Tecumseh Products (TECUA)
Tecumseh
Products is a global manufacturer of compressors, engines, electric motors, and
pumps.
The
stock trades for about 36% of stated book value. The Enterprise Value racks up as follows:
Market
Cap $328M
Debt $357M
Cash ($105M)
EV $580M
EBITDA
in 2004 was $133M, implying 4x EV/EBITDA based on that year. What happened in 2005 and 2006? Cash flows were massively impacted by the
steep rise in copper prices. Tecumseh
can’t pass these costs through immediately.
The
company says that each $0.10/lb increase in copper prices impacts pre-tax
profits by $5M. To put this into some
perspective, remember that copper traded at about $1.30/lb in 2004. This year, copper peaked at over $4.00/lb and
will average about $2.80/lb. The unprecedented
move of roughly $1.50/lb in copper from ’04-’06 cost the company roughly $75M
EBITDA.
The
company has faced additional pressures from a rising Brazilian Real. Several years back, the company chose Brazil rather than China as a low-cost country in
which to expand manufacturing. With Real
appreciation greatly versus the renminbi and the dollar, Tecumseh is now paying
the price for this move. The company
says that each $0.10 rise in the Real against the dollar reduces pre-tax
profits by $10M. The Real has moved from
about $0.33 in 2004 to about $0.45 this year, erasing about $12M of Tecumseh’s
EBITDA.
The
company also has some tough competition and had been managed lackadaisically
for several years coming into 2005-2006.
Foreign suppliers have been improving in quality, and Briggs &
Stratton is a tough domestic competitor in the engines segment.
So
what has the company done in the face of these challenges?
All
the things activists dream about happening at other companies:
*
Added AlixPartners managing director Albert A. Koch to the board of directors
in 2004
*
Began a substantial restructuring and cost cutting campaign, which is expected
to improve EBITDA by $100M
*
Engaged AlixPartners (August ’05) to assist with turning around the engines
unit
*
Negotiated contracts to share more future commodity risks with customers and
suppliers; redesigned products to use less copper
*
Recently obtained liquidity through a facility from Tricap Partners LLC, restructuring
experts in a unit of Brookfield Asset Management. Tricap recently improved the terms of their
offer as former CEO Todd Herrick of the founding Herrick family agreed to
assume role of Chairman. Tricap and the
Tecumseh board will pick a successor.
Several senior marketing managers are also stepping aside.
*
Structured the Tricap facility in a manner that clearly contemplates
significant asset sales during 2007. The
agreement virtually spells out a strategy of selling off non-compressor
businesses next year. The press release
accompanying the announcement of the facility says plainly: “Tecumseh is
continuing to explore opportunities to further reduce debt and increase
liquidity, including evaluating the feasibility of asset sales.” The full agreement is in an 8-K filed on November
15, 2006.
The
restructuring effort is well underway and management seems quite confident the
results will start rolling through the income statement around calendar Q2 of
next year. There is still high-cost
inventory that needs to be worked off that will impact Q4 and Q1. You can get a sense of the situation either
through the conference calls, a discussion with the CFO (who I believe is very
capable), or through the cumulative EBITDA targets in the new credit agreement:
Oct
’06 – Dec ’06: -17M EBITDA
Oct
’06 – Mar ’07: -10M EBITDA
Oct
’06 – Jun ’07: 15M EBITDA
Oct
’06 – Sep ’07: 50M EBITDA
Oct
’06 – Dec ’07: 80M EBITDA
These
targets hypothesize at least +$97M EBITDA in 2007 on the strength of
cost-cutting actions (much of which are already completed) without any
significant relief from copper prices or Real exchange rates. Relief on commodities/exchange is additive.
Asset
Sales
I believe it is very likely the company to sell off some of its businesses through 2007. (According to the new credit agreement, the
minimum cumulative EBITDA #’s stated above will adjust depending on what gets
sold although the exact amounts of the adjustments are confidential— again,
read the 8-K).
So
it is worth taking a back-of-envelope look at how asset sales might progress
and whether the company might suffer some write-downs to its $46 book value in
the process.
The
Electrical Components unit posted EBITDA of $47M, $39M, and $29M over the years
’03, ’04, and ’05. Results have been
impacted by high copper prices. Capex
has run $5M, $4M, and $8M in these years.
Assuming conservative FCF $25M x rock-bottom 6x multiple we get to $150M
sale price or a $240M write-down of book assets in the unit.
The
Engine & Power Train unit posted EBITDA of $18.4M in 2003, $0.1M in 2004,
and ($56.2M) in 2005. This is the unit
being turned around by Alix Partners.
Management has repeatedly said the unit will be “in the black” (on an
EBIT basis) for 2007, assuming no material relief in copper pricing. I believe a ‘normal’ EBIT for the unit is approximately
$40-$50M post-Alix Partners turnaround in a flat copper pricing
environment. Capex is around $20M; FCF =
$20 to 30M, say $25M x rock bottom 6x multiple = $150M or a $145M write-down to
book.
Sounds
bad, right? Let’s rack up the numbers:
Book
value adjusted:
$861M GAAP book value as of last 10-Q (6/30/06)
($240M) electrical components write-down
(no tax credit given)
($145M) engine & power train
write-down (no tax credit given)
$476M conservatively adjusted book value
18.5M shares outstanding =>
$25.73/share or 51% above $17 price
Not
so bad after all.
Let’s
just continue with this scenario. What’s
left in the business? The core
compressor business. While the
compressor business has also been hit by high copper pricing, its average EBITDA
in the past three years (2003, 2004, and 2005) has been $93M. In the scenario above, we just generated
$300M hypothetical cash from asset sales.
Our new EV = $280M at $17 stock price, or just 3x the 3-year average compressor
EBITDA numbers. If we could trade up to just
6x EBITDA, the stock would be $31/share with a rock-solid balance sheet.
Added
Bonuses
Tecumseh
already has a $90M ($4.63/share) deferred tax valuation allowance. This asset could come back onto the balance
sheet once profitability is restored through restructurings & asset sales.
Very
large additional tax assets could be created if big write-downs are generated
in asset sales (as in the scenario given above.) Of course, smaller write downs would be
better. Just pointing out again the
scenario above didn’t tax effect the hypothetical write-downs.
In
the “nits and nats” category, there’s another $7M Brazilian tax reversal that
basically “in the bag” but not yet booked per GAAP.
The
company was just booted from the S&P Midcap 400 index on August
29, 2006
forcing a lot of sellers recently. In
addition the company has struggled to post its 10-Q’s on a) ERP implementation
issues (Q2) and b) interim period (10-Q) tax restatements (Q3), reducing the
number of buyers who might be willing to give this down & dirty value play a
shot.
Perhaps
more importantly, I don’t think the company is done wringing out costs. I believe we will soon have a new CEO that
carries the stamp of approval of the restructuring professionals (Alix, Tricap). I believe it is likely that additional U.S. capacity may be
relocated abroad through 2006-2007 providing another source of cash savings.
Risks To Highlight
Nothing
trades to 36% of book without a reason.
The
following risks deserve a lot of thought:
Copper/Real
could resume their upward climbs
Foreign
competition could win large contracts in U.S.
Recession
could diminish demand in all segments
The
company could trip debt covenants; lenders could play hardball
Write-offs
could be worse than back-of-envelope scenario above
Disclaimer: This report is not intended as a recommendation to buy/sell securities. Tecumseh shares are risky. My firm has a position in Tecumseh and we may buy/sell shares at any time.