|Shares Out. (in M):||18||P/E||0.0x||0.0x|
|Market Cap (in $M):||895||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||560||EBIT||0||0|
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What is Cooper-Standard?
Cooper-Standard (“CPS”) is a manufacturer of body sealing, fluid handling, and anti-vibration systems. Its products are primarily for use in passenger vehicles and light trucks that are manufactured by original equipment manufacturers (“OEMs”) of the global automotive industry. The company is the largest global producer of body sealing systems, the second largest global producer of fluid handling products, and one of the largest North American producers of anti-vibration systems.
CPS Offers an Attractive Reward/Risk Investment Opportunity?
- Orphaned Stock: Despite its role as an important parts supplier to all of the world’s major automotive OEM’s (with products on nearly all of the top 20 models in the US and Europe), CPS has been an orphaned stock since emerging from Chapter 11 in 2010. As a result, several transformative events have gone largely unnoticed by the market.
- Today’s Valuation is Compelling: At $1.46 billion enterprise value, the company trades at roughly 4x our estimate of 2014 EBITDA. This is approximately 40% below its global parts supplier peer group despite CPS having a better growth trajectory and consistently strong margins.
- Restructuring Nearly Complete: Furthermore, the company is on the tail-end of a multi-year operational restructuring which required significant capex and cash restructuring costs. The material cost savings should begin to be realized in mid-2014 when the new Serbia facility will begin operation.
- Growth via Global Platforms: The shift by large auto manufacturers to “global platforms” should lead to a consolidation among their suppliers. As the #1 or #2 player across roughly 90% of its revenues, CPS should win increasing business and take market share.
- Growth in Tooling Receivables Indicates Future Market Share Gains: The Tooling Receivable line item on CPS’s balance sheet has increased nearly 70% since the end of 2011. This suggests new business wins at approx. twice the industry rate. These wins will start to have a material impact on CPS’s revenues and earnings in 2014.
- Valuation: CPS is trading at a low multiple on depressed EBITDA numbers. We believe that it would take a global auto industry downturn to impair capital over the next 18 months. Our downside estimate is ~$40 per share. Should the company grow at industry rates and the restructuring initiatives roll through as expected, we expect that the shares will trade at approx. $80-$90 in 18 to 24 months time. Market share gains offer meaningful additional upside. In addition, we believe that a sale to either a strategic Asian auto company or TI Automotive is a reasonable possibility and will provide upside to these targets.
Historical Background on CPS
In September 2004, Goldman Sachs Merchant Banking and The Cypress Group acquired Cooper-Standard Holdings from Cooper Tire & Rubber Co for ~$1.165 billion, or ~5.8x 2005 EBITDA. Over the next several years, the company spent another ~$450 million on additional acquisitions. Since becoming an independent entity in late 2004, Cooper’s strong market position in each of its segments has helped the company to deliver remarkably steady operational performance. Historical EBITDA margins are in the 11%-12% range which is significantly better than the majority of its parts supplier peer group. In fact, CPS even generated reasonable EBITDA margins of 8.4% and 9.1% in 2008 and 2009, respectively.
The consistency and durability of company margins is due to a few factors. First, CPS is embedded in its customers’ vehicle design and engineering processes. Secondarily, the company is often called upon to make last minute changes to make vehicles “road ready” before launch (e.g. change the size of sealants because the other parts don’t fit perfectly as originally specified). In addition, its products are critically important to the look, touch, and feel of the car, while representing a very small component of the average cost and content per vehicle. Given the small cost and critical importance of the products and service that CPS provides, OEM’s are reluctant to switch suppliers and have been willing to pay up for its products. In short, CPS is a solid, niche business.
Despite the aforementioned stability of the historical operating performance, the company (like many others in the auto industry) was forced to file for Chapter 11 during the financial crisis due to its burdensome debt load of ~$1.2 billion. CPS ultimately emerged from bankruptcy when a small group of bondholders, led by Silver Point and Oak Hill, reached an agreement to provide new capital through the bonds in exchange for the equity. Upon emergence from bankruptcy in May of 2010, the company never listed on a major exchange and was predominantly controlled by Silver Point and Oak Hill. It appears their plan at the time was to sell the company when the cycle recovered and thus, they started a sales process in summer 2011. However, the company did not attract much interest at the time from strategic buyers and ultimately chose to terminate the process without a sale.
Material Headwinds since 2011 are on the verge of either normalizing or becoming tailwinds
- European Financial Crisis: Shortly after the sales process terminated, the European financial crisis ensued. This presented a challenging macro environment for suppliers like CPS that have exposure to the region. Currently, CPS derives roughly 35% of its sales from Europe, 52% from North America, 7% from Asia Pacific, and 5% from South America. As European auto sales bottomed below where they had at the depths of the 2009 financial crisis (and still remain 20% below 2007 levels), CPS experienced a decline in European profitability. The decline in volumes negatively impacted both revenues and margins, as lower capacity utilization resulted in less absorption of fixed costs. Based on company disclosures, EBITDA margins were close to 2% in 2012 (estimated $20 million of adjusted EBITDA on sales in excess of $1 billion). Nevertheless, according to management, variable contribution margins for CPS’s European business are only slightly below contribution margins in North America.
Recent data points surrounding European auto volumes have been encouraging. The European market appears to have reached an inflection point. CPS’s recent low capacity utilization as well as a manufacturing footprint with exposure to high cost European nations (e.g. France) resulted in management’s decision to undertake an operational restructuring in the region. The impact of this restructuring (more on this below) will not begin to materially impact the business until the middle of 2014 when the large Serbia facility begins to ramp up and expenditures are shifted there from higher cost facilities in Germany, Italy, and Poland. The average labor hour in Germany/Italy is $35 per hour, Poland is roughly $10 per hour, and Serbia is roughly $4 per hour. The wage differential alone should save the company nearly $100,000 per day assuming only one shift of eight hours across the expected 500 employees at the Serbia facility: http://www.b92.net/eng/news/business.php?yyyy=2013&mm=07&dd=31&nav_id=87136
- Explosion at Key Supplier Facility: In March of 2012, an explosion at a key supplier’s chemical plant in Germany shut down the facility. The facility made one-half of the world’s CDT, a key ingredient in the production of an important resin used in CPS’s products. While CPS was able to quickly secure CDT from other suppliers, the sudden supply shortage and associated price increase may have impacted margins. The facility reopened in December 2012, but did not ramp to full capacity until the end of Q3 2013.
- Impact of Bankruptcy on New Business Wins: Since new business wins roll through the income statement with a 2-3 year lag, CPS’s current profitability reflects its 2009-2010 status as a supplier in the midst of a bankruptcy process. The company did not win much business while it was in Chapter 11. However, since emerging from bankruptcy the company has been winning new business at a rate that significantly exceeds the broader industry. Management has indicated that the new business wins are reflected in the growth of tooling receivable on the company’s balance sheet. Tooling receivable was $64 million in Q4 2010, $90 million in Q4 2011, $117 million in Q4 2012, and $150 million in Q3 2013. The growth in tooling receivable indicates that CPS may be winning business at roughly twice the industry average. This fits into the global platform trend discussed in the following section. The company generally incurs tooling expense within 12 months of product launch, so the new business represented by the $150 million in tooling receivable will start to flow through to the P&L over the next year and will ramp up in 2015 as the platforms reach run-rate production. The company has stated that they expect to significantly outpace industry growth in 2015.
The Impact of Global Platforms: The large OEMs in the auto industry are increasingly moving to global platforms. Specifically, according to an IHS Global Study, 87.5% of vehicles produced by the top 7 global OEMs will be based off of global platforms by 2016. This theme is expected to cause seismic shifts in the auto industry over the coming years. Global platforms enable OEMs such as GM to use common engineering across vehicle models so that they can place different models on the same assembly line one-after-the-other. Therefore, a company can design and produce vehicles across segments (by price and size) and brands on a global scale. This has many benefits including a significant cut in production time, reduced parts and engineering costs, potential to slash new-model development time, lower dealership training costs, and (of particular benefit to CPS) greater parts sharing among models and regions. While this consolidation has many benefits, there is a strong need to consolidate suppliers to those with global (not just regional) footprints, strong balance sheets, and strong history of engineering precision and expertise since recalls could impact many more vehicles than before due to the increasing similarity across vehicles. This trend is favorable for CPS since the company has global scale and operates in a fragmented markets. In sealing, CPS is the #1 player globally but only has 17% market share. Similarly, in fluid handling, CPS is the #2 player (#1 is TI Automotive) but only has 6% market share. As this shift to global platforms gains momentum, CPS should continue to outpace industry growth as it takes share from smaller regional competitors who cannot compete for a global platform.
Recent Developments at CPS
- New Management: Following the 2011 sales process, the sponsors (Silver Point and Oak Hill) took the company in a different direction. They focused on rebuilding its backlog along with its global footprint. To enhance its presence in Asia, the company (and likely the sponsors) recruited a new CEO in October 2012. They hired Jeff Edwards, who previously ran Johnson Controls in Asia where he was responsible for significant growth. Since Jeff’s arrival, CPS has implemented restructuring actions, including building a new facility in Serbia (opening in Q1 2014), buying a plant in China, building a new facility in India, and closing two underperforming facilities in Western Europe (France, Spain). The company has been spending meaningful capex which has depressed near-term free cash flow. Capex is expected to be $185 million in 2013 (vs. less than $100 million historically). In addition, CPS has spent in excess of $65 million on cash restructuring charges over the past 18 months. Management has communicated that capex and cash restructuring should remain elevated during the first half of 2014, but should then revert to “normalized” levels. This timing should align with revenues from new business wins as indicated by the tooling receivable detailed above. Management seems to be judicious in its near-term cash spend and expects to earn a solid return on that capital.
- Share Repurchases: In May 2013, CPS took repurchased 21% of its outstanding stock at an accretive price of $43 per share. Additionally, the company put in place a $50 million share repurchase program in May 2013.
- Exchange Listing/Analyst Day: In Fall of this year, the company announced that they would list on the NYSE and would host an Analyst Day in late October. There was a ‘tick up’ in volume because investors started to assume that the illiquidity discount would go away. However, the stock has remained illiquid. The large equity holders do not appear to view their “exit” as reasonable at this price. Additionally, the company did a very poor job marketing the event. There was no official press release and the event was “invite only”. For those in attendance, management (there is no dedicated IR team) failed to highlight details that would be meaningful to existing shareholders. There was little discussion of the backlog, the expected return and timing of capex projects, and benefits from the cash restructuring initiatives. Finally, they did not provide investors a bridge from today to the 2015 earnings and cash flow. In recent conversations with management, it appears that they may share more details (e.g. backlog) on upcoming presentations including the Detroit Auto Show in January.
Recent Operating Performance/Projections/Valuation:
- Historic Financials: Prior to the European financial crisis in 2011, the company was on pace to generate ~$2.9 billion of 2011 revenue and adjusted EBITDA of ~$350 million (or ~12% margins, in line with historical operating performance). Ultimately, CPS generated $325 million of EBITDA on $2.85 billion of revenue (11.4% margins). In 2012, CPS’s revenue was roughly flat and adjusted EBITDA declined to $300 million (10.3% margins) due to Europe generating almost no EBITDA. In 2013, topline growth has resumed and is expected to be up ~ 6% to $3.05 billion. Even Europe has experienced some revenue growth this year (~3% year-over-year) despite declining industry volumes. In Q3, CPS reported revenue growth of 12% year-over-year, but EBITDA margins were negatively impacted (down to ~9%) by a number of one-time costs related to new platform launches in North America (e.g. $14 million on items such as overtime related to these new platforms) as well as the hiring of a number of engineers in anticipation of future business. Management has stated that while these costs are expected to continue in Q4, they expect margins to return to normalized historical levels of roughly 11%-12% in 2014.
- EBITDA Expectations in 2014 and 2015: The Q3 2013 increase in revenue should prove to be an initial bump in a more meaningful revenue ramp for CPS based on the trends in global platforms and surge in CPS’s tooling receivable line item. While the likelihood of share gains is high (more on this below), our base case assumes that CPS follows industry growth with no change in share. We assume that CPS volumes will increase by 3.3% and 3.8% in 2014 and 2015, respectively. Additionally, we assume that “pass through” pricing (no margins on it – just driven by material costs passed along to customers) grows at 2% in both 2014 and 2015. Under these ordinary assumptions, revenue is expected to grow at 5.3% and 5.8% in 2014 and 2015, respectively. Assuming that contribution margins are at roughly 22% (management guided to 20%-25%) but only flow through to revenue growth from volume (and not price), this generates an estimated EBITDA of $342 million and $389 million in 2014 and 2015, respectively. This includes $40 million in annual cost savings from the Serbia facility ($20 million realized in 2014 and an additional $20 million realized in 2015). The implied EBITDA margins for CPS under these assumptions are 10.6% and 11.4% in 2014 and 2015, respectively. This is well within historical bands especially considering that there was no positive contribution from the Serbia facility in prior years.
- EBITDA Valuation on Base 2014/2015 Assumptions: We apply a 5x multiple to the estimated 2015 EBITDA. We apply a 10x multiple to the estimated joint venture earnings. We arrive at a fair 2015 Enterprise Value of roughly $2 billion. Assuming that the free cash flow from 2014 and half of 2015 are netted against today’s debt balance, the equity value is roughly $1.5-$1.6 billion. Based on the 18.1 million diluted shares, this equates to approx. $85-$90 per share. Currently, shares trade at approx. $50, implying an estimated 70%-80% upside in 18 to 24 months. In addition, this analysis embeds numerous conservative assumptions including (1) growth at industry levels, (2) contribution margins at the low end of management guidance (3) no growth for the growing JV earnings (up 100% between 2011 and 2013), and (4) no additional restructuring savings besides Serbia. While EBITDAP estimates of valuation are slightly lower at nearly $80 per share, either valuation implies attractive reward while making modest assumptions. On a FCF valuation, we estimated that the company should generate $170 million in FCF in 2015. This equates to a 19% FCF yield to equity. Since we believe that mid-cycle FCF to Equity multiples for an auto supplier should be roughly 8%-12%, the shares again look attractive at this price.
- Bear Case Scenario:, We stress tested the CPS thesis should there be a downturn in the global economy. We assumed that global auto production declines by 3% in 2014 and another 3% in 2015 and this decline is reflected in all of CPS’s markets. To provide perspective on CPS’s primary markets, this would imply that 2015 auto sales in the United States and Western Europe combined would be roughly 26.7 million units (v. 25.4 million in 2009). Furthermore, we assume that CPS takes no share and that pricing remains flat. Finally, we lowered our fair EBITDA multiple from 5x to 4x (vs. peers currently trading at 6x-7x). Using these assumptions, we arrive at a value of $39 per share, ~21% below the current price. Management execution and pricing pressure from OEMs also present potential risks, although management is competent and many OEMs have become more flexible around supplier pricing after their old practices of “not giving an inch” contributed to the financial distress of many suppliers during the recession (in some cases, OEMs had to pump money into their suppliers in order to keep them afloat).
- Base Case Scenario PLUS Market Share Gains: It is expected that OEMs consolidate their supply base in light of the shift to global platforms. As the global #1 Sealant supplier and #2 Fluid Handling supplier, CPS should take share in such an environment. While this theme is well understood by auto analysts and is showing up in CPS’s tooling receivable, a few comments from CPS’s three largest customers provide further context behind it:
The overall consolidation amongst suppliers is an accelerating trend that should benefit CPS materially. For example, even a 1% share gain for CPS across its core product categories (Sealing, Fuel & Brake, Fluid Transfer) would result in nearly $60 million in incremental EBITDA which at a 5x multiple implies an additional $16 in share value. Through various efforts to triangulate data, we believe that the company’s growth in tooling receivable might indicate a 2-3% share gain on contracts offered over the past two years across the industry. Furthermore, since one of the benefits to automakers of global platforms is ‘scaling’ their tooling expenditure, volume per dollar of tooling expenditure might be on the rise. To the extent that the OEMs are scaling their tooling investments over higher volumes, the growth in tooling receivable on CPS’s balance sheet might reflect even higher share gains. This is promising to the blue sky value even though we have not factored this into our base case analysis.
- Sale of Anti-Vibration Business: CPS has stated that it intends to exit the anti-vibration business. Expectation is that this business does roughly $20-$25 million of EBITDA on $300 million of revenue. Based on recent auto parts supplier transactions, it might attract $100-$150 million in a sale. Importantly, it consolidates CPS’s operations for a potential strategic sale (see below).
- Refinancing Debt: CPS currently has $650 million of debt ($200 million callable on 4/1/14 and $450 million callable on 5/1/14) with interest payments of $53 million per year. The interest rate is 7.375% on the $200 million tranche and 8.5% on the $450 million tranche. Assuming that CPS can take in $100 million from the aforementioned asset sale, the company could reduce debt to $550 million and lower its leverage ratio to 1.5x. CPS should be able to refinance the remaining debt at lower rate which could reduce CPS’s annual interest expense by $25 million per year compared to today’s levels (our base case assumes a reduction of $18 million). In fact, management has indicated that debt refinancing is a priority due to the accretive impact this will have on earnings and FCF.
- Improved Shareholder Communication: Following the Analyst Day, a number of holders met with management and expressed their dissatisfaction with the detail presented as well as management’s failure to communicate the one-time items in the Q3 earnings release. These failures in investor communication may relate to an impending asset sale or may simply reflect the company’s lack of experience in communicating with investors. We believe management will soon begin to place more emphasis on investor communications.
- Sale of the Business: We view this as a real possibility in the next 2-3 years (see below)
A Possible Sale of CPS to either an Asian Strategic or TI Automotive
- Asian Strategic: By mid-2014, CPS will have a clear course into the future since (1) the anti-vibration systems business will likely be sold, (2) the debt will likely be refinanced, (3) the Serbia facility should be ramping up materially improving European operating performance, and (4) the remainder of the business should be performing at more “normalized” levels. Therefore, by the summer of 2014, the company should be better positioned to sell the global footprint and backlog to a strategic acquirer. Specifically, Jeff Edwards has an extensive network in Asia and many Asian strategic acquirers would view CPS as a path to access many markets. Due to the strategic and synergistic benefits likely to be realized, a premium to the 5x EBITDA multiple assumed in our Base Scenario is probable.
- TI Automotive: Within the auto industry, it has been speculated that a transformational merger between TI Automotive and CPS makes strategic sense. It would combine the two largest global fluid handling businesses and create a “niche giant” with strong positions in both fluid handling and sealants. While a part of the combined business might need to be divested for anti-trust concerns, the prospective synergies would be significant. Currently, Oak Tree essentially controls TI Automotive and recent reports indicate that Bain is close to getting financing for an acquisition of TI at around 5x EBITDA (or perhaps a bit higher). Should this acquisition occur, Bain might seek to acquire CPS. A combined business capable of doing $7.5 billion of revenue and $1 billion of EBITDA annually would command a higher multiple. Should Oak Tree not find a strategic buyer for TI Automotive at the right price, this would open up the prospect of direct negotiations between Oak Tree and Silver Point to combine CPS and TI Automotive.
In summary, we believe that CPS shares offer a solid margin of safety where only a global recession or auto market collapse would impair capital. The upside in terms of profitability growth, multiple expansion, and the prospect of a strategic sale provide a compelling upside opportunity relative to downside risk.
- Sale of Anti-Vibration Business
- Refinancing Debt
- Improved Shareholder Communication
- Sale of the entire Business
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