Description
Summary
Rockford is a leader in the mobile audio aftermarket and has the #1 market share in car amplifiers (approx 20% of market) and #2 market share in car speakers (approx 12%). I believe ROFO offers at least a double or triple over the next 18 months as it completes a restructuring that will return it to historic levels of profitability. The company has an EV of around $50M, pro-forma sales of $170M, and trades for around 3x normal pre-tax cash flow. As it pays down debt further over the course of 2005 and 2006 through a final asset sale, inventory rationalization, and cost cutting measures, the multiples become even more compelling.
No growth is needed to achieve these goals but you have the added benefit of a de novo OEM business which started in 2003 and already has 6 product wins with a strong pipeline of future business. This complements the core aftermarket business which has historically been a very strong contributor of cash flow and has had normal ROIC ranging from high teens to low twenties
Additionally, at the end of May, CEO Gary Suttle made his first insider purchase in years to bring his total stake in the company to 630k shares, or 6.6%. The purchase was small, but I believe it is a significant indicator of future results given Suttle’s history of purchases and sales, which have without exception been well timed.
Background
Car audio legend and self-proclaimed ‘surround sound guru’ Jim Fosgate founded Rockford Corporation in 1980 with funding from PE firm Camelback Invesment Group, headed by John Bartol. Members of the Bartol family still own about 1/3 of ROFO and maintain two board seats. From 1980, Rockford goes on to be known as innovators and leaders in the high end car audio market through its flagship Rockford-Fosgate line of amps, speakers, and subwoofers. Within its core market of 18-24yo males, Rockford has extremely high brand awareness and identification. ROFO would later acquire the lower-end brand Lightning audio in 1999, but remained strictly an aftermarket audio provider through its IPO in 2000 (at $11/share), manufacturing and distributing product through audio specialists (mom & pops), A/V dealers, and consumer electronics chains (Best Buy). Lightning is sold primarily through mass merchants (Walmart ) as well as auto parts dealers (PepBoy). As a stand alone aftermarket audio company, ROFO looked like this:
Sales EBITDA Margin
1997 87.4 8.0%
1998 87.6 9.0%
1999 123.9 12.0%
2000 144.6 11.7%
2001 151.8 9.9%
2002 155.8 10.0%
AVG. 10.1%
*ROFO non-core ops in 2001 and 2002 are not included here.
Growth slowed from 2000-2002 and the company made a series of acquisitions in an attempt to grow its market, including a European manufacturer of mobile and home audio, MB Quart (2001), A WiFi connection brand, Omnifi (2002), a software developer, Simple Devices (2002), and a home theatre group, NHT (2002). As a group, the acquisitions never represented even 10% of revenues, but diverted resources and attention, and almost without exception were all money losing ventures. Results since the acqusitions clouded the underlying core mobile audio business and the company most recnetly looked like this (not including 2004 write-downs)
Sales EBITDA Margin
2003 166.8 1.0%
2004 169.8 (8.0)%
2005e 170.0 1.0%
CEO Gary Suttle, who joined the company in 1992, has remained with the company, but the board replaced CFO Jim Thomson with Rich Vasek, who had succesfully led the turnaround of Royal Appliance. This is arguably the first time in the company’s history that it has a professional level CFO and restructuring efforts to date have been largely a success.
Restructuring
Phase I: Asset sales. Rockford pretty much called a ‘do-over’ and announced in 2004 that it would be shedding all non-core assets to refocus its attention on its core mobile audio business and its new OEM franchise. MBQuart was quickly put into receivership in Europe and all North American distribution rights have been forfeited, but no liabilities remain. Simple Devices was sold for nearly $8M, with the proceeds being used to reduce debt. Rockford also stopped producing source units and is now only producing speakers and amps (with a very small accessories franchise). The one asset that remains is NHT, the home audio group, which does around $5M of sales and is marginally profitable. Management had stated they expect as much as $5M for the company, but it is clearly going to be under that number given the extended time period they have been shopping the brand. It is pretty much benign at this point, and will supply a positive cash infusion when/if completed. As the company has refocused on its core market, headcount was slashed by nearly 25%. Debt has been reduced by $10M, adjusting for seasonality, to around $20M and the company is now operating at a breakeven cash flow level (company should be profitable in Q2 and Q3 to compensate for small seasonal losses in Q1 and Q4).
Phase II: Aftermarket re-org. Remaining restructuring efforts will now focus on ‘right-sizing’ and re-engineering the core mobile aftermarket group to return to historic double digit EBITDA margins that the company enjoyed from 1997-2002. I’ll divide these efforts into gross margin impact and operating expense cuts. Taken together, they add 1000bps of performance that take the company from its steady state breakeven level to 10% EBITDA margins on its run-rate of $170M sales, adjusting for seasonality. Most benefits are likely ’06 events, and full realization could be pushed longer.
Gross margins: Company has a goal of 35% gross margins vs. normalized 2004 level of 30%. $5M of savings (300bps) will come from increased outsourcing of key products to China. ROFO will increase outsourcing from 25% of its products to b/w 50-60% with an intention to review further opportunities thereafter. ROFO has an experienced team of sourcing partners with relationships dating back to 1999. Further, excess costs from the Rockford-Fosgate 2004 redesign are complete and will be realized in 2005.
Operating expenses: ROFO cost structure is still organized to support multiple brands (had as many as 9 brands and 4 varying business) and a core aftermarket that historically served hundreds of smaller specialty dealers. In simplifying the business, sales, marketing, and R&D will all be able to be reduced and focused. Further and significant savings will come from reduced expenses due to customer concentration (less sales rep, marketing and support costs). Op expense target is 25% from current run-rate of 28.5%. Savings targetted of $5-$6M.
Inventory Management/Debt paydown: The Congress credit facility should be reduced to around $10M by year end after the sale of NHT and as the facility is brought down due to seasonality. The company believes the facility can be paid down entirely by the end of 2006 primarily as a result of improved inventory management. Inventory turns were as low as 2.5x times through much of 2004. This has improved to around 4x and mgmt has a goal of 6x by 2006 through improved inventory management systems and reduced capital requirements of outsourcing. A successful effort would release an additional $10M from working capital.
Aftermarket
Audio aftermarket is a $1.7bn market of which ROFO has around a 10% market share, including 20% in amps and double digit share in speakers/subwoofers. Company has been a consistenet market share gainer over the last decade and in particular the last several years through an industry downturn. Most significant competitors are Pioneer, Alpine, and Kicker. Distribution channels have changed over time from primarily a specialty and A/V retailer channel to more of a national chain model. While specialists remain the largest channel, Best Buy is by far the largest customer at 28% of sales. Best Buy has equivelant margins as specialty channels, and often better than many dealers owing to the benefits of scale and reduced support. Naturally Best Buy store expansion will be an important driver for the company going forward. Mobile Audio has been an important segment for BB since its introduction and has been comping double digits over the last year according to an unscientific sampling of store managers. The satellite radio trend has had a relevant cross-over impact on mobile audio sales, and all indications is that BB will be expanding this segment. They recently added Alpine products to all stores. Incidentally, BB and ROFO have both indicated that ROFO is atually selling better since Alpine has been added to the stores. Despite some positive momentum, I would expect the mobil aftermarket (as a whole, and for Rockford) to grow in the low-to-mid single digits.
OEM
Has grown from 0 to 10% of revenues in roughly 2 years. First product wins were for the Nissan Titan and Frontier trucks, beginning in 2004 with additional wins for the Nissan SE-R and Xterra beginning 2005. ROFO will also be supplying the Mitsubishi Eclipse and Spyder beginning with the 2006 model year (contribution beginning H2 2005). This business complements ROFO aftermarket business by building brand and allows an additional platform for growth. Contract wins are generally long-term and frequently roll-over. Switching costs are high and only completely new or redesigned models go out for bid. The market is twice as big as the aftermarket ($3.6bn in sales) and has been growing at 6.5% per year for the past 7 years as OEMs have increasingly turned to branded autosound systems for market differentiation (10% growth in 2003 and 2004). The two main competitors in OEM audio are Boston Acoustics (BOSA) and Harman Kardon (HAR). HAR is much larger and also does video/navigation systems. BOSA is more similar, but does not have the brand recognition, at least in the mobile market, as ROFO. Lead time on new product wins is long (typically 2 years), but ROFO has a strong pipeline of potential models from new and existing customers. Company has hinted that they are in discussions with Toyota, which makes sense, as ROFO has made inroads with other smaller Japanese manufacturers – this is the typical model for Toyota suppliers. ROFO is also in discussion with several non-Japanese automakers.
To date, OEM has not cannibalized aftermarket sales as typical ROFO aftermarket customers have used and lower priced cars which do not have standard high performance OEM systems. This is unlikely to change despite OEM increased use of branded systems. Many of the ROFO installs incorporate personalized, extremely high performance systems that are just not practical on a wide release car. OEMs, for the most part, design audio systems for reliability as opposed to performance. Most have strict reliability tests that systems must endure, including extreme heat and cold scenarios which make it virtually impossible to design for performance. OEMs have to cater to the mass market, while the demand for aftermarket largely relies on specialization.
Valuation
Enterprise Value:
9.2M fully diluted shares x $2.72 =$25M
Convertible bond =$12M
Congress facility, seasonally adj. =$15M
NHT =($3)M
EV =$50M
NOL=$14M
Normal EBITDA (10% at 170M) =$17M
Maint Capex (>run-rate) =$2.0M
EBITDA-capex =$15M
<3.5x EV/EBITDA-capex at 10% margins on run-rate sales. At 7.5% margins (8% was lowest margin in the 6-year period pre-acquisitons), EBITDA-capex = 11M, or 4.5x. Greatest value will come with the paydown of the congress facility – should be south of $15M by the end of this year, and much lower through 2006. ROFO has a $14M NOL – so they won’t pay taxes for foreseeable future, however I have given no value to the NOL in this analysis.
What I think its worth?
With the sale of NHT business, WC improvements, and ability to use all fcf towards debt reduction (no taxes), I think its realistic that CF can be drawn to 0 by 2006. I’ll assume it remains at $10M. Assuming all warrants, options, and debt convert, as I expect share price will exceed $4, there are 13.5M shares outstanding + $5M of cash from the warrant exercise.
Fully diluted shares 9.2M
Warrants at $3.73 1.2M
Convertible at $4.61 2.7M
Total shares 13.5M
At 7.5% margins At 10% margins
$170M sales $12.8M EBITA $17M EBITDA
Maintenance cap $2.0M $2.0M
EBITDA-Capex $11M $15M
7x $77M $105M
+ $10M debt
-$5M cash from warrant exercise
Equity value $72M $100M
Shares 13.5M 13.5M
Share price $5.30 $7.40
Catalyst
The stock will realize value as the company continues to have success in its restructuring program. There is no reason historic margins won’t be achievable in the future. On the downside, you have a premier branded product company, with a top 2 position in each of its markets trading for book value. If the company is successful, a number of strategic or financial buyers could have interest. BOSA was bought out yesterday by a strategic purchaser for 1.5x sales and a double digit multiple of EBITDA, at arguably high margins. The reduction of debt, hopefully entirely, by the end of next year will have significant value for the equity. Finally, new OEM product wins from either new or existing customers are a bonus, but not needed for significant value creation.