of steel into the size and shape that, when welded together, will form a component of the vehicle (often major structural components like a body side panel, doors, liftgates, etc.). Each piece of steel is of different thicknesses, strength, or alloy. Auto manufacturers need this ability to provide the right steel for the right part of the car—to provide increased strength where needed and lower weight and lower cost where acceptable.

2)       laser welding: the components are clamped and welded together with a laser; the welds can be straight lines or more complex curved welds.

 

Noble buys steel on behalf of the auto manufacturer, produces the laser welded blanks (thin, flat sheets of steel), and ships them to the auto manufacturer. The manufacturer stamps the blank into its final shape and attaches it to the vehicle structure. By using laser welded blanks (instead of spot welds), manufacturers get better control over the type of steel used within the car, which improves safety, lowers costs, lowers weight, and increases fuel efficiency of the vehicle. Noble is well positioned to take advantage of any worldwide legislation for increased fuel economy standards.

 

The company is unlike other auto part suppliers in that growth is not constrained by the number of vehicles produced. There are dozens of incremental applications of the company’s technology that can be designed into future vehicles (more parts per vehicle).

 

Here is a link to a presentation given in March 2007 by someone at the “Tailored Steel Product Alliance” regarding a cost analysis of laser welding using two auto part examples: a rail and a body side inner. The rail weight is 23.4kg for a laser welded part vs 32.2kg for a conventional spot-welded design. The laser welded design uses more high strength steel but still costs 20% less in both small and large manufacturing quantities. The body side inner is 43.8kg using laser welding and 60.1kg under conventional methods. Again, the cost per unit is 20% lower with laser welding.

 

 

Prior to the Arcelor Transaction, GM, Ford, and Chrysler represented >80% of Noble’s revenue.

 

Noble’s largest competitor in laser welding is TWB Company (26% share in North America), a small JV between Worthington Industries and ThyssenKrupp Steel. Noble is the only “pure-play” focused on this market, and since its inception has been the company most devoted to evangelizing the use of more and more laser welded parts per vehicle by the auto manufacturer. In 2006, vehicles had an average of five or six laser welded parts per vehicle; Noble’s goal is to sell the automobile designers and engineers on incremental parts. The company has identified >25 parts per vehicle for which they think laser welding should be used. Here is a Noble presentation to the steel industry regarding cost reduction ideas using laser welded blanks: http://www.autosteel.org/AM/Template.cfm?Section=PDFs&CONTENTFILEID=9267&TEMPLATE=/CM/ContentDisplay.cfm

 

So, yes, while some laser welding (straight welds) is a commodity service and is even done in-house by some of the auto manufacturers, Noble is innovating with technologies like complex curvilinear welds and exposed welds. See http://ils.pennnet.com/display_article/250111/39/ARTCL/none/none/Designing-in-value/ for discussion of some complex laser welds.

 

We’ve spoken with experts representing all three major North American customers. Because Noble works with the engineers of each car model separately, it is extraordinarily difficult to find a single point of reference at these companies who can tell you what growth in spending with Noble (or growth in parts per vehicle) will be. We had one contact at a 30% customer (pre-Arcelor transaction) tell us that spending with Noble will double or triple over the next 2 – 3 years. Not everyone was so bullish, but all contacts were positive about the quality of Noble’s products and technology.

 

If you had been looking at Noble a year ago, the long thesis would have revolved around the ability of Noble to sell more laser welded parts per vehicle. The company has good visibility as to what welding applications will be designed into vehicles to be released in 2 – 3 years. The thesis would have been that the company could grow through any volatility in North American auto production despite laser welding being a high fixed cost business. Since a year ago, the company has transformed itself. Now the growth thesis (and value underpinning/diversification) is even more compelling.

 

 

Noble brought on a new CEO, Tom Saeli, in March 2006. He had been on the board of directors since 2002 and was Vice President of Corporate Development at Lear from 1999 – 2006.

 

In October 2006, the company announced the acquisition of Pullman Industries for $122mm ($91mm cash plus assumption of debt), which was 4x Pullman’s projected 2007 EBITDA. Pullman has a technology for roll-forming flat steel into tubular structures used in the vehicle trim, base structure, and impact systems. Pullman alone is a growing business; like Noble, Pullman was selling auto manufacturers (model by model) on the benefits of its roll forming technology and trying to increase the number of parts per vehicle which used the process. Synergies from the transaction include applying Noble’s laser welding technology to the roll-formed steel parts. Noble identified an additional 17 applications for laser welded tubular structures. Synergies take time to develop (cars designed today won’t be produced for three years), but this will aid in long-term growth of the company.

 

Later in Ocotber, the company announced a letter of intent to combine Arcelor Mittal’s laser welding operations (referred to hereafter as TBA) into Noble. Arcelor got about $130mm cash and 9.375mm shares of stock (40% of the combined company). TBA’s 2006 EBITDA was more than $65mm (total purchase price around 4.5x EBTIDA). TBA had certain North American laser welding assets, including owning a company called Powerlasers through Mittal’s acquisition of Dofasco, which has 9%+ of the NA market; Noble is hoping to close on the purchase of Powerlasers in a separate transaction with Arcelor for which pricing is already determined. More importantly, TBA has 30%+ share in the European laser welding market. Post closing the transaction, the big three will be reduced to 56% of Noble’s revenue. VW, Peugeot, and Renault will represent 36% of the company’s business. Laser welding is used for different applications in Europe (rails and B-pillars) vs. the US (body sides, inner door panels). One major synergy from the acquisition will come from cross-selling applications from one continent to the other.

 

There are few operating expense synergies from the deal (there may be some if they close on the Powerlasers portion), and in our minds, the real value will come from applying Noble’s more focused sales efforts to build the business in Europe. Because laser welding actually reduces steel usage, all of the steel companies that participate in the market have a disincentive to push increased laser applications, and steel companies represent the large majority of the European laser welding market currently.

 

In December Noble signed a 50/50 joint venture with Wuhan Iron and Steel Company, the third largest steel producer in China. The JV is supposed to start producing laser welded blanks later this year. It’s difficult to get excited about a total initial investment of “up to” $1.25mm from each partner; but we believe there are fewer union/legacy manufacturing issues restricting the adoption of laser welding in China and (because laser welding is a better technology!) vehicles can be produced with significantly more laser welded parts per vehicle than in North America/Europe.

 

The TBA transaction includes Arcelor’s 25% interest in its laser welding JV with Shanghai Baosteel and its 50% interest in a similar JV in India with Neel Metal Products. Arcelor’s investments to date in these ventures total just over $5mm.

 

$10mm+ of EBITDA from Asia in 2009 for the combined company doesn’t seem like a stretch.

 

No, it’s not possible to quantify most of this (though we welcome people to help us try).

 

 

The business is lumpy. Changes in North American auto production have had a profound impact on the company’s business in the past (guidance this year was originally $1.50 of EPS; actual results should be around $1). Combined Noble/Pullman/TBA EBITDA should be greater than $120mm in 2007 (there have been some issues with launch costs of new programs this year, largely related to the integration of Pullman, which has restricted EBITDA and EPS growth). We expect 20% EBITDA growth in 2008 to $145+mm. Maintenance capex is very low (lasers can be repurposed when new auto models come online or are eliminated). We estimate the combined maintenance capex for the businesses is $10mm - $15mm per year. Actual capex will be closer to $25 - $30mm in 2008 and then increasing from there. Note that all capex above the maintenance level is directly tied to growth of EBITDA (new vehicle programs coming online). Noble builds its own laser welding equipment at prices <50% of what TBA is paying for it today.

 

In 2008, total free cash flow will be:

 

EBITDA: $145mm

Capex: $30mm

Interest: $20mm

Taxes: $27mm (because of historical depreciation, this number is probably too high; more like $20mm on $2 of EPS)

FCF: $68mm

FCF / Share: $2.73

FCF Yield to equity: 13.7%

 

Enterprise Value: $500 + $250 = $750mm

 

2008 EV / (EBITDA – Capex) = 6.5x

2008 EV / (EBITDA – Maintenance Capex) = 5.7x

2008 EV / EBITDA = 5.2x

 

We expect 2008 earnings to be as much as $1 per share less than free cash flow due to historical depreciation from TBA and charges related to acquisition accounting. Earnings will rise to the levels of free cash flow over the next several years.

 

In 2009, revenue synergies from the acquisitions will kick-in, as will meaningful EBITDA from India and China. EBITDA should be greater than $180mm. We don’t like projecting so far in advance, but we can see maintenance free cash flow per share of $4.40 in 2009 ($180 EBITDA; $30mm taxes; $20mm interest; $20mm maintenance capex). Actual free cash flow will depend on how much the company needs to spend to roll out incremental vehicle programs.

 

It is very difficult to analyze trends in revenue or gross margin percentage because steel costs are a pass-through to the auto manufacturer, but it is our understanding that “value-add” margins for Noble have been consistent.

 

 

Worldwide auto production: The Company’s most recent North American auto production estimate is 15.1mm units. The actual number could be a bit lower than this. Over the long-term, the company can align itself for any sustained reduction in production. In the short-term, this can have a meaningfully negative impact on earnings. Of course, with the closing of the TBA deal, the company is now exposed to the >70mm vehicles produced worldwide. Noble has yet to announce guidance for 2008 but will hold a conference call in October to discuss some projections.

 

Inability to address “launch issues” that have impacted operating margins: the magnitude of the impact on EPS of some of the Pullman-related problems was very large (10+ cents drag at least per quarter in Q4 and Q1). We believe these issues have been fixed in Q3.

 

Will the stock trade on an earnings multiple or free cash flow multiple? We think free cash flow is the more relevant metric, as the excess depreciation will relate largely to the legacy Arcelor spending.

 

Clearly one might ask why TBA was only worth 4.5x EBITDA, and our target price essentially represents an 8x+ multiple on 2008. Good question. First, Arcelor is taking stock (40% of the combined company, presumably the maximum amount Noble would allow), so it will participate in the upside. On its own, TBA is not a substantial grower; Noble is perhaps the only buyer who could push the business. And as I mentioned before, Noble’s capital costs are less than 50% of Arcelor’s because it has the expertise and scale to manufacture its own equipment.

 

DISCLOSURE:  We and our affiliates are long Noble International (NOBL), and may long additional shares or sell some or all of our shares, at any time. We have no obligation to inform anyone of any changes in our views of NOBL. This is not a recommendation to buy or sell shares.