Tecumseh Products TECUA
December 18, 2006 - 9:11am EST by
tickles879
2006 2007
Price: 17.76 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 328 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

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.

Catalyst

Asset sales succeed with reasonable write-offs (Q1-Q2)
New CEO & additional cost cutting announced
Copper and/or Real cool down, lifting EBITDA mid- to late-2007
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