Introduction
synergies associated with the pending HSN transaction, improved free cash flow generation associated with the
pending exchangeable debentures reattribution, outsized share buybacks, further traction with zulily, or
improvement in the Company’s new markets including France and China.
This Year’s Class of Index Orphans
Autoliv, Inc. (ticker: ALV, $126.28)
Autoliv, Inc. is the world’s largest automotive safety supplier and generated $10.1 billion in total net
sales during 2016. The passive safety (78% of sales) business has a 39% global market share across its key
categories (seatbelts, airbags, etc.) while the electronics business (22%) has strong positions in its respective
businesses. Despite Autoliv’s U.S. incorporation and U.S. listing, we believe that the Company is an
underappreciated business (it is excluded from key S&P indices because of its foreign domicile) and that the
recently announced decision to separate the Company could help to highlight its value. A number of factors
should enable Autoliv’s passive safety segment to generate strong future growth including emerging market
vehicle growth, the prospect for increased safety content per vehicle, and strong new order growth with ALV
commanding over 50% of the share of new orders over the past 2-3 years. The Company’s electronics segment
has disappointed investors in terms of both revenue and profitability, but its prospects are looking up and the
business stands to be a significant beneficiary as the movement toward autonomous driving gains traction. At
current levels, we believe that investors are effectively purchasing ALV’s passive safety business at a nearly
10% discount to private market value and are receiving the Company’s high-growth electronics business for
free. Our conservative intrinsic value estimate for the electronics business in the near term is roughly $23 a
share, but could be worth upward of $100 per current Autoliv share longer term.
Axalta Coating Systems Ltd. (ticker: AXTA, $28.29)
Shares of index orphan AXTA recently sold off after reporting disappointing results. With the stock
trading at a compelling valuation, we view AXTA as slightly more attractive today than at the time of our initial
profile (June 2016 at $25.38). AXTA’s private equity overhang has been lifted, and the coatings industry
appears ripe for further consolidation. AXTA is the world’s fifth-largest supplier of industrial coatings. AXTA’s
largest business, refinish coatings (50% of EBITDA), is one of the best and highest margin businesses within
coatings. Overall end market growth in coatings has slowed in recent months, but M&A activity has picked up.
Deal multiples for large companies (like AXTA) have significantly expanded to mid-teens on EBITDA, due to
scarcity value and competition from private equity, while those for smaller companies remain around 10x.
Trading at 11.5x depressed 2017 EBITDA, AXTA stands at the sweet spot of M&A. If the Company were to be
acquired, AXTA could command 13.5x-15x. As a buyer, though, AXTA can continue making bolt-on acquisitions
at attractive multiples. We believe AXTA should be able to sustain mid-single-digit EBITDA growth over the long
term. On our 2020 EBITDA estimate, AXTA trades at an attractive 8.7x. We estimate AXTA’s intrinsic value to
be $41 per share (11.5x) at the end of 2020, for 46% upside. Moreover, AXTA shares come with an embedded
call option on a takeover. We project AXTA’s private market value to be $50-$57 per share at the end of 2020,
offering 79%-104% upside. Index inclusion is an additional catalyst.
Hostess Brands, Inc. (ticker: TWNK, $13.43)
TWNK’s predecessor parent companies made 2 bankruptcy filings in less than 10 years due to
operations plagued by high costs, unmanageable liabilities, and an inefficient business model. However, the
Company was purchased by private equity investors out of Chapter 7 in 2013, and significant restructuring and
investments have been completed that position the firm for sustainable long-term growth. The new Hostess
generates over $700 million in annual revenue and has an EBITDA margin of approximately 30%. The firm’s
more efficient operations are supported by a revamped manufacturing approach, a new distribution system, and
an overhauled product line. Since its first full year of operation after emerging from Chapter 7 in 2014, TWNK
has increased its revenue by over 35%. However, TWNK remains omitted from stock market indices, and
eventual inclusion in one or more indices could be a potential catalyst. Despite having margins and organic
growth that exceed its competitors, TWNK trades at over a 25% discount compared to peers. In our view, there
is no fundamental justification for such a valuation disparity. Our $20 estimate of intrinsic value assumes
multiples that are consistent with the historical trading range of industry peers (13.0x EV/EBITDA, 25.0x P/E,
applied to 2020 projections) but that are a meaningful discount to current valuations for TWNK’s competitors. It
is also worth noting that TWNK could eventually be an acquisition candidate, and recent transactions within the
industry have been priced at an average multiple of approximately 15.0x EV/LTM EBITDA.
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Introduction
Sinclair Broadcast Group, Inc. (ticker: SBGI, $29.65)
Sinclair is the largest local TV broadcaster in the US with 173 stations in 81 markets and $2.7 billion in
annual revenue. Sinclair is controlled by the four sons of founder Julian Sinclair Smith (51% economic and 81%
voting control collectively), which has kept it out of the S&P indexes. It’s not just passive investors that Sinclair is
struggling to attract. SBGI shares are down 30% from their March 2017 highs and are flat since mid-2013,
reflecting negative sentiment toward the broadcast industry, concerns over the Company’s relations with Fox
(which appear overblown), and selling pressure related to a pending merger. Sinclair ($3B market cap, $6B EV)
is awaiting regulatory approval to complete the transformative acquisition of Tribune Media for $6.3B. Sinclair is
acquiring Tribune at a bargain price (~6x core EBITDA), which could be ~20-40% accretive to FCF and nearly
double Sinclair’s scale. In addition to realization of merger synergies, growing broadcast retrans fees could lead
to a re-rating of SBGI shares in the coming years. Even conservatively assuming <1% annual core advertising
growth and valuation multiple contraction to 6.5x EV/EBITDA (2020/21 avg.), or 7x FCF, we derive a year-end
2020 intrinsic value estimate in excess of $47 per share. Additional long-term upside opportunities include
regulatory reform, incremental M&A/accretive capital deployment, successful development of nascent
cable/multicast channels, and the deployment of a new broadcast technology standard (ATSC 3.0).
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