Rockford – ROFO $2.40 / $23M mkt cap

Summary:   Despite a transitioning industry, and a slow-to-react management team, Rockford retains a valuable franchise in high end car audio products led by the Rockford Fosgate line of speakers and amplifiers. We expect revenue to stabilize above $100M and believe that management is under increasing internal and external pressure to realize value for shareholders.  A developing operational turnaround (detailed below) should deliver improved profitability and provide leverage to more seriously explore strategic options as 2007 unfolds. Based on a discount to prior industry transactions and on dialogue with industry sources, franchise value is probably between 50% and 75% of revenue suggesting an enterprise value 25-100% above the current $40M level and a stock price gain of 50-150%.

 

Price: $2.40

Shares: 9.5M

Mkt Cap: $23M

Net Debt: $17M

Ent Value: $40M

Revenue: $100M+ (estimated run rate, TTM and mgmt 2007 goal both higher).

 

With a simplified product mix and reduced corporate overhead, Rockford should be both profitable and free cash flow positive in 2007.  However we think it is likely worth more to a strategic buyer than as a publicly traded micro-cap. 

 

As a stand alone company Rockford can probably slightly improve its current 35% gross margins but sg&a will eat up most of those gross profit dollars at the company’s current size. Breakeven of $90M implies about $31-32M of sg&a.  At $100M, ROFO might do well to do $2M of EBIT for a 2% margin, at $110M, maybe $4-$5M for a 3.5-4.5% EBIT margin. The current $40M enterprise value appears to give some reasonable probability to the latter/high revenue and margin levels.

 

As a part of a larger organization, Rockford could be worth substantially more than $40M.  A resourceful strategic parent, with superior product/manufacturing sourcing and a efficient/scaled corporate expense structure could probably boost gross margins by at least 2 pts (by cutting COGS by just 3%) and cut sg&a by at least $3-5M (10-15%). Thus at $100-$110M of revs a strategic buyer would enjoy EBIT contribution of $7-$11M, still a reasonable assumption at 7-10% ebit margins for a high quality brand name business.  Potential EBIT contribution in the $7-11M range would certainly support our “base case” strategic (enterprise) value of $50-$75M based on 50-75% of  base case 2007 revenue of $100M.  Prior industry transactions have occurred at MULTIPLES of revenue rather than FRACTIONS of revenue, however those were generally more profitable companies in a more stable industry environment.

 

The Rockford Fosgate brands consistently ranks with, JL Audio, MTX, Alpine, Harman, Kenwood, Pioneer and Stillwater Designs in both customer recognition and aftermarket sales.

 

We think both the operational turnaround and the strategic alternatives process will gain traction throughout 2007 with increasing focus on the latter as the first half draws to a close.

 

 

ROFO was previously posted on VIC, in mid-2005 at a slightly higher stock price. Mav44’s write-up provides additional background.  Since that time the story has become simpler, the revenue base smaller and more focused, the balance sheet stronger and the timing for value realization both shortened and clarified.

 

Fundamentally, management was slow to react to the marketplace fragmenting away from the traditional independent specialist and catalog channels to include big box consumer electronics retailers, OEMs and more recently mass merchants and on-line.

In addition, an inefficient product development and production pipeline and even some quality issues in 2005 impaired the company’s competitive position.  The company appears to have added key (and long-needed) hires in both sales & marketing and operations.

 

In the past 2 years, management has greatly simplified the product mix and development process and has begun outsourcing most production to low cost regions.  The company also substantially reduced corporate overhead, such that breakeven is approaching $90M in annualized revenue. We expect the company to meaningfully exceed this threshold in 2007 and to be both earnings and cash flow positive. 

 

At the recent Consumer Electronics Show, the company introduced its best new product line-up in recent history with more on the way and trade reception appears excellent. These new products should support revenue stability (and eventually, growth) and should generate incrementally higher gross margins. The company also designed new products (called 3Sixty, can handle iPod/MP3/Satellite) to aid the independent dealers in integrating replacement audio equipment into new, high end car models: an issue that has restrained growth in that channel.

 

Rockford is a leading designer, marketer and distributor of high-performance mobile (car) audio products (primarily speaker and amplifiers). Products are sold primarily in the aftermarket (80%) for consumer upgrades to existing/factory audio systems and increasingly through OEM relationships (20%) with select vehicle manufacturers (especially on high end vehicles).  Aftermarket includes both Independent Specialists (traditional customer stronghold) and Mass Retail (faster growing). OEM is the fastest growing channel for Rockford and includes Nissan and Mitsubishi, with additional negotiations underway.  Management appeared quite optimistic about the potential for new OEM relationships and expanded penetration of existing OEMs in 2007.

 

 

 

Catalyst: Operational turnaround gains traction followed by strategic review and realization of underlying franchise value.

 

Caveat:   We may have a position in the stock mentioned herein, we may increase or decrease that position at any time.  This note apparently does not constitute research in any way.