NN Inc ($NNBR) — Initiation (4/23/21)

They recently held an investor update which lays the story out pretty well… This post will essentially rehash that update with my commentary sprinkled in.

Here’s the quick story in a nutshell:

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  • New management team came in
  • Cost cutting program cleaned up cost structure
  • Leverage was running pretty hot at >6x EBITDA
  • Sold life sciences business (surgical tools, instruments, etc.) for $825m to bring leverage down to 2-3x (including preferred stock)

So we’re off death’s door and avoided bankruptcy — sure, the stock is up from it’s lows in early 2020 but it’s not really reflecting the progress that’s been made on the turnaround.

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Company overview…

NN operates 2 segments — Mobile Solutions and Power Solutions — making products mainly tied to the automotive industry with some industrial, electrical, and aerospace applications as well. Mobile solutions (known as Autocam) makes things like fuel injectors and steering systems.

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Many of these product lines have some exposure to the conventional gasoline-powered automobile — management highlights this exposure as “ICE Dependent” (internal combustion engine). Today, this end market makes up 28% of sales. Probably the key risk to the stock as most folks believe we’re headed for wide adoption of electric vehicles. Good news is there is plenty of exposure to non-ICE revenue streams here (though I believe this end-market has many many years of time ahead).

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Even with the ICE exposure, management is rolling out a new multi-year plan targeting

  • $600m in 2025 revenue — from $428m in 2020) for a 7.5% CAGR (a 4% CAGR from 2019 revenue level)
  • $100m in 2025 EBITDA — from $46.5m in 2020
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NN feels the newly focused segments are playing into “megatrends” in smart grid offerings and vehicle electrification. They are steering away from the goal of building a multi-industry conglomerate and leaning into what they’ve got.

Financial summary…

They recently pulled together a fairly significant recapitalization of the balance sheet following the divestiture of the life sciences business. This summary reflects those changes:

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As a bonus, if the recently divested Life Sciences business returns to 2019+ performance in 2022, it should net an earn-out payment of up to $70m to NN — this isn’t (and shouldn’t be) reflected in the balance sheet or valuation.

Nothing tells the story of NN better than a long-term cash flow statement…

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In the past, NN attempted to build a multi-industry conglomerate… They acquired into bearings, plastics, engineered metals, medical, life sciences, etc. Along the way, they were forced to divest businesses, raise debt, and raise equity to pay for all of the portfolio shuffling they were doing. In late 2019, a new CEO/CFO came into the picture with an toward reducing debt and refocusing the company on the core businesses.

So while this cash flow statement looks like a mess that you wouldn’t touch with a 10-foot pole… It deters the average investor from digging into what should happen next — organic growth and much smarter uses of cash going forward!

As for future capital allocation, I see 2 primary focus areas right now:

  • Continued debt repay — Debt is at a manageable level but they still have some expensive preferred stock from the refinance — my guess is they’ll want to eliminate that in the next 1-3 years
  • Tuck-in acquisitions — They’ve made it clear there won’t be anymore “transformational” M&A — expect smaller deals that add to the existing businesses

Valuation…

Q4 EBITDA grew 40% off of 7.5% revenue growth and Q1 should look similar. So 2021 estimates of $60-70m in EBITDA seem reasonable. Net debt is $140m so NN is currently trading at ~7x EBITDA.

That multiple is in-line with other lower-quality auto suppliers like Magna (MGA), BorgWaner (BWA), and Adient (ADNT) which all trade at 6-7x 2021 EBITDA.

Other competitors like Gentex (GNTX), which makes dimmable mirrors, and Visteon (VC), which makes climate control products, trade at 10-12x EBITDA.

Here are a few scenarios that could play out in 2021-2022 based on where EBITDA could land — remember that 2020 produced $46.5m in EBITDA and 4Q20/1Q21 saw excellent growth…

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Ultimately, I think NN will be successful in achieving their $100m EBITDA target by 2025 (or sooner). At a 9x multiple that nets a $900m enterprise value. I’ll assume they can keep net debt neutral but must reinvest all cash flow so net debt remains at $140m. This gets me a $760m equity value by 2025. Assume some dilution to 46m shares and you have a share price >$16 for a 20% IRR.

Summary…

This is starting as a normal-sized position in the General bucket for me. Somewhere in the 2% weighting neighborhood.

  1. The world sees NN as just another levered, run-of-the-mill supplier to the auto industry with a poor track record of acquisitions
  2. New management and major divestiture are refocusing this company on organic growth
  3. The story should catch on as fundamentals continue to improve — 4Q20 revenue was +7.5% and 1Q21 is pacing at +9%

I’ll want to see that they use cash as outlined but so long as they refrain from a major acquisition, I’ll let this one play out…