Visteon - a take-out is the next leg to this capital-return story post HVCC sale

Wrote this up a while back when stock was $102+. Could be interesting if it keeps drifting. Target is $120+ if they close the deal and do buybacks at current levels. End-game is that they get bought. CEO pretty studly. Crowded though and absolute upside not huge. Definitely a dance-while-music-is-playing stock.

Thesis

·         Currently at $4.4 Bn market cap, VC had been on a simplification warpath over the last 4 years and delivered significant shareholder value – and we are coming to the last leg of this story as it reached a deal to divest its whole 70% stake in the climate business. Assuming deal close in 2Q15, VC can return 60% of its market cap (70% if it takes in 1-turn of leverage) quickly and should meaningfully shield any downside (as buyback increasingly accretive as price drops). Currently the stubCo implies ~5x EV/EBITDA (Peer @ 7-8x) while growing 8-9% top-line and rapidly approaching peer margins with favorable secular trend and strong market position. The ultimate sale of the remaining company is not out-of-question. $130 PT at 7x FY16 #’s (30% up), $140-160 in a take-out scenario, downside muted without deal-break due to buy-back accretion.

Business Overview

·         Post the transactions, Visteon will be a pure-play auto-electronics business, the #3 player in cockpit electronics (10% market share), #2 player in driver information (22% market share) and #2 player in instrument clusters (19% market share). Management has guided to total revenue of $3.8B by 2017 and 10% plus EBITDA margins supported by a solid net new backlog of business ~ $500MM.

·         Sales by product are comprised of Instrument Clusters and Displays (57% of sales), Audio and Infotainment (27% of sales), Vehicle Electronics (10% of sales) and Controls (6% of sales).

·         36% EU, 29% NA, and 32% Asian Pacific.

·         34% Ford, 14% Nissan/Renault, 9% Mazda, 6% BMW, 5% Honda, 5% GM and 27% Other.

Why does this opportunity exist?

·         Deal risk remains on the table.

·         Event fatigue: VC had been a “crowded” event name for 4 years & many refuse to look due to “missing it”

·         Complexity remains for traditional screen to pick it up; noisiness in forward #’s won’t clear until deal close.

Developments and Considerations

1.     Significant capital return is in-sight and should meaningfully shield any downside.

·         On December 17^th 2014, VC announced that it will sell its 70% stake in Halla Visteon (or ~75% of VC’s prior EBTIDA composition) to a consortium by Hahn & Co (a PE firm) and Hankook Tire Co. Ltd. The transaction translates to a very nice ~10x multiple and should tax-efficiently return ~$3.1 Bn of cash to VC upon closure. Deal is scheduled to close in 1H15.

·         Upon closure, VC will return ~$2.5-2.75 Bn of cash to shareholders. This is ~60% of VC’s current market cap.

·         If the buyback occurs at this level (~$100), The pro-forma VC trades at 5.3x FY16 EBITDA. Assuming 7x, the stock should be worth $130 / share post buy-back. While path-dependency is clearly important (i.e. 7x will get us a lower target if buyback occurs at higher price), the accretion math still works at until $115 / share.

2.     Execution track-record & secular trend provides comfort to growth & margin targets.

·         VC is known to set a low bar then top it – beating EBITDA guidance for the past 4 years and 14 out of 16 quarters. It has also executed on all simplification promises since Tim Leuliette took the CEO role in late 2010

·         Going forward, management had guided to 7-8% top-line growth w/ EBITDA margin hitting 9%+ by 2010.

·         While seemingly ambitious, the cockpit / interface market where VC competes offers a favorable secular trend: the dashboard / cockpit design and interface offers a point of differentiation amongst many OEMs while vehicle-based specs approach homogeneity. There is a clear trend towards digitalization (have you noticed the much cooler dashboards in new car?) and increasing demand for infotainment functionality, and this trend can easily drives 3-4% growth via content ASP/car + 2-3 % growth in broader penetration / share gain for years to come. It is estimated that cockpit electronics market will exceed $50 Bn w/ a 10% CAGR by 2020.

·         This all compares to underlying vehicle growth estimated for this period at ~1.5-2% per annum.

·         Bottom-line is, as a strong #3, there is no reason why VC cannot achieve peer-level 9-10% EBITDA margin – and the trajectory is clear w/ a visible secular tailwind + synergies from recent YFV & JCI acquisitions.

·         I think a decent comp with somewhat similar growth would be HAR which trades at 9-10x forward EBITDA.

3.     While currently not spoken of, strategic interest for VC stub could surface.

·         The next leg after closing the HVCC deal, getting interior divestitures behind, and integrating the 3 electronics pieces may be potential talks on a PE/strategic buy-out should valuation remain muted.

·         Post a sizable capital return problem, VC will stand at ~$1.8-2.2 Bn market cap w/ little debt. A very palatable size for any buyers looking to enter into this fast growth, low CapEx niche.

·         CEO himself will net a ~$40 mm package upon CoC termination (w/ $32 mm being accelerated vesting). While he extended his contract to 2017, I view this 3 year window a perfect opportunity to pamper VC up for sale w/ cleaned up EBITDA at the peak of the cycle (esp. w/ leverage amongst peers at record low since 2000), and marking the most rational full stop to a very successful turnaround.

Risk / Mitigations

·         Deal Risk: closing should be quick (3-5 months) but is still subject to market conditions clearly. I do believe the deal is well-shopped for a year and Hahn as a Korean firm is the most logical buyer w/ a strategic.

·         Macro: Weak auto demand, Asian and European recession, currency, raw material cost increases.

·         Potential transformative acquisitions: Mgmt had guided to shareholder return 1^st and foremost and see no big acquisitions down the road, but this could change 1 year out.

·         Path dependency: The best scenario for VC is if it stays at $95-$100 until buyback is complete – the accretion there will be materially accretive; however, if VC rallies to $115+ pre-deal-close, the then-commenced buyback will be less accretive and will result in lower PT.

Event Path / Catalysts

·         Feb 23, 2015: 4Q14 earning

·         April 30 – June 30, 2015: HVCC Deal Close.

·         April - May 2015: Update on Capital Allocation Plans post deal close.

·         June 2015 – June 2016: Capital Return commencing.