Sensata Technologies' CEO Presents at Morgan Stanley Technology, Media & Telecom Conference (Transcript)

Feb.25.13 | About: Sensata Technologies (ST)

Sensata Technologies Holding N.V. (NYSE:ST)

February 25, 2013 7:35 pm ET

Executives

Martha Sullivan - Chief Executive Officer, President and Executive Director

Analysts

Vance H. Edelson - Morgan Stanley, Research Division

Vance H. Edelson - Morgan Stanley, Research Division

Okay. Thanks, and welcome, everyone to the conference. I'm Vance Edelson from Morgan Stanley. I'm pleased to be joined by Martha Sullivan of Sensata, President and CEO. Thanks for joining us.

Martha Sullivan

My pleasure.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. So I thought we'd start with maybe one of the more top-level basic questions just in case there's any newcomers to the story in the audience. I've always thought that the history of the company and the inherent barriers to entry are part of what makes it such an exciting story. You're literary making millions, if not billions, of these little microprocessors, sensors and controls. And it'd be very tough for anyone else to get into that business. It would take years and a lot of money. So tell us a little bit about how the company got to be where it is, what the roots of the company are, and why it would be tough for anyone else to replicate what you're doing.

Martha Sullivan

Sure. Okay, just a little bit of a stroll down memory lane then. This is a business that's actually been around for a long time. So the forensics of the business go back some 90 years. We were actually acquired by Texas Instruments in the '50s, and that's really where we got our technology DNA. And so to answer your question, Vance, how did we get here? A lot of development around sensing technologies, mechanical, Double E, competencies in the business, a strong tech ladder, legacy that came from TI. And it's a business that really grew up with very much an engineer-to-engineer orientation with our customers that has always been there. We came out of TI in 2006 into Bain Capital at that time, actually went through an IPO in 2010 and since that time, our market cap has increased substantially. Our earnings have grown about 17% since 2010. And so we're enjoying our status as a standalone business and I think we have demonstrated our ability to perform very well in that light. But if you go back to the forensics of the business, the technology DNA that came from TI has been very helpful. We have been focused on emerging application growth for sensors in a variety of end markets, but predominantly the light vehicle and commercial truck market. And our focus is one of gaining share by getting in early into applications that are growing quickly, where mission-critical product is needed. And it is the nature of that product that the design cycles are long, that collaboration with our customers are intense and so that the competitive barriers, once incumbent, are really quite high. And so that's very kind of high-level how we've developed the position that we have.

Vance H. Edelson - Morgan Stanley, Research Division

So the sensors and control simply have to work and on average, they cost very little. So I always think of it in terms of, say, a General Motors. They've got airbags, they need to work, so it's kind of like why would they look anywhere else if they ever needed to cut costs or anything like that. So you have a little bit of protection from that standpoint.

Martha Sullivan

That's right, Vance. So if you look at the cost of our sensors or controls versus the system that they ship into, it's a pretty small cost of the overall. On the other hand, the validation time and the customized nature of the product, there was -- just is not a return to look at that as being a place for significant competitive tension or cost reduction.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. So let's talk about how that works into the visibility of the business because it's almost consultative. You're working with them. Your customers have to let you know well ahead of time what they need and when they need it. So tell us a little bit about how much visibility you have, how it manifests itself and your ability to project the earnings and so forth.

Martha Sullivan

Sure. It's a little bit different between the 2 segments of the business. We have a Sensors business, makes up about 70% of the overall revenue; and a Controls business [indiscernible] through business. The design cycles are approximately 3 years in nature, and that can be a little shorter down to 2 years, and in some cases, it can be 4 or 5 years, depending on how much reach there is in the overall development. The point is though, we're usually dealing with 8 seasons of validation. We're dealing with crash testing or emissions submissions that are our customers have. And so it's a very intensive long-design cycle time. The selection or the commitment to us happens early on when we're selected as the design end provider. And so that being the case, we are assured of the position and we provided a commercial proposal that is lifetime of the product proposal, with multiyear nature of the contracts. So that gives us very good visibility. It can be the case that programs push out or get pulled in, but we'll usually know that well in advance of production which, again, will happen 3 years later.

Vance H. Edelson - Morgan Stanley, Research Division

So on more of a micro basis, if Volkswagen is going to build 10,000 Passats, how early do they have to tell you that? You're working with them over the course of many years...

Martha Sullivan

Right.

Vance H. Edelson - Morgan Stanley, Research Division

But when they actually come to scheduling a production run, what kind of lead time do you have?

Martha Sullivan

Well, it is -- you look at the original launch and in terms of the launch timing, the size and scale of that launch has to be very well solidified within 1 year of the launch. And again, that's around scheduling production, making sure that the capacity is in place. And that would usually be fairly in line with the overall frame for the program that we would have seen back in that 3-year development timeline. And so it's just the nature of these businesses that the assets all have to be in place, that the cost of a missed schedule, that the cost of a quality miss at the time of that launch is pretty critical. So you don't have a lot of competitors who are able to deliver with that kind of performance.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. So let's shift gears a little and talk about some of the growth drivers. I've always thought what sets Sensata apart from a lot of the companies that it's normally comped against is that a lot of those companies are just cyclical, and that's all there is to it. You've got these secular growth drivers, really, a couple of them. So if we start with the content growth over time, tell us what that stems from? What you think the proper range is for a CAGR for content growth? And any chance that it's going to accelerate going forward?

Martha Sullivan

Sure. So for those of you that may be new to the Sensata story, when we talk about content growth, what we're saying is that regardless of how many vehicles are sold in the marketplace or how many trucks are consumed in any particular year, you're going to see more Sensata sensors on that vehicle -- on vehicles on average every single year. And the reason for that is, a lot of our content -- all of our content is driven by 3 major growth drivers: it's a need for more fuel efficiency, it's a need for a clean environment and it's increasing safety standards and safety content. A lot of those systems are responding to regulation that's in the marketplace. And we spend lot of time understanding where regulation is going, and how our customers will respond to it. And it's a wide range of regulation, so it's everything from a Euro 6 emission standard in Europe to a 54-mile per gallon requirement in the U.S. now that the EPA has mandated to China following on with Euro standards -- they're on about a Euro 4 time horizon, to emerging standards now around carbon dioxide emissions as the next wave of fuel economy mandates. That drives a need for new applications and infrastructure on vehicles and in powertrains, and even in subsystems like air-conditioning, which has to get more efficient. And that then drives down to what are the sensors that are needed in those applications and, again, the design cycles that we talked about. So we have the visibility. That translates, on average, for us to top line growth for Sensata between 7% to 10% over a 3- to 5-year horizon. We have had time frames where that's averaged below. We've had time frames where that has accelerated above. 2013 happens to be a year where we're seeing less content growth on average, and we believe, we recognize that, that is a phenomena of the European market which happens to be on the leading edge of regulation. And we saw some delays in the launch timing in '13. We saw those push out in 2014. We saw similar phenomena in 2009, where we were below average and 2010 was year of pretty strong recovery. So we're very confident that '14 is the year where we fall back into the range, whether or not we end up seeing ourselves at the high-end or even beyond that, I think we'll know more as 2013 unfolds.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. And tell us about why the level of content that exists in European automobiles, even though right now it's growing slower than you'd like, that might actually make you optimistic about the rest of the world when you look at the content level in Europe versus the U.S. versus China, for example?

Martha Sullivan

Great question. So if you go back historically and you look at things like cost of fuel in Europe, and you also look at emissions regulations, they have always been the drivers. They have had the most stringent standards and they've had real consumer drive around fuel economy as you can imagine. And as a result, you've seen most of the most fuel-efficient solutions emerge from Europe first. And then what we see is, overtime, many of those same solutions then emanating to other parts of the world. Now there are exceptions to that where we've seen places like Japan develop the first stop-start system or the first continuously variable transmission. And it is our job to get to those applications where they emerge in the market first and make sure we get to the next place in the globe where we're going to see that fan-out happen next. But a lot of that happens in Europe, Vance, to answer your question.

Vance H. Edelson - Morgan Stanley, Research Division

Okay, great. And then if we look at the Controls side of the business, that is a bit more cyclical. China has weighed on that business. What's the latest that you're seeing in terms of appliances and other unit growth in China that might eventually help your business pickup speed?

Martha Sullivan

Sure. One of the characteristics of our Controls business is it's serving a number of diverse markets. So we ship into appliance, HVAC, aircraft, even telecom, datacom, small appliances as well. One of the challenges that we have in that business is if you look at where we are in the supply chain, we have less visibility than we do in the Sensors business. And we tend to see our demand iterate above and below the actual nominal demand. So us understanding the inventory chain becomes very, very important. We had some problems in 2011 with a buildup of inventory in China. I think we've gotten savvy as a result about where to look for retail inventory and supply chain inventory. We think China inventories are in good shape right now, and we're seeing a stronger pull on constructed-related demand in China. So appliances and HVAC in particular have rebounded for us. The other thing that we watch closely in Controls is the PMI index because we think that's a short term measure of sentiment in Controls. And we've seen the PMI trend positively now for the last few months, and that's actually manifesting into a stronger demand for us. What we've got to make sure of is when that PMI turns down, if the demand continues, we're probably responding to inventory buildup. So that's the way we're looking at it right now. But feeling pretty good about the China demand.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. And I'd be remiss if I didn't ask the same type of question about European autos. I think on your most recent conference call it was described as still disappointingly sluggish and it's been that way for a while. When do you feel like you might actually have a pickup there? And can you differentiate by region? Is it stronger in the North versus the South?

Martha Sullivan

Yes. Europe is lackluster. There's just no question about it. We think what we're seeing now is a market that's really bouncing along the bottom in terms of the overall sales and demand. The really ugly regions that have been down are about -- are staying down. What we saw in the late half -- late portions of 2012 and we think we're still seeing, is that some degradation, even among the strong economies. So we started to see Germany, their comparisons to 1 year ago, begin to slow down. We saw that late in 2012. We're expecting that market to be down from a production basis about 3%, stronger in the first quarter, where we're dealing with a tougher comp back in the first quarter of 2012. And that appears to be very much in line with what our overall prediction was. It does end up being a market, and most of the automotives are, where we got pretty good order visibility, backlog visibility. Our backlog is lining up with the market the way we had called that.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. And if I remember correctly, in Japan, you've maybe got some headwinds on the automobile side in terms of year-over-year comps this year. Is that a bounce back from the earthquake?

Martha Sullivan

Yes. We dealt with a pretty strong production bounce back in 2012 -- in the first part of 2012. So that ends up having a production year that's down year-over-year, '12 to '13, so that's one of our challenges as well.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. So maybe one more question for me, then we'll poll the audience for questions. Out of all the companies I've covered, Sensata tends to have one of the highest margins. And I guess the flip-side is, maybe it's as high as it can get, which is nothing to sneeze at since it is an attractive margin. But do you think that there's anything that could push the EBITDA margin higher over time?

Martha Sullivan

Well, we really think that our margins should be in the frame of an adjusted net income. That's, we think, an important measure of the business, between 20% and 23% ANI. We're operating a little bit below that right now, and we've operated in that range before. So the near-term challenge is to complete the integration performance of some of our acquired businesses. We are consolidating another manufacturing site in Korea to complete that integration -- that consolidation and we think that we'll operate in that frame consistently over time. And prior to that is we have a variable cost structure. And so, if you look back on the downturn in 2009 when we suffered revenue contractions as a lot of companies did, our lowest EBITDA quarter was the first quarter of 2009. We were at 24% EBITDA. And that was our ability then to move quickly to size our cost and to align our costs with that reduced revenue level. The flip side is, when we see revenue increase, we don't see a ton of fall-through. We do see some, but we think it's really important to follow that fall-through back into our growth resources to make sure that we keep the content growth in place. So this is not a major margin expansion story, and I don't want to mislead potential investors with that thought.

Vance H. Edelson - Morgan Stanley, Research Division

Okay, let's pause for a second to have a question right there.

Unknown Analyst

I apologize, I came in late. I'm not sure if you answered this already. Can you talk us a little bit about what your balance sheet looks like today? What your targets are for tomorrow? What your capital return or capital allocation strategy is going forward?

Martha Sullivan

Sure. Our balance sheet is in really great shape. We have about $1.8 billion of long-term debt on the balance sheet. We think that's really appropriate. We've been a very leveraged business. So our ability to operate with a lot more debt is there, but we think given that we're a public company, we understand the appetite for leverage with our equity shareholders. We think staying in between that 2% to 3% EBITDA range -- net debt range is important. And that's where we intend to stay. We sit with about $400 million in cash on the balance sheet, and we're delivering at that same pace in 2013. So it does become the question of how do we make sure that we are strong capital allocators, and that is our ambition. We continue to believe that M&A presents the greatest opportunity to provide returns, and we've got a pipeline that's fairly robust. So between M&A, the share-back program that we announced in October of last year, $150 million share back repurchased -- we haven't executed a lot of that at this point. And we think there's really good opportunity to put cash to use to realize a strong return for our shareholders.

Vance H. Edelson - Morgan Stanley, Research Division

Great. Down in the front row. Microphone coming right behind you. There you go.

Unknown Analyst

There were some comments on the most recent quarterly conference call about expanding the scope of the type of targets you're looking at from an M&A perspective. Can you speak a little bit to that? And I know European auto has been a bit of a hiccup for the company or at least a headwind for the company in the last 18 months or so. Is that suggestive that you want to move somewhat outside of the light vehicle segment in terms of the acquisitions you're looking at? And maybe you can elaborate on that.

Martha Sullivan

Yes. Let me be really, really clear on this point. When I think about what we might want to do with M&A, and I think outside of automotive, it's a notion of the potential to dilute our automotive position, not to move away from it. And we think we do very, very well in auto. We think we probably will, from time to time, continue to find great opportunities in auto centers. It the world knows that, that's the business that we're in so we get to see opportunities. What we are recognizing is that there are good center opportunities and embedded electronic opportunities in adjacent markets beyond the light vehicle market. Some of those markets we serve today in our Controls business. So we're trying to be more fulsome in the way that we look at vertical markets. We're looking at markets that are influenced by the same growth drivers that we see in our light auto business. So for example, the need for energy efficiency, the need for safety standards. And we recognize that those are driving secular growth in other vertical markets, and we think that there are interesting targets and opportunities in play in those markets as well. So it is not at all an attempt to move away from the markets that we're in and light vehicle. And as I said, we'll continue to probably see opportunity and execute on those opportunities. We're really taking the proactive bandwidth that we have in the business and I'm making sure that when we look at markets beyond automotive for opportunities in M&A, and that we also increase the sort of the discipline in the process of developing that pipeline, so that we increase the probability of getting to some targets and an executing on those over the next several months.

Vance H. Edelson - Morgan Stanley, Research Division

Another one right here.

Unknown Analyst

Can you just talk a little bit about why customers likes Sensata on the upfront to be the design provider? And how you think you're differentiated and then maybe if you have any comments on win rates on some of that business?

Martha Sullivan

Sure. I'm going to actually answer the second one first. The win rates, we actually hold ourselves to an 80% hit ratio, and so that is on design wins, we track every single month, what -- how many times did we come up to bat? How many times did we win? And are we at that 80%, and then we look at the Pareto of why we didn't win and why we won. To answer the question of why we win, it really is a collection of competencies and the waiting on any individual by decision on those competencies can move around. But let me talk about what they are. First of all, it's a very strong track record of being able to deliver, number one, flawless launch execution; number two, great product performance and that's really, really key. You've got to have the product that the customer wants at the performance level that they want. Lifetime economics of the product, really important. So the ability not just to be viable upfront, but to deliver the kind of economics our customers need over the lifetime of the product.

Global deployment. I talked about the fact that we recognize an application the first time it happens in the world, and then we look all around the world to see where it will happen next. Our customers are increasingly global and very often, we are the glue that will hold the launch together. They'll want to do it first in Germany and then on to China. They may be moving to Brazil. We are positioned there and we're very connected to each other in those locales. So that global deployment is a really important piece. And then there are other things that -- around relationships that become, I think, very, very important as well. So those are the big ones. Quality performance, absolutely imperative, kind of a given in the market that we're in.

Unknown Analyst

I've got 2 very different questions. Firstly, can you talk to us about currently what is the dollar content of sensors, let's just say that the dollar market in western Europe or in U.S. right now in an automotive, in a car?

Martha Sullivan

Sure. So it's a little bit different by geography. Our highest dollar content region is Europe. So it sits at about low-$30s on average across Europe.

Unknown Analyst

$30.

Martha Sullivan

Yes, that's right. And in North America, you're in the low-$20s, very similar to that in mature Asia. When you get to China, you're talking about $8 to $10 of content positioning across the fleet. And that can be as low as $2, and in China, it can be as high as very close to even to the European standards if you're inside of a multinational joint venture. So there's quite a range on -- in China on what that can look like.

Unknown Analyst

The second question is can you talk to us a little bit about what the synergies are between the Sensors & Controls business? Because from the outsider looking in, they seem to be very different. And so, I guess, from the profile -- from a public company profile, have you ever considered if the synergies aren't great potentially separating those 2 businesses?

Martha Sullivan

Sure. If you think about the business model -- start with the overall business model and there's some really interesting interdependencies between the business. Controls is the portfolio that takes us first and early into emerging markets. And when I say early, we've been in China since the early 1990s, wholly-owned in the mid-1990s. That gave us a position and a line of sight way ahead of any of our auto competitors and we were doing business in China. And the reasons that happens is that the Controls portfolio takes you into infrastructure build, takes you into white goods, and as that economy develops and you begin to see an indigenous auto market, we're there very early and it's very easy for us to have a position there. So we do think that, that's important. The back end of Sensata is highly, highly integrated and highly leveraged. So if you walked into any of our manufacturing facilities, you would see a Sensors line right next to a Controls line and that does a lot for us. One of the things it does is we have different seasonality in the business. We're able to take our team that works on a line in the Sensors business and if we see a seasonal turndown on that, we can move them into other parts of the business. The skills to work in those operations are very, very similar. The ability, I think, to understand markets more broadly is actually a little stronger on the Controls side of the business because we are used to multi-vertical market management. And I think that's probably something that we have under-levered a bit, and are looking at pretty closely going forward. So could you carve it out? Could you break it up? It would be open heart surgery, but you could probably do that and it is something that we've thought about from time to time.

Vance H. Edelson - Morgan Stanley, Research Division

Going back to his question on the content per vehicle in Europe, it averages around $30. What about the most high end or most sophisticated vehicle? Is that the way of the future? Is there anything out there above $100, for example, per vehicle?

Martha Sullivan

There are some platforms that are above $100. And it's interesting, some of those are very, very high-end platforms. But some of them are also the way the customer has decided to address the fuel economy challenge. So we talk about the Volkswagen TDI Diesel a lot. It happens to be a platform where they have a pressure sensor in every single cylinder on that engine. And they have a break-in system with our product. And they have an air-conditioning system with our product. So that will average in way up beyond the $100. I want to be careful because I don't want to set the expectation that's where the whole market is moving. But we can show you examples of each. We can show you examples in Europe on a sort of a low-end gasoline engine where you would probably see us down in the low-teens, those -- that's sort of how you average.

Vance H. Edelson - Morgan Stanley, Research Division

So it can have more to do with the fuel line and the drivetrain as opposed to amenities, for instance?

Martha Sullivan

That's right. Yes. I would say it's much less about convenience features.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. Great. Right there.

Unknown Analyst

I know that Sensata had a legacy strength, particularly in the pressure-sensoring business, and you've made acquisitions in the temperature and in the position-sensing business. Have you been able to grow those on a same-store basis at the same types of rates you enjoyed in the positions -- in the pressure sensors, I'm sorry? And then just in terms of why are those adjacencies not something you were able to do on your own? Why were those needed to be acquired since you obviously had a history at least in one subsegment of the Sensor business.

Martha Sullivan

Sure. On the 2 businesses, a little bit different, and I'll start with the HTS and the Sensor-NITE business. One of the things that attracted us to that business is that it really was growing content very close to our average, and it was doing that focused solely and very narrowly in Europe. So we completed that acquisition at the end of 2011. We have been able to secure design-ins outside of Europe. Keep in mind the design cycle is the same as Sensata's. So we'll see the realization of those opportunities out in that time frame. So that one I think progressing very well, and growing at a rate that was pretty close to Sensata's rate anyway. That particular acquisition is exposed -- highly exposed to Europe. So the end market dynamic is offsetting some of that content growth, but it's performing well from a content perspective. The MSP business out of Honeywell, a little bit different. That was a business that had not seen R&D investment for a while -- for a couple of years. Was actively not making capital investment. So we knew that was one we were going to have to replenish the portfolio and then get it to Sensata content growth. We've done -- we've brought in a much stronger R&D team. Again, we've had some design-in wins on that front. I would say it's not yet at the Sensata overall average. I think that it will get there. I think that one's going to take time. From a margin standpoint, that business happens to be very close to the overall Sensata. So the -- we made the investment thesis on that solely on the cost basis with the content growth being an option for upside. To answer you question though, "Why didn't we just go do that ourselves?" It really comes back to this notion of the end market that we play in with these mission-critical sensors, incumbency accounts for a lot. So we could have gone at that space very hard with organic growth and 15 years later, we might have the position that you get by starting with critical mass and building on some stock. That's why we make the acquisitions that we make.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. According to the shot clock, we have time for one more quick question.

Unknown Analyst

What's your market share in China and what are the dynamics? How do see the dynamics playing out in China over the next, like, 5 or so years?

Martha Sullivan

I missed that first part of that question.

Unknown Analyst

What's your market share in China?

Martha Sullivan

Market share. Our shares in China, I'm going to give it to you on Controls versus Sensors. On the Controls business, we actually parse the shares into 2 different segments. We look at our share with multinationals, and we look at our share with what we call Chinese emerging producers. Our share with the China emerging producers is at about 34%. Our share with the multinationals is about 65%. Four years ago, our share with the Chinese emerging producers was single digit. So that share focus, growing our shares in Controls with the emerging producers is a really important growth initiative inside of Controls. On the -- China's overall Sensor market share is -- that's a little tougher to describe because the overall content level is actually pretty low. So what we would be measuring in that share are mature sensors that have been in that market long before we got there. So we tend to be more in the high-20s, 30%. Our share growth will not come from going after those old sockets; it will come from winning the new content growth as it comes into play. Very confident that we're going to be at the overall Sensata sensors worldwide share, which is at about the low-40%.

Vance H. Edelson - Morgan Stanley, Research Division

Okay. With that, we are out of time. Thanks, very much, Martha. And thanks, everyone, for coming.

Martha Sullivan

My pleasure. Thank you, everybody.

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