Value Investors Club / SPX CORP (SPX C)

Description

SPXC is a diversified industrial company with leading positions in commercial and industrial cooling, residential heating, fare collection and radiodetection. After splitting from SPX FLOW (“FLOW”) in September 2015, the new management team transformed the company with a focus on profitability, free cash flow and shareholder value. What was regarded as a growth-challenged, low-margin company with unrelated businesses and led by an unproven management team, is now a growing enterprise with 30%+ gross margins that has consistently beaten expectations.

Despite successful operational execution and the announcement of an accretive acquisition, we believe the new SPXC remains an under-the-radar company with a materially undervalued stock. Armed with a great balance sheet and ramping cash generation, management could execute more M&A and share repurchases worth almost half of the company’s current market cap over the next 3 years. We believe there is 40% upside in the stock near term, but also see SPXC as a potential double over the next 18-24 months. Ultimately, our view is that the company can be split up again, with its pieces worth significantly more to strategic buyers.

Given the announced acquisition yesterday, we believe this is a new stock, and have posted the idea despite a recent write-up in February.

Business Transformation

“Now let's get into the primary reason we're here: value creation.” – CEO Gene Lowe (9/2/15)

When CEO Gene Lowe and his team took over SPXC, the company was plagued by inconsistent execution and write-downs. While the foundation of the company was high quality replacement cycle businesses, with visibility and minimal capital requirements, a sputtering power project division overshadowed the strength of the core segments. The top priority for management was made abundantly clear from the beginning – create maximum shareholder value by withdrawing from long- duration power plant build-outs, allowing the company’s HVAC, Detection & Measurement and remaining Engineered Solutions businesses to drive the company.

“We've made a lot of progress since the spin, and we now have three healthy platforms with strong brands and leading positions in attractive growth markets.” – CEO Gene Lowe (2/15/18)

The company’s HVAC segment focuses on residential heat boilers and commercial cooling equipment. With 75% of revenue on a replacement cycle, the HVAC business has both high visibility and pent-up demand after two abnormally mild winters in a row. This weather pattern has created somewhat of a coiled-spring dynamic in the residential boiler market – pure upside for current investors. Additionally, management has revamped the boiler business to not only meet replacement demand, but to also participate in the new-build markets as well.

The Detection & Measurement division is a collection of leading niche businesses, including Radiodetection, GenFare and Communications Technologies. Radiodetection, representing 55% of this segment (pro forma for CUES, Inc. acquisition), develops equipment and technologies which locate subterranean cable, fiber and pipe networks that must be avoided by builders and engineers in large infrastructure projects worldwide. The recently announced accretive acquisition of CUES for a net purchase price of $158m (net of cash/equivs on the CUES balance sheet) adds market-leading robotic pipe inspection services to the Radiodetection portfolio. GenFare’s fare collection equipment for public transportation throughout North America represents approximately 20% of segment revenue. On top of replacement revenue from wear-and-tear and transportation system overhauls by municipalities, the development of mobile ticketing and cloud-based data hosting has added more growth to this niche, value-add business. The remaining 25% of revenue in Detection & Measurement comes from being the leading North American supplier of obstruction lighting products used at airports, plus satellite and drone monitoring technologies used by governments.

Finally, the Engineered Solutions segment has been whittled down and transformed under new management into a domestic transformers and after-market cooling equipment business, serving other industrial and power generation companies. SPXC has a strong brand name as a leading supplier of power transformers to North American electric utilities and independent power producers. An installed base with an average age of 40 years and increasingly tougher regulatory standards have created a pipeline of replacement business for the company. The remaining core of this division will soon be growing organically and boast double-digit EBIT margins – a far cry from the negative top line and 4% EBIT margin reported in 2015.

Balance Sheet and Capital Allocation

“Our balance sheet is the strongest since the spin...we now expect to have more than $600 million of capital available between now and the end of 2020…” – CEO Gene Lowe (2/15/18)

With visibility in its businesses, ramping free cash flow and pro forma adjusted leverage (including leverage from the recently announced CUES acquisition, postretirement liabilities and cash obligations to complete a legacy power project in South Africa) of only 2.3x pro forma 2018 EBITDA, SPXC has the opportunity to buy back its stock at relatively low multiples. We believe that with such high quality and predictable cash flows, this company could operate with leverage of 2.5x-3.5x EBITDA. Combining over $400MM of free cash flow from 2018 to 2020 with 3.0x leverage (net of current pro forma leverage) yields $675MM in cash available for deployment over 3 years – a staggering 50% of today’s market cap. With CEO Gene Lowe focused on allocating the cash to create value, we expect SPXC stock to benefit from a higher multiple driven by a better growth profile, higher margins, fewer shares outstanding and higher earnings per share.

Valuation

“We’re always going to be looking at the best way to deploy capital to drive value for shareholders.” – CEO Gene Lowe (2/15/18)

Due to poor management prior to the 2015 spinoff, insufficient sell-side research coverage following the spinoff and seemingly shrinking revenues and low margins, we see SPXC as misunderstood, under- followed and under-valued. The market sees noisy GAAP results and a value-destructive history. The market also sees minimal information on the CUES transaction, mainly due to a 45-day “go-shop” provision which does not incentivize SPXC to be outwardly bullish on the prospects of the company post deal closing. Through our lens, we see an entirely different mosaic. CEO Gene Lowe and his team have been meeting, beating and raising earnings expectations since taking the reins, all while paring down the company to its growing and most valuable parts. Meanwhile, the balance sheet has plenty of capacity for additional leverage and free cash flow is ramping. We believe memories of the previous management team will fade as the new SPXC reports quarters of growth, higher margins and allocation of capital, leading to a larger following of the stock. Furthermore, we expect updated forward guidance and accretion from the CUES deal to excite shareholders about future capital allocation.

The stock is trading at just 14.5x pro forma 2018 EPS versus industrial peers trading at 22x on average (peer set includes both HVAC competitors and detection/monitoring businesses as well). In the near term, we expect continued strong execution to drive a re-rating of the shares to 20x pro forma 2018 earnings, or a $45 stock. This opportunity gets even more interesting assuming the company deploys $300m toward incremental M&A and $200MM toward share repurchases through 2020. We believe that would drive EPS toward $3.50 in 2020, leading to a $70 stock price. Ultimately, we believe management could spin the HVAC business into a standalone entity, which would allow the two pieces to trade in-line with peers and become potential takeover targets, introducing even more upside to the shares. As CEO Gene Lowe remarked in his first investor day with SPXC shareholders in September 2015, his “primary reason” for running the company is to create value, and we expect him to pull the levers at his disposal to do exactly that.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- updated guidance following the closing of the CUES, Inc. acquisition

- quarterly earnings in which SPXC meet/beats expectations

- realization by the market that SPXC could earn well above $3.00/share in 2020

- future capital allocation toward more M&A and initiating a share buyback program

- eventual break-up of the company

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			2018	2019
Price:	32.00	EPS	0	0
Shares Out. (in M):	45	P/E	0	0
Market Cap (in $M):	1,440	P/FCF	0	0
Net Debt (in $M):	465	EBIT	0	0
TEV (in $M):	1,905	TEV/EBIT	0	0