| 2019 | 2020 | ||||||
| Price: | 15.31 | EPS | 0 | 0 | |||
| Shares Out. (in M): | 81 | P/E | 0 | 0 | |||
| Market Cap (in $M): | 1,077 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | 6,816 | EBIT | 0 | 0 | |||
| TEV (in $M): | 7,893 | TEV/EBIT | 0 | 0 | |||
| Borrow Cost: | General Collateral | ||||||
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Description
Tenneco is a short. In addition to fraudulent reporting practices and nonstop resegmentation/obfuscation of financials, the company has generated -$497mm of FCF YTD on a market cap of $1.1bn (cut their div and postponed a split of the company in 2Q). While this is clearly a problem, cyclical dynamics are going to pressure this even more - November SAAR in the US came in at 16.5, China auto sales have peaked and class 8 orders are tracking down 60-70%. What’s worse is the business is facing intense competition from cheaper substitute products (private label shocks/struts) and better capitalized competitors (faurecia in exhaust). Furthermore, they are going to have to pay the piper for horrible historical management - hexavalent chromium off-balance sheet liability (while lying to investors about the reason for plant closures), piston product warranty time bomb (pistons are not lasting as long as designed due to increasing turbocharger penetration/heat in engine; can’t just replace a piston- have to replace whole $20,000 engine), no capital to invest for future product innovation, no exposure to BEVs. TEN’s Z-Score = 1.47. 84% of companies with a Z-Score of
Exhaust
- No content in a BEV. Tenneco has zero clean air content in a full battery electric vehicle obviously. They have some noise, vibration harshness (NVH) business but it’s immaterial. As BEV’s take share over time, clean air revenue will decline and factory utilizations will be pressured, resulting in factory closures.
- Plant closure costs = massive off-balance sheet liability. The company recorded $19mm in cash charges for the closure of one factory in Australia. The company has 63 clean air production facilities. Were the clean air segment to be shuttered tomorrow the company could face a $1.2bn liability assuming similar charges.
- Hexavalent chromium = off-balance sheet liability #2. The company has a problem with hexavalent chromium (more on this below) and is currently in the process of shutting down plants and managing toxic tort from their employees. They are also going to have to find a new way to manufacture their products.
- This business doesn’t actually generate any free cash flow. Each exhaust system has to be designed for each and every platform. By the time you recover your tooling and RD&E there isn’t much left over for profits. Lousy metal bending business.
Shocks/Struts
- Facing intense competition from cheaper imports and private label products. At one point they had like 60% market share in North America. Now they are getting overrun by ‘shocks in a box,’ ie, cheap imports from South America, Asia, everywhere. Their customers are also insourcing their business (more on this below). In Europe, the big distributors have been buying up their mom/pop customers and cutting them out and squeezing them on price- this dynamic is also happening in North America. Auto-parts retailer store count has been flat for a decade - as the big three auto parts retailers continue to buy up the mom and pop retailers, Tenneco’s market share will continue to decline. The big three carry private label shocks and struts which are priced way below Tenneco’s products– the mom and pops do not carry private label shocks and struts.
- No content in a BEV. Conti and Wabco have air suspension offerings – Tenneco does not. They were spending on air suspension at one point but then dropped it – I do not know why. This video illustrates why air suspension is important for BEVs. https://www.youtube.com/watch?v=4hQiKBBZwRY
Fed Mogul
- Piston business is a massive off-balance sheet liability. Pistons are a core product for these guys. But there is a problem- engines have gotten hotter and hotter with increased use of turbochargers. To withstand the heat, nickel alloys and other materials are required, but these are expensive. This company has a massive off-balance sheet liability in all of the pistons they have sold. When a piston ring corrodes you have to replace the whole engine ($20,000).
- Losing money. Buying a business from Icahn is just not a good idea. Especially businesses that lose money. This one did NEGATIVE $214mm in cumulative FCF from 2016-2017. Excluding dividends from JVs (ya know, from emerging markets where earnings evaporate when the economy turns down) operational FCF was an even worse cumulative NEGATIVE $341mm from 2016-2017.
- Lastly, yep, you guessed it, no content in a BEV.
TIMELINE:
September 2017
Tenneco amends their 10K and discloses a material weakness in internal controls; restates 2016 EBIT lower by $12mm and cites a number of issues, including:
Accounting Issue #1: Realizing payments that should have been deferred / amortized. They blamed this one on the ineptitude of their China sub.
“Intentional mischaracterizations of accounting transactions related to payments received from suppliers. For the periods from April 1, 2013 through March 31, 2017, we identified approximately $34 million in lump sum payments from our suppliers that were incorrectly recorded upon receipt as a reduction to cost of sales. Of the lump sum payments that were accounted for incorrectly, $28 million were received from our suppliers prior to December 31, 2016. These payments should have been deferred and amortized over the life of the underlying supplier agreements. The deferred credit balance related to these payments was $23 million and $16 million at December 31, 2016 and 2015, respectively.”
Accounting Issue #2: Understating COGs. This was happening at the corporate level.
“$7 million in cost of sales should have been accrued in prior periods for substrate liabilities”
Accounting Issue #3: Inflating Revenue. This was also happening at the corporate level.
“Correction from gross revenue reporting to net revenue reporting for certain transactions where it was determined that we earned a fee as an agent. These previously known adjustments reduced both revenue and cost of sales by $28 million and $39 million for years ended December 31, 2015 and 2014, respectively.”
November 2017 – Local news reports on Tenneco workers exposed to Hexavalent Chromium (causes cancer). Numerous Tenneco facilities have been cited for violations related to hexavalent chromium. 5 of their plants are currently operating under temporary waivers.
https://www.youtube.com/watch?v=wjcakZS_KwE
https://www.youtube.com/watch?v=jeIMedTosA4
https://www.osha.gov/news/newsreleases/region4/11172014
March 2, 2018: Executive Chairman (Former CEO) head for the exits. (No longer holds an executive function but remains Chairman and retains oversight)
April 10, 2018: Announced acquisition of Federal Mogul from Carl Icahn. Fed Mogul did NEGATIVE $214mm FCF from 2016-2017. Excluding dividends from JVs (ya know, from emerging markets where earnings evaporate when the economy turns down) operational FCF was a cumulative NEGATIVE $341mm from 2016-2017.
April 27, 2018: Announces change to segment reporting (don’t bother keeping count; they move the shells around and re-segment literally every other quarter)
May 2018: Former CFO heads for the exits... to stay on in an executive role. (no longer has to sign off on financials but can still pull the strings)
Summer 2018: Shocks and struts competition continues to increase (aftermarket / ride performance segments). AC DELCO (GM private label) and Detroit Axle expanding capacity while Tenneco shrinks as their brand is viewed as low quality (see link below). Note Tenneco’s Monroe brand had 60% market share of shocks and struts in North America in 2013. They no longer report market share..
Notice the number of shocks and struts offerings below – only 28,553 to choose from..
September 2018: Apparently, they are losing key business (Grass Lake sits in their exhaust segment).
November 2018
Accounting Issue #4: Discloses company has aggressive (fraudulent?) revenue recognition
From Tenneco’s 10Q: Performance Obligations. The Company generates revenue through the design, manufacture, and sale of clean air and ride performance systems and products for light vehicle, commercial truck, off-highway and other applications. We recognize revenue for sales to our OE and aftermarket customers when transfer of control of the related good or service has occurred. Revenue from most of OE and aftermarket goods and services is transferred to customers occurs at a point in time. Contract terms with certain of our OE customers results in products and services being transferred over time due to the customized nature of some of our products together with contractual provisions in certain of our customer contracts that provide us with an enforceable right to payment for performance completed to date. Under typical terms, we do not have the right to consideration until the time of shipment from our plants or distribution center or the time of delivery to our customers. The timing of revenue recognition from products transferred to customers over time may be slightly accelerated compared to our right to consideration at the time of shipment or delivery. We invoice the customer once transfer of control has occurred and we have a right to payment. Our typical payment terms vary based on the customer and the type of goods and services in the contract. The period of time between invoicing and when payment is due is not significant. Amounts billed and due from our customers are classified as receivables on the condensed consolidated balance sheet. As our standard payment terms are less than one year, we have elected the practical expedient under ASC paragraph 606-10-32-18 to not assess whether a contract has a significant financing component.
November 2018:
Tenneco announces closure of Hartwell GA plant (One of many plants cited to have issues with hexavalent chromium; was placed on OSHA’s severe violator list in 2014). “In a press release, Tenneco co-CEO Brian Kesseler said the plant closings are part of an initiative to realign its manufacturing footprint in response to changing market conditions.” This was a lie.
https://wnegradio.com/tenneco-inc-announces-closing-of-hartwell-plant-eliminating-over-570-jobs/
Winter 2018 / 2019: Apparently they have a horrible culture at the HQ, don’t maintenance their equipment, employ a bunch of felons, and best of all, are going down hill and picking up speed – sounds like fun.
March 2019
Accounting Issue #5: Capitalizing expenses
Tenneco files a NT-10K, discloses error identified in the capitalization of expenditures within inventory in previously issued financial statements.
Accounting Issue #6: Overstating aftermarket revenue
Restated 1Q18-3Q18 aftermarket revenues (from 979mm to 953mm, -26mm) in 4Q18. First 9 mos 2018 aftermarket growth revised lower from +1.2% to -1.4%, while 3Q18 aftermarket growth was revised lower from UP 4.7% to DOWN 4.3%. Neither Clean Air revenues or Ride Performance revenues were restated for prior periods. I think this is due to aggressive revenue recognition on receivables factoring and related drafting agreements.
March 2019: Company starts disclosing gross draws / repayments on its revolver. (more on this later…)
March 2019: Former quality technician says management is great. Wait, I’m sorry, terrible. He says management is terrible. Whatever, he was probably biased.
April 2019: Faurecia receives 2019 PACE award for resonance free tail pipe technology – reduces tailpipe weight by 50% (important given increasing emissions requirements). This went into production in 2018. I expect this to weigh on Tenneco’s clean air market share.
From Faurecia’s annual report:
Powered by diesel for the most part, utility vehicles will have to reduce their emissions levels in the years to come in order to adapt to strict regulations. Faurecia is developing new architectures for post-treatment of habitual pollutants like nitrogen oxide (NOx), in order to comply with ultra-low international emission standards such as CARB and Euro 7. In 2018, Faurecia offered an innovative solution to an important General Motors program to save fuel and reduce CO 2 emissions. Recently launched and already rewarded, this “Resonance Free PipeTM” (RFPTM) will equip two of General Motors’ major pickups, the Chevrolet Silverado and the GMC Sierra. Among the primary advantages for the carmaker, the RFPTM, without a muffler, reduces the weight and architectural complexity of exhaust by eliminating resonance.
April 2019: Apparently Fed Mogul is on new business hold with no new business past 2021. This is one of their piston plants. No mention of hexavalent chromium here though so that’s good...
April 2019:
Accounting Issue #7: PWC refuses to sign off on internal controls over Fed Mogul financials. This is despite Tenneco having nearly half a year to integrate the books.
April 2019: Company announces delay of spin / split citing macro and operational instability. Their grand plan had been to separate the shocks and struts business with the exhaust business, thus making boatloads of money. Thought process being, the shocks and struts business could trade at a big multiple.
April 2019: Company draws $2.1bn on their revolver intra-quarter and pays back $2bn, for a $138mm net draw). Total size of the revolver is $1.5bn.
MAY 2019: More bad people and they’re unorganized. Great
July, 2019: Company cancels the dividend
October, 2019: People are openly looking for jobs at HQ, dropping like flies left and right and don't even have jobs to go to, and some of them were in key positions! Sound fantastic.
Present: Company generates NEGATIVE 500MM of FCF through the end of 3Q. November SAAR comes in at 16.5.
BRIAN KESSELER, CEO
JASON HOLLAR, CFO
Joined Tenneco having been the CFO of Sears from 2016-2017.
KENNETH TRAMMELL, Former CFO
Throughout Tenneco’s entire existence as a public corporation, its books have been managed by one man, Kenneth Trammell. That is, until he stepped down from the CFO role last year at age 57. Trammell joined Tenneco in 1996 from Arthur Andersen’s Houston office, where had been a senior manager for 14 years. When Tenneco became a stand-alone entity in 1999, Trammell was named VP and Controller. He was promoted to CFO in 2003.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
SAAR declines, Off-highway and class 8 production declines (they make big margin here), increased competition in aftermarket shocks/struts continues to drive margins lower, OEMs extending service warranties weigh on aftermarket results (Toyota, Volkswagen and Suburu have all extended warranties to 5 years from 3 years, more accounting issues/restatements, hexavalent chromium plant closures and toxic tort liabilities weigh on cash flow and R&D, warranty expense/cash outlays continue to increase due to increase in piston corrosion, increased bev share gains pressure revenue/cash flow (will start to accelerate in 2020).
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