Value Play: Vishay Precision Group (NYSE: VPG)

The latest Wall Street craze is splitting up companies through spinoffs. Hewlett-Packard just announced a spinoff of its enterprise servicing business from its computer and printer business, while eBay plans a spinoff of its PayPal division next year.

In the late 1960s, conglomerates were all the rage as they were viewed as a way to diversify revenue streams and make corporate earnings smoother from year-to-year. Since investors hate uncertainty, the thinking was that a conglomerate’s more stable earnings and “synergies” would obtain a higher market valuation. The common wisdom proved wrong as conglomerates ended up becoming unfocused behemoths that were nothing more than a bunch of unrelated, second-rate businesses. If one of the businesses was a high-growth star, its higher-deserved valuation often went unrealized because investors became distracted by the conglomerate’s other slow-growth businesses. Ever since the 60s, investment bankers have convinced corporations to break up into specialized and focused companies so that the higher valuations of the most profitable business units would be recognized by the marketplace.

Focused and Independent Spinoff Companies are More Profitable

If focused companies do a better job, they’ll win more business, make more profits, and command a higher valuation. Joel Greenblatt of Gotham Capital in his funny-sounding book You Can Be a Stock Market Genius, writes that spin-off companies outperform other stocks. He points to a 1993 Penn State study that found spinoffs outperform the S&P 500 by an average of 10% per year  in their first three years of independence. Similarly, a 1999 McKinsey & Company study also found that spinoffs produced returns in the first two years of independence of more than 27% annualized! I’ve never forgotten what Joel Greenblatt wrote about the “stub” stock in a corporate reorganization (what I think of as the “ugly duckling” portion of the reorganization) usually being the best investment:

If the common stock of XYZ after the recap (usually referred to as the stub stock) were to trade at only $6, the price/earnings ratio would be down to 5. That’s usually much too low. It’s no science, but a new price/earnings ratio of 8 or 9 wouldn’t seem unreasonable.

The stub stock is where you can make the big money. Essentially, investing in the stub stock is just like investing in the equity portion of a publicly-traded leveraged buyout. Many leveraged buyouts have returned five or ten times the original equity investment, and several stub stocks have produced similarly spectacular returns.

(Emphasis added)

According to Greenblatt, the best time to invest in a spinoff is not immediately:

Spinoff stocks perform better in the 2^nd year after the spinoff, not in the 1^st. Greenblatt explains this behavior saying that it takes time for it (now with a new plan and probably a new staff) to implement the changes that can put the company on the right path.

What this means is that investors should not be anxious to invest in the Hewlett-Packard spinoff when it becomes available, but should be looking for past spinoffs that have already taken the time to “work out the bugs” and are now ready to execute their growth plans.

A Seasoned Spinoff Ready to Outperform

Vishay Precision Group (VPG) is one such “seasoned” spinoff that is primed for future outperformance. The company was spun off from semiconductor manufacturer Vishay Intertechnology (VSH) in July 2010. In the press release announcing the spinoff, the rationale was greater focus and flexibility:

Vishay Precision Group will have enhanced potential as a stand-alone company as it is not a core component of Vishay’s overall operations, in terms of products, technology, manufacturing processes, markets and customers.

The spin-off would enable the management teams of both companies to better focus on the unique issues facing their respective businesses and permit each company to pursue its own business plan, resource allocation and growth strategies, as well as attract the best personnel through compensation that is more closely tied to the performance of each company. If the spin-off is completed, Vishay is expected to be a more competitive, pure-play discrete electronic components company.

With this separation, Vishay Precision Group will have more autonomy and flexibility to allocate resources for its future growth, and investors will have better clarity into the financial, market and business dynamics of the measurements and foil resistor businesses, which have not been fully realized as part of the larger Vishay organization.

As expected, the VPG spinoff has outperformed the VSH parent starting from the beginning of the second year of its independent existence:

VPG Has Beaten VSH

Source: Bloomberg

Since it began trading on July 7, 2010, VPG has appreciated about 50 percent, which is good, but not as good as S&P 500 index, which is up about double that amount. But here’s the thing: we don’t care about the past, only the future, and VPG is so cheap and growth oriented that it is primed to significantly outperform the S&P 500 over the next few years:

VPG is Primed to Outperform the S&P 500

Source: Morningstar

Vishay Precision Group is a leading provider of sensors and sensor-based systems for high precision measurement of force, stress, weight, pressure and currents, all of which are built on its proprietary “resistive foil” technology. The company generated $240.3 million in revenues last year and has three business segments:

Vishay Precision Group’s Three Business Segments

Source: Company 10-Q Filing (p.16)

The company’s end markets are diversified so that it can make money in any part of the business cycle. I also like the fact that VPG has some steel-industry exposure, because it allows the Value Portfolio to remain in steel even after selling GrafTech:

Source: Investor Presentation (Oct. 2014)

The geographical source of business provides VPG with an additional level of diversification:

Vishay Precision Group Grows as a Non-Cylical

Although the specific purpose and details of the company’s industrial products may be hard to understand for laymen, the important thing to remember is that these products are in heavy demand by all sorts of industries and the government, which means that Vishay Precision Group will do well if the economy — or government spending – do well. Since government spending tends to increase when the economy needs stimulus and tends to wane when the economy is strong, VPG is not considered a “cyclical” company but a “slow growth” company, which can succeed in all types of economic environments.

Catalyst: Fundamentals are Improving and Yet Valuation is Cheap

Since its spinoff in July 2010, revenue growth in the high single-digits has been consistent, whereas earnings growth has been inconsistent thanks to some one-time charges involving acquisition purchase accounting and the costly implementation of an enterprise resource planning (ERP) software integration system. But with those charges now behind the company, earnings growth should become much stronger and consistent. For example, in the recent second-quarter financial report, VPG grew quarterly earnings year-over-year by 150%. CEO Ziv Shoshani stated:

The global business environment remains strong. This is supported by our solid backlog. We believe our results validate our strategy of increasing shareholder value through product innovation and internal operational improvement, while we continue to pursue acquisitions. In light of the continued market demand, we expect net revenues in the range of $61 million to $66 million for the third quarter of 2014, despite the normal seasonal slowdown that is inclined to occur during this period.

The last sentence of his statement is important because it indicates that business is so good and positive revenue momentum is so strong that the seasonal weakness that normally occurs in the third quarter will not occur this year.  

In the Q2 conference call, several analysts were impressed by the company’s financial performance:

Analyst No. 1:

“It’s been quite some time since we’ve had such a relatively good outlook in a seasonally weak quarter.”

Analyst No. 2:

“This most recent quarter was not an outlier. There is nothing one-time in nature that caused the elevated profit margin in the quarter.”

Analyst No. 3:

“From $245 to $260 million is sort of the [annual revenue] run rate, it sort of annualizes at $37.5 million of EBITDA and you look at your enterprise value, you guys trade under four times EBITDA with a 19.5% free cash flow yield for a business that is not cyclical. And you are either sole sourced or dual sourced in almost everything you do. And you look at the landscape and you’ve got the acquisitions out there and the peers are 11 times EBITDA. Why wouldn’t you guys just tender back your shares at four times EBITDA, I mean [acquisitions] just don’t make sense from a capital structure perspective, you’re so undervalued relative to the market.

(Emphasis added)

With analyst “interrogators” like those three heaping praise, what company needs an investor relations department? Very positive evaluations of Vishay Precision Group from the analyst community, which should encourage the average investor to jump on board now.

Based on the trailing 12 months EBITDA, VPG is trading an enterprise value-to-EBITDA ratio of 6.7 but, as analyst no. 3 points out, if you annualize the revenue and EBITDA from the most recent second quarter, the ratio is even cheaper at 4.

Bottom line: Vishay Precision Group is extremely cheap!

Founder Family CEO and Significant Insider Ownership

I’m a big fan of founder-family CEOs and Vishay Precision Group qualifies in spades. Chairman Marc Zandman is the son of Vishay Intertechnology’s late founder Felix Zandman and CEO Ziv Shoshani (page 11) is Felix Zandman’s nephew and Marc Zandman’s first cousin. Family members have passion for their company’s success and take a long-term, value-creating perspective.

Shoshani was the chief operating officer of Vishay Intertechnology prior to the spinoff and Marc Zandman remains the chairman of Vishay Intertechnology, so the parent and spinoff do not have totally separate management teams as some spinoffs do.

As for insider ownership, Vishay Precision Group has a dual-class share structure, with 12.73 million class A shares with one vote each and 1.03 million class B shares with ten votes each. The Sandman family trio consisting of Chairman Marc, his mother Ruta, and CEO Shoshani, collectively own a tiny 1% of the class A shares, but own 76.8% of the class B shares, which constitute 34.3% of the company’s total voting power (page 16). The family’s collective economic interest is 6.7%, so it has a much larger voting interest than economic interest, but both interests are substantial in the sense of aligning the Sandman’s financial interests with the average minority shareholder.

Marc Sandman is only 52 years old and Ziv Shoshani is even younger at 47, so the family management team is vigorous with many decades left to grow the business.

VPG is a Strong Buy

When you combine passionate family management, a cheap EV-to-EBITDA valuation, a strong balance sheet with a low 10.7% debt-to-capital ratio, and an accelerating earnings-growth profile with a non-cyclical, diversified industrial customer base throughout the world, you’ve got a winning investment.  

Vishay Precision Group is a buy up to $20; I’m also adding the stock to my Value Portfolio.

Value Sell Alert

To make room for Vishay Product Group, Roadrunner is selling:

• GrafTech International (GTI)

On September 23rd, the steel-related company shocked analysts when it issued severely-reduced  cash-flow guidance for the remaining two quarters of fiscal 2014, blaming “a weakening in graphite electrode demand” in its Industrial Materials division and “weak end-market consumer electronic product launches” reducing shipments in its Engineered Solutions division. In other words, both of the company’s two main business segments are failing. Furthermore, the company announced that the increasing uncertainty of demand in all of the company’s end markets is making it impossible to issue forward guidance in the future. Although the headline 22.8% reduction in EBITDA guidance from a midpoint of $142.5 million to $110 million appears survivable, the picture darkens after realizing that the positive $110 million EBITDA figure excludes $199 million  in one-time charges. Let me emphasize that these charges are extraordinary and do not include the interest, tax, and depreciation charges that are normally excluded from an EBITDA calculation. Including these extraordinary charges yields an EBITDA number that is negative $89 million. 

As a value investor, I am willing to be patient and give companies time to work through temporary problems as long as the income statement continues to show a profit and the balance sheet is strong. Since GrafTech’s cash-flow warning, the stock has collapsed by 47% and is currently trading at 3.88 — less than half its $8.55 book value as of the end of June. Looks incredibly cheap, but keep in mind that $450 million of its $1.16 billion in shareholder equity is inventory, a substantial portion of which is likely to be written off thanks to the weak demand for its products. Even if all of this inventory was written down to zero, however, the stock would still be trading around book value. Tempting, but the deal-breaker for me was the news that Moody’s was downgrading GrafTech’s junk credit rating  of Ba1 to an even more junky Ba2.

The combination of negative EBITDA (I don’t accept the company’s removal of impairment charges) and a weakening balance sheet is too much pain to endure. Furthermore, a Piotroski financial score of only 4 and an Altman-Z bankruptcy score under 1.0 are red flags. The most successful small-cap stocks are those that are both cheap and exhibit improving fundamentals. Since GrafTech’s fundamentals are deteriorating, not improving, the company may not be strong enough to wait out the weak steel business cycle. Lastly, the fact that GrafTech is an industrial stock and a cyclical — two attributes which are over-represented in the Roadrunner Value Portfolio, the principle of portfolio diversification advocates selling the stock.

The recovery potential of GrafTech is enormous, but so is the risk. If I didn’t have a 20-stock limit for the Value Portfolio, I would be tempted to hold on for a recovery. But can I honestly say that GrafTech is one of the best small-cap stocks out there, such that it deserves one of the 20 portfolio slots more than a healthier company? Not a chance.

GrafTech International is being sold from the Value Portfolio.

Momentum Buy:

NuStar GP Holdings (NYSE: NSH)

NuStar GP Holdings is the general partner and 15% owner of NuStar Energy L.P. (NS), which has interests in 82 terminal and storage facilities with approximately 91 million barrels of storage capacity; and 8,643 miles of crude oil and refined product pipelines. NuStar GP Holdings is a rumored takeover candidate.

• Price gain between 12 months ago and 3 months ago = 94.40% (99th percentile)
• Price gain over the past 2 months = 3.78%
• Price gain over the past month = -1.30%
• Roadrunner Momentum Rating: 94.40 – (3.78) – (3*-1.30) = 94.52

NuStar GP Holdings is a buy up to $50; I’m also adding the stock to my Momentum Portfolio.

Momentum Sell Alert

To make room for NuStar GP Holdings, Roadrunner will be selling an energy non-operator acreage play that has suffered from reduced oil prices and insider selling.

• Panhandle Oil & Gas (PHX)