By John Rolfe :
The bull case for Horizon Global Corporation ("Horizon," "HZN," or the "Company") is straightforward. The business trades for a 7x multiple of current cash EPS. If the Company can hit its operating targets, it is trading at less than 5x 2019-20 EPS. These are attractive multiples in a pricey market for a business with a mid-teens ROIC and significantly higher ROEs. Horizon is a levered equity that should benefit from the current coordinated global recovery. Sentiment on the name is horrible, so any positive news flow should benefit the shares. Lastly, the debt and equity markets appear to be sending conflicting signals about the future of the business, with the debt market decidedly more sanguine.
First, some caveats. Horizon's management team has disappointed multiple times over the past 12 months, and many shareholders feel burned. Pessimists on the name believe that following a recently-announced acquisition of Brink Group, Horizon will primarily be a highly levered proxy for the health of the towing/trailering market. There is merit to this argument. However, that said, the most recent sell-off is overdone, Horizon's issues are fixable and the news flow is likely to be incrementally positive over the near-to-medium term. Management has not distinguished themselves recently. At best, they have been overly optimistic in their communication and too ambitious with respect to the pace at which they believe they can deliver organizational change. Recent senior management changes indicate that they are beginning to address these issues.
Horizon manufactures and markets towing, trailering, and cargo management products. These products include hitches, wiring harnesses, ball mounts, brake controls, jacks, winches, cargo carriers, roof cross bar systems, and luggage boxes. Company brands include Reese, Draw-Tite, and Westfalia. Horizon sells/distributes through three primary channels: OEM, aftermarket (retailers - both specialty and mass market, independent installers), and retail/e-commerce. The Company is a top 2 player globally, and together with competitor Curt Manufacturing they control about half of the global trailer/towing market. The markets served by Horizon have benefited from the increasing popularity of SUVs, as SUVs tend to do significantly more towing/trailering/hauling activies than passenger cars.
An abbreviated timeline of the Company's history since coming public is instructive in understanding why shares trade where they do today:
- Jul 2015: Horizon is spun out of Trimas Corporation. Stock comes out in the mid-teens, subsequently trades as low as the mid-8s as Trimas holders dump.
- Mid-2015 to mid-2016: Management executes well in first few quarters as a public company. Shows steady progress towards stated mid-term milestone achievement of 10% segment operating margins. Trajectory of margin improvement is ahead of market expectations. Stock trades up into the mid-to-high teens.
- Aug 2016: Company announces acquisition of Westfalia from Deutsche Private Equity. Westfalia is a primarily European provider of trailering/towing products. Deal value of approximately $200mm. Mgmt claims acquisition multiple of 10x trailing EBITDA, but 4x pro forma for cost takeouts w/in three years.
- Late 2016: Management continues to raise full-year guide w/release of 3Q 2016 earnings. Shares trade as high as $25/shr.
- Jan 2017: Company sells combination of stock and convertible debt. Stock sells off into the offering into the high teens. Equity piece is priced at $18.50/shr.
- Mar 2017: Full-year 2016 results announced. 2017 guide provided, and it is well below consensus. Much of the negative delta appears to be result of Westfalia acquisition coming in materially below expectations. Management pushes back, claims that original disclosure of Westfalia EBITDA (and associated purchase multiple) was based on IFRS nums that allow capitalization of R&D, while newer "updated" numbers reflect GAAP requirement of full expensing. Market doesn't like the explanation/excuse…stock sells off into low-to-mid teens.
- Aug 2017: 2Q 2017 results announced. Guidance raised. Shares trade up into mid-to-high teens.
- Oct 2017: 3Q 2017 results announced. Results are messy/noisy. Stock promptly trades right back down to where it was prior to 2Q results.
- Dec 2017: Company announces acquisition of Brink Group, a Netherlands-based global provider of trailering/towing products. Deal value of roughly $200mm. Mgmt claims acquisition multiple of 9x current EBITDA, or 6x pro forma for cost takeouts w/in a few years. Shares hang in current trading range in low-to-mid teens.
- Jan 2018: Company takes down 4Q 2017 (and by extension, full year) guide. Shares drop 35% over subsequent week to current $8.25.
There are a few relevant takeaways from this history. First, this is a lumpy business. Guidance has been taken up, and it has been taken down. Broadly speaking, guidance and results volatility has been the result of two drivers. The first of these is sales volatility, particularly with respect to the retail channel. On multiple occasions, management has pointed to customer destocking as a driver of downside quarterly sales volatility. As an aside, it is worth noting that the business has been consistently exceeding expectations in the OEM channel. The second primary driver has been messiness and/or misexecution with respect to operational restructuring. Since the spin, management has been relatively aggressive with respect to restructuring multiple elements of both the manufacturing process and the distribution footprint. These results have caused hiccups in the quarterly financials. With respect to the former issue (sales lumpiness), my take is that this is a characteristic of the business that you have to accept, and factor into your assessment of fair value. This is not a high-quality business deserving of an aggressive multiple; I'd characterize it as an average business (low double digit ROICs, high teens ROEs). With respect to the latter issue (restructuring), I'm more oprimistic. It is true that management has been overly rosy in its assessment of the speed at which they can manage meaningful organizational change. Their guidance on timing associated with margin progression has clearly proven overly aggressive. However, I would argue that while their timeline may be aggressive, they do typically eventually reach their goals.
M&A activity is another area that deserves discussion. At a minimum, communication over the Westfalia deal was massively botched. Management maintains that it did not initially mislead investors (via the IFRS/GAAP EBITDA discrepancy), but judging by stock price and sell-side reaction, most investors disagree. That said, the Company has continued to find cost takeout opportunities at Westfalia, putting it within the 4x pro forma EBITDA guide that was initially disclosed. There has also been some unhappiness over the recently announced Brink deal. Bears cite the healthy multiple being paid (EBITDA multiple @ 9x face, 6x with full synergy credit) and the unfavorable leverage profile HZN will have post-deal. These are both valid points. Returns on the deal clearly remain to be seen. Management has never been shy in its stated desire to build the business through acquisition, and this is a characteristic that you have to accept if you plan on owning shares. Qualitatively, the Brink deal has a couple of advantages: i) it will both lower HZN's overall reliance on the cyclical OEM channel and diversify the customer base in that channel, and ii) it increases overall exposure to higher margin and higher value-add products, which HZN can ultimately feed through its other channels and geographies. It is also worth noting that Brink is not a fixer-upper situation. The business has a strong management team and a strong margin profile, and should require little in the way of restructuring activity. Lastly, I do see a silver lining. While the consolidated business will likely be levered north of 4.5x post-Brink, this level of debt will impose discipline on the management team in the near-to-medium term, as they will be forced to optimize existing operations in order to maximize cash flow and pay down debt, as opposed to taking their eye off the ball and pursuing additional tuck-in M&A activity.
Interestingly, there has been a significant dichotomy between the equity and debt markets' recent outlook for HZN. While the stock was selling off hard on the 4Q preannouncement, management was out meeting with lenders in order to replace and upsize the existing term loan facility, so as to provide the necessary cash to finance the Brink acquisition. A little over a week ago, it closed on the new facility. The new term loan is for $385mm, and bears interest at LIBOR+500bp, with a 1% floor on LIBOR. This rate actually represents an improvement over the prior term loan's LIBOR+600bp rate. In addition, the new facility has more lenient covenants than the existing term loan, with the maintenance covenant moving from 5.25x to 6x, and a material decrease in the amortization schedule. I consider the relative optimism of the debt markets to be a more timely indicator of Company prospects than the equity markets, given that lenders have had more recent interaction with management.
There also seems to be concern in the marketplace that management may undertake an equity offering. I think this is highly unlikely, certainly at current price levels. While an equity offering may be in the Company's future (given their predilection for M&A), I'm confident that they're well aware that shareholders who bought into the Jan 2017 offering feel badly misled by the sequence of events since that time. Based on my conversations with them, I think that they feel that there is a soft line in the sand at the offering price ($18.50), below which they realize that if they offer equity, it may effectively shut off future market access.
It's always hard to know when a stock has fully capitulated. Are we there yet with HZN? I don't know, but I feel like there are a few mild causes for optimism. First off, the sell-side appears to have finally thrown in the towel. The two sell-side analysts who have covered HZN the longest have now taken their price targets down to levels at/near/below where they were when they first launched coverage soon after the Company came public. All other sell-side analysts have reduce target prices meaningfully as well. Second, out year sell-side estimates now have the Company with an EBITDA margin of roughly 9.5% in 2019. This is 250-300bp below management's prior consolidated target (extrapolating from their 10% consolidated operating margin target). I am cautiously optimistic that a more reasonable bar may now be set against which execution will be measured. More than 30% of the float has traded out subsequent to the guide-down; this is a sizable number. And, lastly, it feels like the scale of the sell-off (35%) on a roughly 10% operating income guide-down feels excessive.
Management is in the process of putting together a detailed remediation plan, which they expect to disclose on the 4Q 2017 earnings call in early March. I expect medium-to-long term guidance to remain largely unchanged w/respect to achievement of a 10% consolidated operating margin target, although I think it likely that the timeframe on this gets pushed back to 2020. The first concrete step towards addressing the current issues was the recent announcement of a new President of the America's division (the source of many of the recent operational missteps).
Today (pre-Brink), HZN is trading at 6x EBITDA and 7x cash EPS. The Company has a bit over $10mm in annual acqn-related amortization, which works out to $0.30/shr. I am adding this back to get to my "cash" earnings. I think that the core (pre-Brink) business is growing, and I believe that management will confirm this on the upcoming call. 7x cash EPS is cheap for a growing business, albeit one that's cyclical, in the current coordinated global growth environment. A broad group of other US-based auto supplier comps trades at 7x EBITDA and 11x EPS, respectively (see below). If Horizon's business can actually hit management targets for a 10% consolidated operating margin in the next few years, then the business is extremely cheap. In that case, it probably approaches $140mm of EBITDA and $2.00/shr in cash EPS. That would put it at 5x on both enterprise value and cash EPS multiple, respectively. If reality lies somewhere in-between the current run-rate and management targets, the stock should do well from here.
- Timing. In the past, notwithstanding quarterly results volatility, management has generally been able to get operational issues fixed within a couple of quarters. To the extent it takes longer, earnings suffer as a result, and any recovery gets pushed into the back half of the current fiscal year, the stock could mark time or take another leg down from here. The cadence of any potential recovery is unclear.
- Leverage. As mentioned, pro forma for Brink leverage will likely peak between 4.5x and 5x. This is high. Although I believe it should become more manageable reasonably quickly (i.e. high 3s w/in 12 mos), a combination of operational execution and demand tailwinds will be necessary to make this happen.
- Demand. Currently, Horizon has some tailwinds in its favor, including a coordinated global recovery and favorable consumer trends for trucks/SUVs (which have a higher take rate on towing equipment). The outlook, though, is not all blue sky. Consumer savings rates in the U.S. are low, a function of spending outpacing income growth. This trend can not persist indefinitely. Vehicles are (obviously) high dollar items and we may be past peak demand vehicle in the U.S. The OEM business is key driver for Horizon.
- Management. Probably the biggest question mark. Credibility is an issue.