Value Investors Club / VISHAY PRECISION GROUP INC (VPG)

Description

Vishay Precision Group (“Vishay”, “VPG”, or the “Company”) is a niche manufacturer of highly

specialized electronic sensors. VPG currently operates three business segments: (1) foil

technology products which consists of strain gauges and foil resistors, (2) force sensors which

manufactures a broad line of load cells and force transducers, and (3) weighing and control

systems which provide customized weighing and control mechanisms.

We believe Vishay is a timely investment due to a recent announcement that the Company

has hired Evercore to sell the Company. Currently trading for ~6.6x EBITDA, Vishay trades

at a significant discount to multiple private market transactions which have been

consummated in excess of 10x EBITDA. Vishay is a classic example of an attractive niche

business woefully undermanaged. Despite poor management, our customer checks revealed

that VPG’s products are highly regarded with little to no alternatives in the foil space, making

them an attractive target for numerous industrial conglomerates. Furthermore, VPG is one of

the largest niche sensor assets on the market currently for sale. If a transaction is executed

on the lower end of private comps, VPG shareholders would receive ~$20 per share or ~40%

upside.

This opportunity exists as the founding family has a long history of milking Vishay and under-

delivering on its strategy, which when combined with an inefficient cost structure has led to

EBITDA margins roughly half that of peers. This scenario has now changed as Management

will likely be held accountable by new board members, an activist investor along and

additional like-minded shareholders.

Even without a sale outcome, we find the set-up attractive as the market is over-looking

Vishay’s business fundamentals consisting of (1) leading market position; (2) numerous

capital allocation opportunities; (3) strong cash generation through the cycle supplemented

with a rock solid balance sheet; (4) exposure to multiple healthy end markets such as

healthcare; and (5) recent corporate changes which should lead to significant belt tightening

and cost cuts.

 Dominate Market Position & Attractive Niche

o Vishay is the largest foil products/resistor manufacturer, with over 50% market

share of certain niche sensor verticals.

o The Company’s size provides the requisite scale to carry a wide category of

products on favorable terms (working capital and price) with vendors.

o VPG’s dominate market position has allowed for the Company to generate ~40%

or higher gross margins in its foil business while generating returns on invested

capital in excess of 20%.

o Given VPG’s products’ average selling prices are a low percentage of the end

product’s total cost, competition tends to be determined on quality and

performance with price being the laggard. Due to VPG’s technical know-how and

scale within their respective niche, Vishay has a clear advantage.

o VPG is #1 in foil technology, a high margin cash generative business & leader in

the fragmented weighing and control systems market.

 Diversified Customer Base & End Markets

o Vishay boasts a diversified customer base with no customers totaling more than

5% of revenues as well as no meaningful top ten customer concentration.

o Customer base includes companies operating in a variety of industries ranging

from medical equipment, semiconductor, precision measuring, aerospace,

industrials and consumer equipment among others. This helps smooth negative

revenue impacts if one end market is weak (i.e. steel in FY14/FY15).

o The Company’s customer base is diversified across multiple channels consisting of

OEMs, EMS, distributors and end users.

o VPG’s products are sold into a variety of end markets, inclusive of those with

positive long-term outlook such as aerospace and healthcare.

o Vishay’s fragmented customer and distribution base across the world allows for the

Company to maintain pricing as well as partially insulate its business from a

degradation in one region or industry.

 Durable Cash Generative Business Model with a Strong Financial Position

o Vishay consistently generates free cash flow through multiple business cycles, with

only one negative year of free cash flow over the past 8 years, which was

predominantly driven by growth CapEx.

o The Company’s financial profile for Foil Technology and Weighing & Control

Systems is strong, with gross margins at ~40% and 25% or greater EBITDA

margins while requiring very little CapEx.

o EBITDA-CapEx conversion is strong historically in excess of ~75% and consistently

above 80% in prior years.

o Maintenance CapEx is low at ~$6MM per annum roughly 3% to 4% of revenues.

o The Company boasts a strong balance sheet with ~$15MM of net cash.

o Solidifying VPG’s business model, in FY09 during the downturn Vishay experienced

a ~30% trough in revenues, yet free cash flow remained strong at $20MM.

 Inexpensive Valuation below Private Market Transactions

o Vishay currently trades for a 6.6x FY15E EBITDA, an undemanding multiple for a

niche sensor and systems market leader, which has demonstrated consistent cash

generation and near a ~10% EV to FCF yield.

o Vishay’s industry has been active as of recent for acquisitions, with peers

purchased from 12.0x to 20.0x EBITDA. Due to VPG’s size and business

characteristics, a 10x – 12x EBITDA multiple would not be surprising given the

synergies a large acquirer could remove and would represent ~60% upside

assuming 10x multiple.

o One recent example includes Measurement Specialties, which was purchased in

2014 by TE Connectivity for ~20.0x EBITDA.

o VPG currently trades at a discount to tangible book value, a rough approximate of

liquidation value. Hence with only minimal downside, VPG offers an asymmetric

opportunity.

o Golden Gate Capital is a 4.8% shareholder and currently owns an industrial sensor

business, Humanetics/Hitec which is a possible acquirer. Furthermore, competitors

such as Spectris plc, Sensata and Curtiss-Wright are likely highly interested in

VPG’s assets noting Vishay’s strong market share has kept many participants out

of the market. Finally, VPG is one of the largest sensor assets in the market.

o In August 2016, it was announced that VPG hired Evercore to run a sale process.

 Capital Allocation Opportunities

o Management has begun to execute on their share repurchase plan, repurchasing a

little over ~$5MM of shares or 3% of shares outstanding since the beginning of

FY15. Near tangible book value, this represents significant value. Furthermore,

this only represents 1/4th of its ~2MM share repurchase program.

o Additional opportunities remain for small bolt-on acquisitions (likely too pricey in

this environment) or a leveraged recapitalization. In order for the Company to

achieve its ~$300MM revenue/20% or greater EBITDA margin goals, a niche

acquisition is likely.

o Management has looked at select acquisition targets with high gross margins (45%

or greater) for which they believe they can easily handle ~3.0x leverage. While

Foil Technology Products could easily handle 3.0x leverage or more, the

Management team has not handled significant leverage at VPG.

 Operating Leverage Imminent & Cash Flow Inflection Point

o VPG’s operating model carries tremendous operating leverage, with incremental

EBITDA margins of ~50% for additional revenue over $250MM.

o Moreover Vishay has been aggressively spending on various business

improvements, such as the build-out of its advanced sensor platform in the foil

unit, as well as operating initiatives in its two remaining segments. This has also

spread to the CapEx line, with normalized CapEx estimated at ~$6MM to $8MM per

annum versus the $10MM spent for FY15.

o Management’s plan is for once $300MM of revenues is achieved, EBITDA margins

should be roughly ~20% or $60MM in EBITDA. Currently the Company generates

~$24MM of EBITDA on $232MM of revenues, signaling significant leverage.

o Vishay likely reach it’s ~$300MM goal through a combination of organic growth

from its foils and WCS segments and potentially a tuck-in acquisition.

o Management expects FTP can grow gross margins from 40% to the low to mid 40%

range, force sensors to sustainably operate in the high 20% range, and depending

on the cycle, WCS from its trough 45% gross margins to 50%. With ~$28MM of

fixed corporate costs, operating leverage is significant.

o Corporate overhead is egregious at Vishay and offers a significant cost cutting

opportunity. Corporate overhead runs between ~$25MM to$26MMand does not

include R&D, segment S&M and segment accounting costs (i.e. division controllers)

which run through the three segment P&Ls. Per our estimates, VPG could easily

eliminate ~$10MM of corporate costs while a strategic or sponsor could remove

$15MM to $20MM of corporate costs. Additionally we believe VPG could shrink its

manufacturing footprint.

Why Does This Opportunity Exist?

 FX & End Market Headwinds

o VPG has experienced significant headwinds in certain end markets, particularly

steel mills, which has impacted its WCS division.

 Lack of Sell-Side Coverage & Size

o As evidenced by the Company’s conference calls, VPG has no analyst coverage

beyond an occasional note by Sidoti and B.Riley.

o Vishay’s sub $200MM market capitalization limits the size of potential investors.

 Controlled Entity

o Vishay is controlled by the Zandman/Shosani family through B-class super voting

shares as well as class A equity.

 Value Trap?

o Since its spin-off in 2010, Vishay has remained cheap to a certain extent, defined

as not trading above 2x TBV or ~10x EBITDA.

o Due to recent industry consolidation and ability to scale, this scenario likely has

changed. Furthermore, business quality relative to actual value is the most

important determinant.

o Business quality is solid as defined by strong returns on capital and recent capital

allocation decisions have increased intrinsic business value

 Investor Fatigue

o Long time investors from the spin-off such as Century Management, Gates Capital

have exited due to a lack of acquisitions (one of the Company’s key strategy points

from the spin-off) and lack of large-scale share repurchase programs.

Valuation

Over the past two years, there have been multiple precedent transactions in VPG’s universe

as well as adjacent spaces. Multiples as of recent have ranged from ~10x to 20.0x EBITDA.

Assuming reasonable multiple to VPG derives the following return profile and a significant

margin of safety:

Moreover, our private market and upside valuation are supported by a sum-of-the-parts

scenario, which values the Company’s attractive FTP segment at a multiple in-line with private

market transactions and a multiple significantly below comps applied to the Company’s WCS

and Force Sensors businesses.

Catalysts

 Take-Private

o Vishay currently trades at ~5.5x EBITDA. Currently acquisitions have taken

place over the past year at ~12.0x to 20.0x EBITDA, with Measurement

Specialties recently purchased for 20.0x.

o Assuming VPG sells for ~8x – 12x EBITDA, current investors would gain over

50% upside.

o Financial Sponsor Golden Gate Capital is a 4.8% shareholder and owns

competitor Humanetics. Moreover, Golden Gate has been aggressive in rolling

up the industry.

 Operating Leverage & Cost Cutting Opportunities

o Vishay’s segments carry strong incremental EBITDA margins, estimated at

~50% for incremental revenue over $250MM.

o Assuming Vishay reaches its internal goals of $300MM of revenues, implied

EBITDA would range from ~$50MM to $60MM before corporate cost cuts.

o Despite Management announcing over $6MM of costs to be removed from the

business in FY16, we believe there are significant opportunities for additional

cost cuts as well as working capital optimization. This will likely be on the

agenda of the Company’s new board member, Cary Wood.

o For instance, VPG has ~$25MM of corporate overhead which is excessive for a

$180MM market capitalization and considering all R&D, sales and segment

accounting costs run through segment P&Ls. Per our estimates, at minimum

$10MM - $15MM can be cut from corporate overhead. This is a slam dunk line

item for a sponsor or strategic.

 Capital Allocation

o Continued share repurchases under 6.0x EBITDA and near TBV are highly

accretive to intrinsic value and precedent transactions.

o The Company is under-levered with no net debt. Assuming ~2x debt to EBITDA,

VPG could repurchase over 30% of its shares outstanding.

o Smart bolt-in acquisitions in niches similar to foil technologies under 6.0x pre-

synergy EBITDA would potentially be highly accretive for the Company due to

scale and incremental margins. The Pacific Instruments acquisition likely fits

this bucket.

Risks

 Reliance on Industry CapEx Cycle & Overall Cyclicality

o Cheap valuation prices in a downturn.

o Ability to rationalize cost base as $10M - $15MM of corporate overhead alone

could be cut, creating significant cash flow regardless of market conditions.

o VPG’s financial profile is linked to multiple end markets. Moreover in FY09

EBITDA materially declined yet FCF generation was strong at over $20MM.

 Management Continues M&A Strategy

o Recent transactions such as the Kelk acquisition (for ~6.3x headline EBITDA),

have not been a success thus far given the weakness inthe target end markets.

o Cash will generally be better utilized for process improvement in foil technology

as well as share repurchases.

o Activists and the hiring of Evercore likely reduce this risk for the near-term.

 Family Control & Perennially Cheap

o Mitigated by recent corporate action such as the hiring of Evercore and

activist intervention.

o Management has repurchased shares over the past year.

o The Company’s EBITDA trading multiple has ranged from ~4.5x to ~9.0x over

the past 4 years as well as a 20% -50% premium to tangible book. Assuming

a normalized multiple or improvement in the business, VPG equity should re-

rate to ~8x or higher.

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

Catalyst

Sales process

Further Cost Cuts

Management Change

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			2016	2017
Price:	14.00	EPS	0	0
Shares Out. (in M):	13	P/E	0	0
Market Cap (in $M):	185	P/FCF	0	0
Net Debt (in $M):	-15	EBIT	0	0
TEV (in $M):	170	TEV/EBIT	0	0