Thermadyne Holdings is a turnaround story since emerging from Chapter 11 in 2003. The company has been flying below Wall Street’s radar due to its niche market, small market capitalization, and Chapter 11 filing. We think, at present multiples, the company has an easy 50% upside from its current quote.  This view is based on the stock price’s substantial discount to its peers, the improved quality of its earnings, and the leadership of the CEO, who is value-oriented and motivated.  Furthermore, a predictable business with substantial recurring revenues and strong brands combine to offer a solid holding in the current macro economic environment.

 

Business:

 

Thermadyne is a leading global manufacturer and supplier of cutting and welding products targeted to serve $11 BB global market across Americas (30%), Europe (30%), and Asia (40%).  The company’s products fall in the following broad categories:  Gas equipment (market leadership position with 50% of the market in US); arc accessories (market leadership position with 40% of the market in US); plasma cutting; welding equipment; and filler metals.  Gas equipment and arc accessories contributed to approximately 60% of company’s 2007 sales.  The new management, since return from bankruptcy, has diversified its revenue base by expanding internationally and by steadying revenues in the USA.  Conceptually, company sales strategy is similar to Gillette’s Razor-Razorblades, wherein 15% of sales are for durable products (“razors”) at margin of 32% with the rest of sales for filler metals, consumables, and torches (“razorblades”) at up to 47% margin.   These “razorblades” are non-discretionary and provide a stable and recurring revenue stream.

 

The company adopted a three-tiered brand strategy to drive profitability.  The products are categorized as Professional (superior product preserving brand power, resulting in increased pricing power); Cutskill (quality product for value oriented customer with competitive pricing); and Firepower (targeted for price conscious customer).  Furthermore, the company strives to position itself ahead of its competition by developing innovative products, as evident from the fact that it holds 208 patents.  The company serves currently strong market segments such as infrastructure, energy, mining, agriculture, and heavy industry markets and limited exposure to residential and commercial building HVAC and plumbing markets.  Therefore, general malaise in US economy has limited affect on company’s performance as discussed later.  

 

 

Under current CEO, Paul Melnuk, the company is laser focused on the bottom line by:

 

 

As a turnaround plan, the company adopted a global continuous improvement program referred to as TCP and promoted the foreign sourcing of manufacturing.  The effect of the plan has improved gross margin from 26% to current 33% range.  Below are quarterly snapshots of the company’s turnaround since returning from bankruptcy and with Melnuk as CEO.

 

 

Due to the above listed reasons, the company is ramping up its gross profit each passing quarter.  In addition to the increase in margins, the company has recorded consistent growth in its top line, thanks to its strategy of exploring new untapped international markets with its superior and branded products.  With its turnaround complete in FY 2007, the company foresees a substantial improvement in its margin percentage, as described by Melnuk in August 2008 quarterly call:

 

“However, the most exciting aspect of where we are today is that we are just beginning to scratch the surface of the opportunity for growth from within the company and from the industry”. 

 

Also, the company has been successful in passing on increases in commodity costs to its customers.  The company is introducing new products since end of FY 2007, which is gaining momentum in all the geographies it serves.  This in turn is developing a steady market for its high margin consumables.  Starting in 2008, the company instituted a forward purchase commitment with its vendors, increasing visibility, and better planning to lower input commodity costs.   We suggest taking a look at the company’s presentations on its website.  The company has been consistently paying down its debt as shown in table below:

 

 

As evident from above data, the company has been consistently improving its performance in all the metrics.  The ratings agencies have taken notice and recently upgraded the company’s credit rating.  Also, with leverage ratio less than 3, the company’s debt costs will come down by 50 basis points coming quarter.  At present, the company guides for long-term gross margins to expand to 36% and EBITDA margins in the range of 16%-19%.  We believe, going forward, motivated management will continue to implement a gradual and sustained turnaround driving PPS higher.  The conference calls featuring Melnuk suggests he is a value oriented manager with long-term vision for improved business performance.

 

Valuation:

 

Thermadyne’s operates in a niche industry supplying entire suite of welding products and consumable industrial goods.  Per the most recent 10K, the company lists three large full-line competitors:  Lincoln Electric Company, a Charter PLC subsidiary, and divisions of Illinois Tool Works.  The company successfully competes with large and small competitors based on superior brand recognition, performance, functionality, price, and customer service and support.  Also, the company focuses on innovative industry leading products in their niche product areas.  The company employs approximately 100 employees in development of new products to meet customer needs.  Most products are sold through a network of approximately 100 national and international industrial gas distributors like Airgas, and Praxair, Inc.  Company maintains excellent relationships with these distributors, some lasting over 20 years. 

 

Due to high predictability and limited number of large players and large operating histories, companies in this space trade at EV/EBITDA of 10.  The players have remained the same for many years, barring a few mergers.  International competitors have not had much success in penetrating US distribution channels.  The company is undervalued today based on company’s conservative estimate of adjusted EBITDA for 2008 and a share price of $20; the company is trading at an EV/EBITDA multiple of about 6.  If history is any guide, the company under Paul Melnuk has consistently under-promised and over-delivered.   Even though EBITDA margins have improved substantially since 2005, they are only half way towards the current publicized target of 19%.  Furthermore, the majority of company’s top-line growth of 8% to 10% will drop to the bottom-line due to successful management initiatives like TCP. 

 

Thermadyne’s current capex requirements are about $15mm to $17mm.  Most of company’s cash flow goes directly to reduction of debt.  Per my estimates, the levered free cash flow for 2008 and 2009 increases to $34mm and $43mm from $18mm for 2007.  Also, the company qualifies for lower effective taxes of about 23% as the company utilizes NOLs of $122mm and $15mm in foreign tax credits. 

 

Based on the above and the fact that the company is market leader in major segments in welding industry, we believe current shareholder could easily gain 50% from the current quote the in next 18 months just to get even with its industry group.  Any further improvements in its turnaround strategy will contribute additional upside to current quote.  Jeffrey Gendell’s recent 13F shows Tontine Partners have initiated new position of greater than one million shares in this thinly traded stock.  Angelo Gordon has owned 1/3 of the company since 2005.  Also, insiders have scooped up 250,000 shares earlier this year, demonstrating confidence in the company’s business.