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Parrot PARRO FP
December 19, 2008 - 10:32pm EST by
tony411
2008 2009
Price: 4.40 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 59 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Description

Parrot is a small French maker of Bluetooth car accessories which is trading next to its cash value. In fact, Parrot trades at 27% of the firms €221 in LTM sales, 4x the €1.16 in consensus ’08 earnings, and only slightly above its roughly €50 million Ben Graham net-net value (Cash + 75% of A/R + 50% inventory – all liabilities). With a €59 million market cap, €53.6 million in cash and no debt, the company’s operations can be bought for only €5.4 million.    What do you get for that price? The key asset is a dominant 83% market share in Europe for in-car hands-free Bluetooth devices (excluding Bluetooth headsets, which are a different segment). Parrot was founded in 1994 and has several advantages, discussed in the writeup below, that make it hard for competitors to enter this segment. The result is that the company has been growing fast (from €29 million in ’04 sales to €220 in ’07), maintains a roughly 50% gross margin, generated €1/share of FCF in the 1H of ’08 and posted a 21% ROE last year. Of course, that was all before the financial crisis: the outlook for 2009 sales is very hard to predict and will probably be down significantly.   Parrot has already announced cost-cutting measures.  Nevertheless, at €5.4 million EV and with a €53 million cash cushion, you have downside protection and are effectively buying a very cheap call option on the business. People continue to drive their cars, and the regulatory trend around the world is that drivers increasingly are required to use hand-free devices when calling, suggesting that there will be a long-term demand for the service Parrot is providing.
 
BUSINESS
 
Roughly 85% of Parrot’s sales come from Bluetooth systems that are installed in the car—either factory-installed systems or aftermarket installations—and additional services and accessories related to these installed kits. The aftermarket takes the lion’s share of the business and has the best margins: roughly 2/3rd of total sales and 55-60% gross margin. Parrot’s OEM segment is small but growing: 16% of Q3 sales at a 55-60% gross margin. Customers include Renault, Peugeot, Nissan, and Fiat, and Parrot signed a number of new OEM partners in 2008 that come online in 2009: Hyundai, Pioneer, Kenwood, JVC, and Alpine.
 

Three key factors protect Parrot’s core business from new entrants and help explain how margins can remain strong:

  1. The ability to support multiple phone models is essential. So, competitors like Nokia (which is #2 in the market with a 6-7% share) are at a disadvantage when it comes to integrating with other phone brands.
  2. Especially for Europe multi-language voice recognition is an important feature. Parrot’s technology supports voice command in 20 languages and has been in development since 1994—so it is difficult for low-cost Chinese entrants to copy. 
  3. It takes a long time to develop distribution relationships with after-market installers and even longer (18 months) to get OEM wins.
Parrot has also launched a line of lower-cost plug-and-play car systems, which emphasize design and simplicity of use. See, for example: http://www.parrot.com/usa/products/plugnplaycarkits/parrotminikitslim. This is an emerging category (from 4% of Parrot’s sales in ’07 to 9% of sales in Q3) and industry participants I spoke with said they expect good growth in this category. Parrot’s “plug-and-play” strategy makes sense to me as Parrot’s main competition is from other kinds of hands-free devices such as cheap Bluetooth headsets.   However, gross margins in this segment are in the 30-40% range and could more easily come under pressure due to the need for retailers to sell inventory as the financial crisis progresses and pricing pressure comes from Asian manufacturers. Finally, if you visit Parrot’s web site you’ll see lots of attention focused on new products like Bluetooth photo frames and portable speakers. However, these products generate next to no sales (less than 1% of revenues in the last nine months). I give zero value to these emerging lines of business and probably they are just a net drag on resources. 
 

MARKET VIEW

 
Like any company trading at such a low valuation, there are a number of concerns weighing on the stock:
  1. The biggest concern of course is that consumers will cut back on spending during the financial crisis. This is no doubt justified, and Parrot is implementing cost-cutting measures which I will discuss further below.
  2. The second concern is that falling car sales (reportedly down 30% YoY in Europe) will impact Bluetooth sales. However, this is not necessarily the case. Since so much of Parrot’s business is currently in aftermarket and self-installs, people keeping their cars longer may choose to opt for a Parrot solution. Note that across Europe and the US, the law is increasingly mandating hand-free solutions for drivers using cell phones. In fact, a greater concern for Parrot was high gas prices, as people were driving less. Now that gas prices are back down, driving has picked up again and people are more likely to invest a little in their car.
  3. Another concern is that drivers will opt for low-cost Bluetooth in-ear headsets instead of dedicated car solutions. Certainly this substitution effect is already very pronounced in Parrot’s business. Spain’s regulations, for instance, forbid the use of in-ear headsets in cars, and so Spain represents a third of Parrot’s global sales, compared to the single-digits for most other European countries. So, we can expect that to some extent this substitution effect is already occurring in Parrot’s sales, and may accelerate with the economic downturn.
  4. Finally, Analysts are concerned about the effect of dollar-euro exchange rate fluctuations.
RISKS
 
Given the current economic uncertainty, the key investment risk is how much Parrot’s sales will fall in 2009 and whether the company will be able to cut fixed costs fast enough. Indeed, the company expects losses in Q4. Given that, what will the cost structure look like in 2009? R&D expenses are roughly €20 million/year, and according to IR in the beginning of January Parrot will end the contracts of roughly 20 engineers who fall under subcontracting agreements—which should generate €2-4 million in savings. Marketing expenses are around €45million/year of which IR estimates 50% is fixed and the rest discretionary. Other overhead is about €18 million/year and can probably be cut slightly. That leaves roughly €55-€70 million in annual overhead. CapEx net of depreciation adds roughly about €2 million per year, based in 1H CapEx spend. At a 50% gross margin, the company would need roughly €115-145 million in sales to reach cash-flow break even: a 30-45% drop from current levels.   It is extremely hard to predict what 2009 will bring, but certainly the stock is pricing in an absolutely terrible scenario, and it seems likely Parrot can at least break even. 
 
Another essential question is what management does with their cash. Currently, the company has a small stock-buyback program, which is probably a net positive, so long and they keep enough cash on hand to get through the crisis. The company has not indicated interest in doing an acquisition, but there is always a risk they do a poorly thought-though deal. Another concern is that the CFO who took the company public left for personal reasons in April and was only replaced in September. Nevertheless, the auditors, KPMG, have not shown any concerns during their last audit. Confidence in the company is also helped by the fact that the CEO, who founded Parrot, still owns a third of the shares.
 
VALUATION
 
Looking forward 3-4 years, what should Parrot be worth?   The downside is that the stock trades roughly at cash (perhaps less some losses incurred as the company downsizes). Note also that as of their last balance sheet filing in June ’08, the company also had €20 million in inventory, €52 million in accounts receivable, and €44 million in total liabilities. On the upside, assuming zero value for the plug-and-play products and other emerging lines of business, Parrot’s core business of installed systems generated 210 million in revenues and 105 million in gross margin last year. If we assume Parrot can return to 80% of those levels and using the €70 million in annual overhead calculated above, then Parrot would earn €1/share. A modest 12x PE gives a €12/share valuation, nearly 3x the current price.

Catalyst

- OEM deals coming online in ’09.
- Cost-cutting in 1H ‘09.
- Some time in the future, the economy improves.
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