Description

VPG – Long

• VPG has sustainable competitive advantages, a scalable business model with excess capacity in its facilities, a strong balance sheet and reasonable growth opportunities.
• Since its spin-out in 2010 from its much larger parent, Vishay Intertechnology (VSH), VPG has disappointed investors due to weakness stemming primarily from its European markets. 
• At the current price, VPG offers an attractive risk/reward opportunity although it is worth noting that VPG is a medium to long-term opportunity without clear near-term catalysts.

 Valuation/Financials (includes Kelk)

• Above is my estimate for 2013 which I believe is below normalized earnings given the current weakness in Europe and the incremental growth potential from new products, the Kelk integration and the benefit of operating leverage. VPG’s revenue and earnings can be lumpy so accurately estimating normalized earnings is challenging.
• At the current price and at below normalized levels, VPG trades at ~6x 2013E EBITDA and ~8x pre-tax 2013E FCF, an attractive price for a company with VPG’s characteristics and strong balance sheet. The Company will also benefit from its NOLs in multiple jurisdictions.  As about 70-80% of the cash is held offshore, it is important to note that the cash would be taxed if shifted back to the US.

VPG core biz overview

VPG has three reporting segments: Foil Technology Products (FTP), Force Sensors (FS), and Weighing and Control Systems (WCS), which are all based on foil resistor technology and are used in applications/devices, etc. that require measuring across force, stress, weight and pressure (e.g. MRI machines). The Company has a global manufacturing footprint with its corporate headquarters in Malvern, PA.

FTP (foil resistors and strain gages)

• Foil Resistor:  A resistor is an electromechanical component that is designed to provide a specific amount of resistance in an electronic circuit.  Since many electronic components have capacity for more electrical current than is necessary and additional electrical current is harmful, resistors serve a regulatory function by assuring that appropriate levels of voltage go to specific parts of an electronic circuit.   
• Foil Resistance Strain Gage:   A strain gage is a sensor that measures the amount of deformation caused to a body due to an applied force (i.e. weight and other forms of mechanical stress).  Specifically, a strain gage’s electrical resistance varies in proportion to the amount of strain in the device.  As the foil is subjected to stress, the resistance of the foil changes in a defined way.
• End-Markets: Medical testing equipment, high-performance audio equipment, precision measuring instruments, aerospace and military, industrial, automotive, agricultural, and down-hole drilling
• While the resistor market is frequently a high-volume, low-differentiation business where high performance is unnecessary and prices of $0.10-$0.50 per resistor reflect the commoditized nature, VPG is different.   Vishay’s resistors are primarily used in highly-specialized, performance-sensitive devices.  Therefore, VPG’s pricing reflects this premium product.  It typically sells its resistors for approx. $4 to $8 per resistor.  

Force Sensors

• Load Cells:  A load cell, also referred to as a transducer, consists of an array of foil resistance strain gages bonded to a metallic support.  This is then mounted to an industrial scale platform.  A load cell operates in the same way as a single foil resistance strain gage but has enhanced measuring precision and reliability because of the multiple strain gages.  Furthermore, it can be manufactured with different designs and configurations for various applications.
• Modules: Modules combine load cells with sophisticated electronic instruments and embedded software for specialized stress measurement and control applications such as process weighing, vehicular on-board weighing and web tension. 

Weighing & Control Systems (WCS )

• Although it is VPG’s smallest segment, WCS includes the Company’s most complex and customized products. VPG designs, manufactures, installs and services complete systems for commercial and industrial processes based upon the detection and measurement of weight and other types of mechanical stress.

End-market/product applications (from 10K)

Geographic revenue split

While the geographic distribution of sales is weighted toward the United States and Europe, Asia is expected to represent upwards of 25% of VPG’s sales in FY 2013 due to the acquisition of Kelk and its solid Asia business.  The acquisition strategically helps VPG not only to expand geographical distribution, but also to cross-sell VPG/Kelk products to a broader customer base. 

Competitive advantages

• Majority of VPG’s cash flow is generated by Foil Technology Products – VPG has a dominant position in pure foil resistors and majority of the market share in strain gages.
• Because these components are typically inexpensive relative to the cost of any project/device etc., competition is based on quality and performance not price.  Market size and economies of scale keep new entrants away. As mentioned above, VPG’s resistors tend to cost $4 to $8 each whereas resistors in the commoditized mass market are closer to $0.10-$0.50.  
• There are also barriers to entry due to high switching costs (once VPG has its more complex systems embedded into an OEM’s product line, the OEM is unlikely to switch out during the  production life given the time/resources taken to spec in a new high-end sensor for an OEM.
• VPG’s patented Bulk Metal Foil technology is superior in quality and performance (and different) to the metal foil components of any potential competitors– IRC, Taddock, and Flat for Resistors and HBM, Kyowa, and NMB for Strain Gages.  VPG’s Bulk Metal Foil technology has a 0.005% tolerance, whereas competitor resistors do not even have resistors with tolerance below 1%.  In addition, VPG’s Bulk Metal technology has a temperature control resistance (TCR) of +/- 0.2 ppm/degrees Celsius, which is significantly lower than competitor components with TCR’s of more than +/- 50 ppm/degrees Celsius.

Customer overview

VPG’s products are sold to OEMs, electronic manufacturing services companies, distributors, and end users.  Typically, the simpler the product, the more likely it is purchased by equipment manufacturers as a component in a more complex, larger product or system.    Therefore the FTP and FS market have a greater concentration of sales to equipment manufacturers than the more complex WCS segment.

The customer base is diversified with no major concentration and includes:

• Medical Testing Equipment – Cardinal Health, Stryker, Pfizer, Siemens, Abbott Medical Optics
• High-Performance Audio Equipment – Placette Audio, TotalDAC, Verity Audio & Engineering
• Precision Measuring Instruments – Rice Lake Weighing Systems, Avery Weigh-Tronix, Satorius, Mettler Toledo
• Aerospace and Military – Boeing, NASA, Embraer, Lockheed Martin, KAI, BAE Systems, Saab, Rolls Royce

Growth opportunities

• Some of VPG’s key end-markets – aerospace, medical and precision measurement – offer growth opportunities, while others, military in particular, could see some decline.
• VPG primarily concentrates on the high-end markets of aerospace, military, medical, and precision management, where accuracy, reliability, and stability under extreme conditions are of the utmost importance.
• Aerospace: The aerospace end-market offers promising trends.  These trends include an aging aircraft fleet with new aircraft added annually and a typical 3-year replacement cycle for foil resistors.  There is also increased regulation, including a push for greater efficiency through More Electric Aircraft (MEA), which would be beneficial to VPG. 
• Healthcare: Despite recent declines, capital spending in the medical segment is expected to increase.  Furthermore, the escalating trend of home-based healthcare could also benefit VPG. 
• Military: While there are high barriers to entry in the Military end-market as there are strict requirements and certifications, there is a risk that the US will further cut its defense and NASA budget over the next 5 years while other military budgets (such as the UK) might also see a decline.
• Acquisitions are a part of the growth strategy: Since the spin from VSH there has only been the Kelk acquisition (discussed below) yet management is looking at other acquisitions. Management is focused on sensor companies that already purchase foil resistive sensors from VPG and, as the Kelk acquisition has shown, management appears open to diversifying into other sensor lines. Operating leverage from organic growth or smart acquisitions (as facilities have capacity) would increase cash flow.  I would point to Measurement Specialties’ (MEAS) history as an example – Frank Guidone, CEO of MEAS, has built his company through acquisitions that leverage the existing SG&A and I believe VPG can follow this path.
• Other growth opportunities: The Company put $4M capex into a new mini-strain gage line.  This product is smaller with similar resistance and is expected to enhance revenue opportunities (including the potential to be included in battery-operated types of applications) even though it is currently producing de minimus revenue as it takes 12-24 months to spec-in.  These mini strain gages are not expected to cannibalize existing business.

Recent KELK acquisition

• VPG recently acquired Kelk, a private Canadian Company that manufactures high-end electronic measurement equipment used primarily in steel and aluminum rolling mills, paper mills, mining and resources applications.  Kelk’s principle facility is in Toronto. You can see Kelk’s products (e.g. tension measuring equipment, Fluid Pressure Transducers etc.) at http://www.kelk.com/Pages/about.html
• Kelk has a dominant position in its niche. While VPG’s Nobel subsidiary is the market leader in such products in Europe, Kelk is the market leader in North America and Asia.  Kelk also has a sizeable aftermarket service offering and it already uses Vishay’s foil resistors for part of its operations. The acquisition also marks the first diversification of VPG’s business beyond foil resistive technology, as 50% of Kelk’s product line is based on optical sensors.  
• Although the acquisition price was a little higher than I expected, it is a solid add-on that offers cross-selling opportunities, geographical diversity, a broader product offering, and should lead to increased margins.

Management

• Management and the estate of the founder (the late Dr. Felix Sandman) have voting control
• There is class A and B stock and voting control is held by the estate of Felix Sandman (primarily his widow, his son who runs the old parent company, and Ziv Shoshani, his nephew who is the CEO of VPG after working at the company for many years). 
• Management has not done anything to disadvantage other shareholders but the control structure is not ideal and remains a risk.  It is also disappointing that Management has not repurchased any stock.

Risks

• Bad acquisitions (and failed integration of Kelk)
• The overall macroeconomic environment deteriorates, and Europe worsens and remains depressed.
• The traditionally slow process (12-36 months) associated with OEMs working through the various ‘specs’ of VPG’s customized products is stymied further by weak industrial investment globally.
• VPG is working to make the Force Sensor segment, its weakest segment, more reliant on customized products. This approach may not be successful and this segment could remain a drag on profitability.

Catalyst

• Successful integration of Kelk and further acquisitions
• Europe demand begins to return
• Margins improve