Friday, July 1, 2011

Federal Mogul (FDML) - Long Idea

Buy: Between USD 20 and USD 22. Potential Value can go up to USD 32
Company: Federal Mogul (FDML) Trade: USD 21
Market Capitalization: USD 2.5bn; Shares Outstanding: Approximatly 100m
Industry: Industrial – Auto
Situation: Post bankruptcy play
Main Catalyst: Hiring of Lazard in Mar-2011, CEO Compensation structure, Cost basis of the largest shareholder, large cash position, unique business model & upside from Improving fundamentals, turnaround in auto industry business cycle
Probable timeline: 6 to 24 months
Main Shareholder: Carl Icahn. Acquired 75% equity through bankruptcy process

What can happen?

  1. Carl Icahn can potentially sell the entire company to entities wanting to participate in emerging market growth in addition to capitalize on the upturn in the upturn in the auto industry cycle in the US and EU.
  2. Carl Icahn can give up his controlling shares, thereby creating higher liquidity for FDML stock. This helps other potential bidders/ shareholders to participate in FDML upside due to the improving fundamentals. Furthermore, more liquidity makes it easier for a potential buyer to build up a stake in the company keeping M&A rumors alive and providing a floor for the stock.
  3. Third option is a possible deleveraging of the balance sheet and small acquisition accretive to earnings. A potential sale to 2012

     What are the catalysts for the Owners to sell:

    *       Carl Icahn who has approx. USD 1bn invested in FDML since 2008 has earned no dividend on his investments due to debt covenants. The only returns have been in the form of capital appreciation of stock. With his cost basis as USD 14 to USD 17 a share, this may be a good time to take some cash off the table. The point is further verified by FDML’s hiring of Lazard. Icahn is chairman of the board.
    *       Mr. Alapont, the CEO, agreed to an amendment to the CEO compensation structure in 2010. In the new compensation structure, the CEO gave up the put options he held on the original call options. He holds options on “4%” or “4m shares” of FDML. As of 2010, he holds only call options on 4m or 4% of FDML at strike price of USD 19.50. In addition to giving up the put, he extended his employment agreement until 2013.Mr. Alapont, the CEO, has been at the helm since 2005 and has led the company through bankruptcy. His options expire in 2014 and remain unexercised. In an event of sale or liquidation of stock, the CEO has an incentive to maximize the sale price.
    *       Turnaround in the auto cycle in the west and continued growth in Emerging markets might lure some buyers to pay hefty premiums.

    What are the catalysts for the potential buyers:

    *       Fundamentally, the company is doing really well. Good margins, 20% to 30% growth in emerging markets, substantial increase in net and operating income in addition to growth in YoY EBITDA margins. Company has USD 1bn in Cash and USD 2.8bn in debt. High cash is an added bonus for PE bidders.
    *       FDML’s business model gives any buyer unique access to both side of the markets, namely the auto parts after markets and the OEM markets. This dual access creates a hedge during potential market downturns.
    *       The board structure has been simplified since emerging from bankruptcy, meaning, annual meetings and no poison pills. Moreover, the structure now allows for a sale of the company
    *       A upside in auto cycle with added global growth for FDML serves as an added incentive
    *       2 Board members are former executives at Dana and Lear Corp, FDML’s direct competitors. They may help generate interest on the strategic side.

    Potential Value if the sale occurs:

    *       FDML’s 2011 fundamental value from competitive analysis and industry estimates can be approximated to be around USD 26 a share.
    *       An approximate 40% transaction premium for M&A deals within the Industrial sector in 2011 remain undiscounted.
    *       Additional value beyond the 2011 fundamentals and potential M&A come from FDML’s unique business model, furthering restructuring of the business, emerging market growth and improving business fundamentals that may still not be discounted in the share price.

    Downside hedge if the sale does not occur:

    *       Assuming that FDML is in active discussions, what might derail the process is a much higher ask price for the firm from Icahn. If that happens, fundamentals in addition to CEO compensation structure may provide floor to the equity price. Stock may see volatility in the short term

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