|Shares Out. (in M):||276||P/E||7.8x||7.2x|
|Market Cap (in $M):||1,227||P/FCF||6.1x||3.1x|
|Net Debt (in $M):||371||EBIT||229||243|
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Thesis Summary: Cookson (CKSN) presents an opportunity to buy a high quality industrial business with dominant global market share in niche products, significant pricing power, recurring revenue, and operating within high barriers to entry at a 45% discount to its intrinsic value. At the current valuation CKSN trades at 7% 2010 FCF yield and 13% 2011 FCF yield implying over 30% discount to its peer group. This discounted valuation that does not give the company any credit for its restructuring program and reflects CKSN's poorly understood exposure to macro headwinds and its ability to unlock value through asset sales. Strong operational performance will alleviate at least some of the macro concerns in the near future and will facilitate dividend reinstatement, helping the equity's appeal to a broader shareholder base. In the medium term, spin-off CKSN's highly cyclical electronics business will trigger multiple re-ratings and unlock additional value for the shareholders.
CKSN has two main business segments: Ceramics (59% of sales, 60% of adjusted EBIT) and Electronics (27% of sales, 33% of adjusted EBIT). The rest is made up by its small Precious Metals business.
Ceramics consists of four key product categories, each of which is a form of consumable product used in predominantly in steel and foundry industries as well as other industrial sectors. The products include steel flow control, lining materials, metal feeding systems, solar crucibles and others.
Electronics consists of two sub-divisions, Assembly Materials and Chemistry, each of which sells consumable products, such as solder based products, chemicals used in printed circuit board manufacture, etc. into consumer and industrial electronics markets. Volumes are linked to end market activity levels.
Why the Opportunity Exists:
Fear of a slowing Chinese economy. Perception: "Cookson's sales are levered to global steel production volumes. With China producing ~50% of world's steel, any slow-down in economic and/or construction activity in China would have adverse effect on CKSN's sales". Reality: (1) CKSN's derives 5% of revenue from Chinese sales of steel-related products. Even if CKSN's operation in China came to complete halt, the impact on EPS wouldn't exceed 6-8%. (2) CKSN's products are used in flat steel manufacturing processes. Unlike long steel, which is used in construction, flat steel is used in appliances and auto manufacturing. As a result, CKSN's sales in China are not only uncorrelated with construction activity, but are actually positioned to benefit from Chinese economic rebalancing towards consumption. Future steel industry consolidation (and re-tooling) position CKSN to grow revenues at rates exceeding those of overall steel consumption.
Double-dip recession fears. Perception: "CKSN suffered 48% trading profit declines in 2009 over 2008. Should the global economy double dip, the profitability will drop at a similar magnitude again". Reality: Steel production is a lot less cyclical than the recent recession made it appear. The 61% drop in the US steel production at the end of 2008 was the largest drop in over 30 years, and was largely driven by inventory reductions (destocking). Restocking from the rock-bottom levels has not yet occurred, and global steel inventories remain at 40 year lows. Consequently, a slump of a similar magnitude is unlikely to occur.
CKSN Management suffers a poor reputation Perception: "CKSN's management team has a propensity to destroy value by implementing poorly timed acquisitions and failing to prudently manage the balance sheet considering the cyclical nature of the business". Reality: CKSN's structural repositioning coincided with the recession. The management did, in fact, buy Foseco at a peak valuation in 2008. The transaction was funded with debt and the subsequent slump in profitability forced CKSN to do an equity rights issue and cut the dividend in order to repair its balance sheet and maintain liquidity. However, the acquisition of Forseco repositions the company for less cyclicality and higher future margins. The original plan, disposal of the electronics business, was derailed by the global recession, and management had to resort to damage control while waiting for their opportunity to realign the business.
I view the sale of Electronics as imminent, and therefore value CKSN on the sum of the parts ("SOTP") basis.
Ceramics have the following normalized mid-cycle EBIT margins: Steel Flow Control 17%, Foundry 12%, Linings 10%, Solar 15%, resulting in a blended normalized margin of 10.1%. On projected 2011 sales of £1,441m, normalized NOPAT is £145m. Considering the business characteristics, a premium multiple of 10-11x NOPAT is warranted, resulting in EV of £1.45bn for the Ceramics division.
The electronics business is highly cyclical, and because products become obsolete every 5 years, it requires constant investment. The normalized EBITDA margin for this business is close to 12%, and management believes that it can be sold to a strategic or a PE buyer at 9x EBITDA. Assuming 9x EBITDA exit multiple, on the 2011 sales of £651m, the business is worth £703m.
I do not assign any EV to the Precious Metals, but assume management will eventually move to liquidate it. This segment will remain a low priority as long it doesn't burn cash (currently generates ~£10m in FCF per year).
The SOTP EV of Electronics and Ceramics is £2.078bn, translating into equity value of £1.79bn, or 646p per share, implying 45% upside from the current share price.
On July 19th, 2010, Tomkins Plc ("TOMK"), a UK engineering firm comparable to CKSN, announced that it received a $4.37Bn (£2.87Bn) takeover approach from a private equity consortium lead by Onix, a Canadian PE firm. This is a first large PE transaction in the UK engineering space since the beginning of the economic downturn in 2008. The offer values TOMK at ~£3.00 per share, a 14x 2011 P/E, compared to 7x 2011 P/E for CKSN.
|Cookson Group Plc||436.8||1,207.5||1,597.1||8.5x||7.1x||5.4x||4.8x|
|Charter International Plc||700.5||1,163.0||1,153.5||10.9x||8.9x||6.3x||5.4x|
|Smiths Group Plc||1,115.0||4,356.2||5,275.8||14.6x||12.5x||9.8x||8.6x|
|IMI Group Plc||750.0||2,404.2||2,561.1||12.7x||11.3x||7.4x||6.8x|
|Premium/(Discount) to Average||(41%)||(40%)||(35%)||(35%)|
|Source: Bloomberg, all prices as of COB 7/21/2010|
|(£ in millions ex. per share)||2006A||2007A||2008A||2009A||2010E||2011E|
|Headline Net Income||89.2||107.0||124.6||45.8||143.5||156.9|
|Headline EPS (pence)||46.2||54.3||88.4||18.0||56.4||61.6|
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