Seeking Alpha
Value, long only, medium-term horizon, small-cap
Profile| Send Message|
( followers)

LoJack Corporation (NASDAQ:LOJN) provides technology products and services for the tracking and recovery of mobile assets, stolen vehicles, motorcycles, construction equipment, cargo, and people at risk.

This article examines the fundamental value of the company, particularly in view of improving economic conditions, and business resizing following major losses accumulated during the most recent three fiscal years.

Activity

Benefits encompass early notification to vehicle owners in the event of an unauthorized user operating the vehicle, identification of the vehicle’s location, and a registration database that facilitates the return of lost valuables; and tracking and rescuing people at risk of wandering (Alzheimer’s, dementia).

Unlike systems based on GPS technology, LOJN’s technologies can penetrate buildings and containers for the effective tracking and recovery of stolen mobile assets hidden from view. LOJN’s products are installed without visible antennas or markings on the vehicle that would disclose the presence of the product. The vehicle owner’s report of the theft to police results in the automatic activation of the LOJN unit; therefore no third party intermediaries are involved in the activation or tracking process.

In the United States, radio frequency coverage extends through 28 states and the District of Columbia, and in major metropolitan areas, cities, and high crime areas. Transmissions are made on a nationwide radio frequency allocated by the Federal Communications Commission, or FCC, as a law enforcement radio service.

Two principal segments are North America, including Canada (71% of $135.01 million, total revenues in FYE 12/09), and International, including Italy (27% of total revenues in FYE 12/09).

In the U.S. market, unit volume trends consistently track retail trends in the broader domestic auto market. Despite the growth in total auto sales recorded in the third quarter, actual retail auto sales declined (fleet sales rose 24%). U.S. automobile industry figures indicate that new vehicle sales reached 11.2 million units in 2010.

The company has relationships with local police units (that operate LOJN tracking units), law enforcement agencies, life-preserving institutions, insurance companies (that offer rebates to LOJN product users), insurance brokers, and auto dealerships (that in the U.S. originate 85% of 2009 U.S. revenue), in various aspects of promoting, selling, and maintaining the products and services offered.

Internationally the company does business in 32 countries from where it derives most of the revenue from products (96% of international revenues for FYE 12/09). Other revenue sources are system infrastructure components, royalties, and licensing fees.

LOJN contracts manufacturing for components sold in the North America and International divisions, and assembles certain units in the company’s own facilities.

LOJN’s competitive advantage relates to the relationships established with its network of dealers and the independent third-party installers of LOJN systems; relationships with police departments and other law-enforcing entities; and with the FCC for nationwide radio frequency use.

Auto security and theft prevention devices such as GPS devices compete with LOJN’s products, although the company markets its products as stolen vehicle recovery products. None of these competing products, however, are integrated with law enforcement systems, or operated by them, as are LOJN products.

Strategy

The company focuses primarily on the top 30 global markets based on high per-capita thefts, high annual recurring sales of new vehicles, and large numbers of vehicles operating in the area. Integration with law enforcement agencies in the United States, together with proprietary technology and its wireless network, provide an effective means of tracking and recovery.

Expansion strategy includes investments in new or existing international licensees and markets and/or the formation of new international subsidiaries. Investments in international licensees consist of a 12.5% equity investment in a Mexican licensee, 5.5% in a French licensee, and 17.5% in a Benelux licensee, and less than 10% in licenses in Argentina and Hong Kong. Its aggregate carrying value was $2.8 million as of FYE 12/09.

In 2006, commercial activities were initiated in Italy, the only country outside the U.S. where LOJN owns and operates a stolen vehicle recovery network. At FYE 12/09, aggregate investment in this wholly-owned subsidiary amounted to $20.0 million (build out and operating losses). Additional investments on the order of $2.0 million/yr. are expected over the next two to three years.

Investment focus is on the company’s principal two segments, and on expanding SafetyNet, the program that protects people at risk (SafetyNet is included in the third business segment). LOJN is expanding the network of law enforcement and public safety agencies that provide the tracking and rescue of people at risk, and marketing the services directly to caregivers of those with Alzheimer’s, autism and other cognitive disorders.

Management deserves high marks for business resizing. Meanwhile, progress in the International segment has come at significant cost. Witness the sizeable costs related to the Canadian business and the legal settlement with an international licensee (see Business Resizing).

Performance Assessment

Revenues, EBIT, and free cash flow (FCF) are subject to extreme volatility, as would be expected from a business closely related to the automotive industry. Likewise, the performance metrics in the table reflect the economic contraction and crisis of confidence that gained force in 2008 and 2009.

  • FCF = Free Cash Flow = NOPAT - Net Investment in Operating Capital during the period
  • NOPAT = Net Operating Profits after Taxes = EBIT (1 – Tax Rate)
  • ROIC = Return on Invested Capital = NOPAT / Operating Capital
  • Operating Capital = NOWC (Net Op. Working Capital) + OLTA (Operating LT Assets)
  • Cash & Marketable Securities, net of debt.

LoJack Table --Selected Metrics

(Amounts in millions of US$, unless otherwise noted)

FYE 12/06

FYE 12/07

FYE 12/08

FYE 12/09

4-Yr. Avg. (2006-09)

Revenues

213.29

222.75

198.68

135.01

192.43

Revenue Growth (y-o-y)

12%

4%

-11%

-32%

-7%

EBIT

23.48

30.27

-26.9

-44.19

-4.34

EBIT / Revenues

11%

14%

-14%

-33%

-5%

EBIT Growth (y-o-y)

-13%

29%

nm

nm

nm

Cash Flow from Ops.

28.05

38.48

7.44

-6.49

16.87

CF f/Ops.Growth (y-o-y)

11%

37%

-81%

nm

nm

Free Cash Flow

20.72

27.31

-1.19

-15.29

7.89

FCF / Revenues

10%

12%

-1%

-11%

3%

FCF Growth (y-o-y)

10%

32%

nm

nm

nm

Cash (& Market.Secs.)

27.68

44.75

38.44

25.54

Cash Growth (y-o-y)

-1%

62%

-14%

-34%

4%

# Shares

19.24

18.93

17.30

17.17

# Shares Growth (y-o-y)

2%

-2%

-9%

-1%

-2%

Q 9/09

Q 9/10

YTD 9/09

YTD 9/10

Change (y-o-y)

Revenues

36.12

38.49

99.37

106.62

7%

EBIT

-20.3

2.95

-42.55

-4.42

nm

EBIT (excl.Legal & Asset Impairment Charges)

-2.05

2.95

-10.26

-4.42

nm

Cash Flow from Ops.

-13.55

5.35

-12.52

7.95

nm

Free Cash Flow

-17.49

1.83

-18.00

2.16

nm

Cash (& Market.Secs.)

21.08

31.16

21.08

31.16

48%

# Shares

17.23

17.74

17.15

17.33

1%

- Economy

Macro-variables influencing revenue performance are aggregate levels of consumer demand, level of interest rates, credit availability, consumer confidence, and auto retail sales, among others.

In 2008, the domestic auto industry experienced its worst performance in 16 years, with the seasonally adjusted annual rate, or SAAR, of new vehicle sales in the United States declining approximately 18% from the prior year to approximately 13.2 million vehicles sold. This trend continued to worsen during 2009, with the SAAR of new vehicle sales in the United States of only 10.4 million units for the year. Industry figures indicate new vehicle sales of approximately 11.2 million units for 2010.

There are indications that, from a macroeconomic perspective, the worst economic performance is behind the company. In February 2011, car sales were up over 16% year over year, and up 34% from February 2009. Overall car sales are expected to rise in 2011. Further, credit seems to be flowing more freely and progress on unemployment claims is becoming visible.

- Capital Efficiency

Deferred revenues ($53.10 million at Q 9/10 end) are an important source of financing for LOJN. These originate from cash payments received in anticipation of revenue recognition. Such source of funds contributes to finance net operating working capital (NOWC) and operating Long Term Assets (OLTA).

Thus, NOWC contributes to a negative, or minimal, use of Operating Capital. In other words, LOJN is an efficient user of capital.

  • Operating Capital = NOWC (Net Op. Working Capital) + OLTA (Operating LT Assets)
  • NOWC / Revenues = minus 21% (Q 9/10 annualized)
  • Operating Capital / Revenues = minus 2% (Q 9/10 annualized)

- Operating Risk

Along with cyclical revenues and volatile EBIT and FCF, recent history suggests high investment risk (read: assets impairments) and legal suit exposure (see below).

Adding to uncertainty is the relatively long lead time between investment inflows and free cash outflows. Relevant to this concern is investment in the Italian subsidiary discussed above, and the investment in SC-Integrity, Inc., a company providing tracking and rescue technology. Since 2006, LOJN has invested $8.3 million in SC-I. Currently LOJN holds 60% equity interest in the company. As far as it can be determined, this initiative is still in its build-up phase. (SC-I is included in the third, “all other,” business segment. All Other segment revenues were less than 2% of Q 9/10 revenues; EBIT was minus $0.52 million).

- Business Resizing

LOJN has reduced operations workforce, both domestically and in Canada, in order to minimize costs and resize to an appropriate level of demand. In Q 12/09 the company moved to integrate the Canadian operations into the U.S. operating structure.

There had been a shift in the Canadian auto market away from high-end vehicles, where LOJN had a high penetration rate. Further, in 2008, cellular telephone companies in Canada phased out their analog network in favor of a digital-only network, forcing the company to move its analog subscriber base from analog to digital tracking and recovery technology.

Goodwill and asset impairment charges in the Canadian business were $14.04 million in FYE 12/09, $38.09 million in FYE 12/08 and $3.30 million in FYE 12/07. These charges contributed to weak EBIT in 2008 and 2009. Also contributing to weakness was an $18.25 million litigation settlement charge in 2009 for improperly terminating a license agreement with an international licensee.

Q 9/10 results show significant improvement in the cost structure (excluding non-recurring charges, legal settlement and asset impairments). Such costs were reduced by $6.23 million, or 27% y-o-y, from $22.63 million in Q 9/09 to $16.40 million in Q 9/10. On an annual basis the reduction would represent close to $25.00 million per year.

A 7% consolidated revenue increase in Q 9/10 y-o-y was sufficient to improve EBIT for the quarter from minus $2.05 million in Q 9/09 (excluding non-recurring legal settlement and asset impairment charges) to plus $2.95 million in Q 9/10.

Most of the EBIT improvement was from the International segment (from minus $1.66 million in Q 9/09 to plus $4.69 million in Q 9/10) where revenue was up by 47% y-o-y.

In the North America segment, revenues declined 7% in Q 9/10 y-o-y. Q 9/09 comparables are unfavorable due to the temporary surge in auto sales driven by the U.S. government’s $3.0 billion "Cash for Clunkers" program from 7/27/09 to 8/25/09. Further, industry-wide growth in total auto sales recorded in Q 9/10 was fueled entirely by fleet sales, which rose 24%. Meanwhile retail sales, which track LOJN revenues, actually declined.

EBIT (excluding non-recurring legal settlement and assets impairment charges) decreased from $0.34 million in Q 9/09 to minus $1.21 million in Q 9/10.

Resizing has reduced both assets and ongoing costs. These sizeable adjustments, along with the economic reinvigoration currently underway, ought to contribute to positive operational leverage and to produce increasingly attractive shareholder returns.

The discussion below examines the opportunity to invest, given trade off among the operational issues discussed, the recovery underway, and the price of the stock.

Fundamental Value

Fundamental value is conservatively estimated at $8.00/share. This is based on the formulae and assumptions shown below.

  • Enterprise Value = Present Value of FCF growing at g, discounted at WACC
  • g = FCF Growth Rate
  • WACC = Weighted Average Cost of Capital
  • Equity Value (Fundamental) = Enterprise Value + Cash – Debt
  • Share Fundamental Value = Equity Value / # Shares.

Assumptions: Base FCF is $7.32 million, g is 5%, and WACC is 11.5%.

  • Base FCF of $7.32 million is computed by annualizing $1.83 million, Q 9/10 FCF. Such base FCF represents 4.75% of annualized Q 9/10 revenues; well below the FCF / Revenues ratio in FYE 12/06 (10%) and FYE 12/07 (12%), that can be considered years closer to the norm.
  • LOJN is a cyclical business that has significantly resized to depressed levels of demand. According to prevailing general wisdom, we are at the beginning of (albeit slow) economic recovery.
  • Growth of FCF at 5% seems reasonable; performance metrics shown in the Table refer to a period of time reflecting economic slowdown and crises in confidence, followed presumably, by the beginning of recovery.
  • A comparison of EBIT improvement for Q 9/10 y-o-y against YTD 9/10 y-o-y (see Table) suggests that EBIT (excluding legal settlement costs and asset impairment charges) is growing at an accelerating rate.
  • WACC is estimated conservatively at 11.5%. The combination of input estimates for FCF growth and WACC weight heavily on the estimated price of the stock. Growing at 5% and discounting it at 11.5% is a punishing mathematical load, leading to a conservative estimate.

The fundamental value estimate, based on stringent assumptions, represents over 20% gain from the current $6.65/share, stock price.

Summary

Risk in a cyclical business is inherently on the high side. By necessity, LoJack’s position at this point in the economic recovery cycle does not show good performance metrics. In fact, the metrics discussed are depressed by reason of aggregate demand, asset write-offs, and litigation costs. Perhaps more clearly, the price of the stock has declined from about $19.00/share at the end of 2005 to $6.65/share currently.

High capital efficiency, principally due to a high level of deferred revenues, supports the company cash position and enables attractive ROIC in times of steady product demand. Such efficiency is a relatively permanent attribute in LoJack’s business model.

The fundamental valuation, as constructed, is based on very stringent assumptions. It shows an attractive investment opportunity over the medium term due to the discount of fundamental value to current market price. Having said this, the steady trajectory of FCF growth implicit in the estimation of fundamental value can be upset by one-off events, similar to the charge-offs in the international segment, discussed earlier.

Looking ahead, the company has dramatically cut costs and resized the business in line with existing market demand. Going forward, operating leverage should provide the wind on the back, provided economic recovery and retail auto sales resume growth.

In fact, EBIT, the operating engine behind NOPAT, FCF, and the stock’s fundamental value, is growing and accelerating. This means that, other things being equal, gains in the growth rate of EBIT could potentially be a multiple of the growth rate of broad economic measures. Such potentially rapid operating improvement provides the impetus for positive stock price action and the opportunity for a short term investment gain in excess of that related to fundamental value.

Disclosure: I am long LOJN.

Source: Is LoJack Ready for an Upswing?