Titan International TWI
October 11, 2005 - 6:46pm EST by
evan73
2005 2006
Price: 13.28 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 257 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Tonight’s management buyout bid is a complete lowball at $18, a 35.5% premium to current price. TWI just became an arb play with potential for higher bidders and shareholder activism.

The following write-up we planned to submit to VIC tomorrow. Coincidentally just now, at 5:00pm on Tuesday Oct. 11th, Titan announced a cash offer for $18.00 per share made by One Equity Partners LLC. Richard Cashin Jr. is the managing partner of One Equity and has served on the board of Titan International for 11 years. In the press release, it was announced that Morry Taylor (Chairman and CEO) is also expected to participate. If you read the prepared write-up below, you will see that $18 is a low-ball bid and this is an attempt by management and the board to take out the company in the 11th hour of closing a corporate-changing acquisition. We expect that there will be significant shareholder concern, and this could be an excellent arb opportunity in which a higher bid is likely to emerge.

Titan is an under-the-radar industrial with nearly monopolistic market shares, a surprisingly good moat, hidden asset values, and growing free cash flows. Trading at 4.6x ’06E EBITDA with a 15.6% yield on ‘06E FCF, the stock is very attractively valued.

There are several potential near-term catalysts that could help drive the stock towards intrinsic value: the closing of the acquisition of Goodyear’s agricultural tire business, new labor contracts spanning the rest of the decade, the announcement of additional acquisition(s), and the initiation of sell-side coverage.

Titan manufactures wheels, tires, and assemblies for the North American off-highway market (mostly agriculture and construction). Currently 62% of the company’s revenues are from the agriculture market, 31% from earthmoving/construction, and 7% from consumer. The Company is expected to close its acquisition of Goodyear’s Ag. tire business in Freeport, IL in the next month. Titan currently has an 80% market share in the N. American wheel market and will have a 60-65% share of the ag. and construction tire market following the acquisition. Titan will have three production facilities: a non-union wheel plant in Quincy, IL, a unionized tire plant in Des Moines, IA, and a unionized tire plant in Freeport, IL. Titan has a frozen pension plan and de minimis legacy liabilities.

History
Three key issues in Titan’s history:
1) In 1998, the USWA initiated a strike that lasted 3 yrs. When concluded in late 2001, the union accepted the initial contract proposed by Titan in 1998. During the interim period, Titan rationalized production from 7 facilities to 2 and reduced its workforce by 200 at the striking plant. Upon the resolution of the strike Titan entered into a 5 yr. union contract running through 2006. With the closing of the Goodyear deal, both Freeport and Des Moines will enter into new 5 yr. contracts through 2010.

2) Titan had a step change in margins beginning in 2004. Following the labor force and production facility rationalization, Titan’s costs were reduced and it then changed the pricing structure for all its products. Starting in 2004, Titan stipulated they would make between 15-20% gross margin on all SKUs sold. Titan’s largest customer, John Deere, entered into a 3yr. supply agreement running through Dec. 2007.

3) In Q1 2004, Titan IPO’d its European subsidiary. Titan retained 29% ownership. Q1’04 is the last quarter in which Titan Europe was included in consolidated results.

Asset Values
Titan has valuable hidden assets that are not fully reflected on its balance sheet or in its market valuation:
- Market value of TWI’s ownership of Titan Europe is $45MM.

- PP&E classified as available for sale with a book value (when first classified) of $37.8MM. Not included in these assets available for sale, the Company has a 1.2mm sq. ft. idled facility in Natchez, MS.

- $13MM purchase option on the 1mm sq.ft. Brownsville facility and land which has an appraised value of $30MM, $17MM of value.

- Restricted cash of $24.5MM related to an appeal of a patent infringement suit in the California state court. Titan was prevailed twice in federal court regarding this lawsuit. Even if Titan loses the appeal, $8.5MM (less court interest) will be returned to Titan as unrestricted cash.

- Titan also has a $9.2MM note receivable from Titan Europe due in 2009.

- Finally, in Titan’s acquisition of Goodyear’s Freeport facility, they purchased $46MM of inventory. Morry Taylor believes a significant amount of this is excess inventory, around $20MM.

This adds up to $153MM, we are conservatively assuming 50% of this value -- $77MM. To be clear, we don’t believe all of this asset value will be realized in cash (e.g. Titan Europe stake), but it is real economic asset value that is not generating any associated cash flow. As an additional kicker, management believes that the maintenance of these idled assets costs $6-7MM annually to pay for utilities, security, etc. Once these assets are disposed of, these savings would flow to free cash flow and earnings.

Barriers to Entry
Foreign competition in the on-highway wheel market has been intense as readily seen by the challenges facing companies like Hayes Lemmerz and Superior Industries. Why should the off-highway market be any different? Off-highway users of tires and wheels have much more diverse needs and conditions under which they operate their equipment. As such, Titan produces 20,000 different wheel SKUs and 1,400 different tires. In fact, the wheel business is more like a custom job shop than an automated manufacturing business. The wheels and tires are one of the few things a farmer can customize when purchasing a tractor. The high number of SKUs and frequent low-volume production runs make foreign producers less competitive. Management claims that the manufacturing equipment, tooling, molds and dies needed to produce their products would cost over $1B – prohibitively expensive for a competitor wanting to enter the market to nibble away at Titan’s dominant market share. Finally, shipping costs are significant on wheels due to their weight (125 -7,000 lbs) and on tires because they are large and bulky, not efficiently packed into a shipping container.

Acquisitions & Growth
Titan plans to purchase the Goodyear business for $100MM – $46MM in inventory and $54MM in PP&E. Using management’s assumption that the Goodyear plant will do $35MM in run-rate EBITDA, Titan will pay 2.9x EBITDA. Titan is assuming no post-retirement liabilities, is employing 68% of the employees (500), and has negotiated more favorable hourly wages and work rules. The deal has effectively been given the green light by USWA union leadership in Pittsburgh and the close is pending approval of work rules by the local union. While the closing deadline was just recently postponed (again) to November 1st, negotiations seem to have made progress.

Titan is simply the only willing and capable buyer amidst a market full of sellers looking to raise cash. Titan has the potential to make significant additional acquisitions in the next 12-18 months. Some likely targets are as follows:
Continental OTR (‘off-the road’): On Sept. 26, a “Tire Business” article stated that Titan has begun talks to buy Continental’s OTR tire business that serves the mining industry. Continental says this unit does about $150MM in revenue.

Goodyear OTR: Goodyear is also looking to monetize its unprofitable OTR tire business. Titan has expressed interest in this asset with estimated revenue of $175MM.

Firestone Ag: This plant is in Des Moines, only 6 miles from Titan’s plant. Firestone has had numerous problems with the union and recently granted a 1 yr. labor contract expiring in July ’06. Titan has expressed interest in this plant, and many in the industry believe they will buy the business after Firestone lets the union contract expire in July. Firestone Ag. has estimated revenue of $250MM.

All of these businesses reportedly burn cash, largely due to high labor costs and inefficient operations. On the other hand, Titan runs Des Moines and (upon closing) will run Freeport with a rationalized workforce, no pension or OPEB costs, and more efficient work rules enabling it to generate substantial cash flow from these assets. If the union’s leadership comes to realize that more USWA jobs will be preserved via Titan rolling up the industry, rather than the shuttering of unprofitable plants, acquisitions could be completed with increasing facility. This would not be dissimilar to what Wilbur Ross was able to achieve with ISG on a much larger scale. Management has stated a goal of having over $1B in revenue by FYE 2007. Given the revenues of the assets listed above, and assuming that TWI could acquire at valuations comparable to the Freeport plant, the value accretion could be remarkable.

Projections and Assumptions
LTM 6/30/05
$493.2MM Revenue
$38.6MM EBIT
$61.8MM EBITDA
$2.8MM Capex
$22.8MM FCF
$33.6MM Adjusted FCF (excluded changes in wking. cap. and normalized cash taxes)
15.7% Gross margin
6.6%: SG&A margin

Pro-forma FY’06
$800.3MM Revenue
$62.8MM EBIT
$85.1MM EBITDA
$9.0MM Capex
$40.3MM FCF
15.7% Gross margin
7.5% SG&A margin

To reach $800MM in revenue we assume 2.1% y/y revenue growth on the base business for 2H’05, so far in 1H’05 revenues have been up 13.5% y/y. We also assume run-rate revenue of $250MM for the Freeport plant, per management’s guidance. This gets you to pro-forma FY’05 revenue of $748MM. We then model just under a 7% increase in top line for FY’06 to reflect likely price increases.

We are also modeling a significant increase in FY’06 SG&A expense and margin to $60MM and 7.5% respectively, up from $32.5MM and 6.6% LTM. The new union contract that will apply to Freeport and Des Moines will likely be at modestly higher wages than under the current Des Moines contract. We think accounting for such a large increase in SG&A expense is overly conservative. Titan has about 600 employees at Des Moines, about 1,200 at Quincy, and will have 500 in Freeport. This implies an 85% increase in SG&A for a 28% increase in headcount.

As you can see above, capital expenditures are extremely low running at less than 1% of sales for FY’04 and LTM. Titan direct expenses much of what could be considered maintenance capex. In addition, they own a lot of spare equipment and parts from shuttered facilities that they use for replacements and repairs in their plants that are operating.

Valuation
$257MM: Mkt. Cap with 19.5mm shares out
$215MM: Pro-forma debt (currently $115MM)
$472MM: TEV
$77MM: 50% of cashable asset value
$395MM: Adjusted TEV

After accounting for the aforementioned conservative appraisal of cashable asset values of $77MM, TWI shares currently trade at 4.8x EBITDA. Even without acquisitions or growth, the current valuation looks cheap. At 7x FY06E EBITDA of $85MM, the stock would trade at $23-24. A $23-24 price would have the stock valued at 14.1x earnings with a 9% FCF yield. If Titan can achieve its longer-term goal of $1B in revenue, at LTM EBITDA margins of 12.5% and a 7x multiple, the stock would trade for $37. These valuation scenarios provide bookends for the potential upside on this sleepy industrial.

Management
Morry Taylor (60), nicknamed ‘the Grizz’, is the CEO and Chairman of the Company and owns 1.87MM shares or 9.6% of shares outstanding. Taylor started off as a die maker and has spent his career in manufacturing. He is not a wall-street polished CEO, nor would he ever aim to be. Your first conference call with him will undoubtedly involve curse words and war metaphors. In addition, he plans to spend a few hours working every manufacturing job alongside the employees at the Freeport plant upon taking control. He is somewhat controversial for his hard-line stance with the unions during the strike, a period in which TWI’s stock price declined to below a dollar. However, his principles in negotiating with organized labor and customers that dwarf him in size, have kept Titan’s cost structure inline and its margins intact. Without this unique but effective management, Titan would probably have ended up like so many manufacturers – saddled with a burdensome cost structure and thin margins, leading to bankruptcy and the loss of another 1,800 jobs in the mid-west. Instead, Titan is in a position to create additional value, grow the business, acquire factories, and preserve jobs.

Risks
- Goodyear deal falls through.
- Significant downturn in the agriculture market. TWI will have increased exposure to this industry post-Goodyear acquisition.
- TWI’s customers are more aggressive and successful at sourcing higher-volume SKUs overseas.
- Titan is somewhat dependant on Morry Taylor.

Catalyst

- Goodyear transaction closing.
- Additional acquisitions of assets at low valuations.
- Union contracts spanning the rest of the decade.
- Sell-side coverage
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