|Shares Out. (in M):||133||P/E||7.5x||6.0x|
|Market Cap (in $M):||625||P/FCF||2.9x||4.0x|
|Net Debt (in $M):||422||EBIT||155||161|
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Summary: Catalysts for share price appreciation:
(1). Major deleveraging will shift analyst / investor attention away from the possibility of breaching debt covenants (no longer an issue) towards the company's considerable FCF and earnings generation potential
(2). Interest expense is high and a refinancing of the existing debt would unlock considerable value for shareholders, with management having stated that it is actively evaluating this course of action
(3). Attractive take over candidate - Northgate has been the subject of bids from strategics and sponsors in the recent past and LBO analysis suggests major scope for value creation for a sponsor, even after paying a large price premium
Details: Catalysts for share price appreciation:
Improving leverage profile - Northgate went into the financial crisis highly geared, with 2.8x net debt / LTM EBITDA. When profits in 2009 declined, a great deal of investors’ and analysts’ attention between 2009 and 2012 focused on whether Northgate would be able to stay within its debt covenants.
Having successfully navigated this risk (Northgate now has comfortable headroom within its covenants), the company has begun to demonstrate strong FCF generation (consistently converting 150%+ of net income into equity FCF over 2008-12A). This has prompted analysts and investors’ focus to shift away from balance sheet risk to upside earnings potential, which will have positive implications for share price momentum.
Net debt / LTM EBITDA has steadily from ~2.7x between 2006A and 2009A to 1.4x in 2012A. Even with conservative future forecasts for revenue growth, operating margins and capex intensity, Northgate's high FCF generation means that can de-lever to 1.1x in 2013E, 0.9x in 2014E and 0.5x in 2015E.
Northgate now has a much stronger balance sheet and – as it continues to generate substantial FCF – can begin to shift focus from paying down debt towards returning funds to shareholders (eg. the company re-initiated its dividend in late CY 2012) and/orinvesting capex in fleet growth.
Reducing financing costs - interest expense, at £46m in 2012A, absorbs a meaningful 40% of EBITA. Refinancing the current debt structure could be costly in the short term (c. £15m to £20m) but would payback in less than two years by reducing annual cash interest payments by c. £12m (improving PBT considerably, by 15 to 20% per year).
Management stated in 2012 that it is actively exploring the opportunity to simplify Northgate’s debt structure and reduce its blended interest rate (relatively high, at 7%). Any announcement of a refinancing (perhaps at FYE this April) would likely be a major boost to profits in the mid-term and a clear catalyst for share price appreciation.
Attractive takeover candidate - In October 2012, Northgate was reportedly the target of a 400p offer from Avis (a 28% premium to the then current share price) but the offer was purportedly rejected by Northgate management as being too low. Northgate has also previously been a target for numerous financial sponsors, including Terra Firma, who had a 1,200p bid rejected in 2006.
It’s not far-fetched to envision an offer midway between the current share price of 305p and the top end of intrinsic value of 500p to 600p, which would (a) be actively considered by Northgate management, (b) create considerable value for an acquirer (even without factoring in synergies in the case of a strategic buyer), and (c) deliver considerable upside from the current price for investors.
The private valuation analysis in the previous section shows that a financial sponsor could bid 520p (~70% premium to today’s price) and still expect an IRR between 28% and 33% (assuming the same conservative operating and financial estimates as noted in the previous section and the sponsor exiting at 3.0 to 4.0x LTM EBITDA, in line with historic mid-cycle multiples).
The point of this analysis is not to suggest that a bid is likely at a specific price but to reiterate that Northgate has (a) been the target of interest for a number of potential acquirers historically and (b) its current valuation means an acquirer could justify a substantial premium to the current share price and still create significant value. The potential for a bid for the company in the next 12 to 18 months should not be discounted.
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