Former private equity owners, Carlyle and Onex, as well as the executive team have highlighted the strong growth in Allison Transmission (ALSN) based off trough 2008 numbers. In reality, the PE firms acquired ALSN in mid-2007, and since 2006, ALSN's revenue, EBIT, net income, assets and shareholders' equity have all declined.
Former PE owners exited their ALSN investment primarily through secondary offerings in 2013 and 2014 following a limited 2012 IPO. ALSN provided share price support in the PE secondary offerings by repurchasing approximately 11% of the secondary offerings at a blended average P/E multiple of 29x (3.5% yield). 5 of the 9 ALSN board members who authorized the share repurchases were part of/employees of Carlyle and Onex. At the time, ALSN could have repurchased its 7.125% bonds for twice the yield of the share repurchase.
The former PE owners highlight a significant return of $4B on their initial $1.5B investment, highlighting the strong ALSN growth based off trough 2008 numbers. However, the entire PE return on the ALSN investment stems from P/E multiple expansion from 4.3x (purchase multiple) to 28.2x (final exit multiple). The equity value of ALSN between the time of purchase and sale of the PE owners declined by approximately $20M (despite the increase in multiple). Currently, the equity value of ALSN is $1.2B less than it was when the sponsors acquired ALSN from General Motors (NYSE:GM).
Since the 2012 IPO, ALSN spent a total of $655M on share repurchases (including periods of non-PE secondary offerings) at a blended average P/E multiple of 27x. It is highly unlikely that the share repurchases will generate an adequate positive IRR over time.
There are significant concerns regarding ALSN's executives, board, and prior PE owners' actions. ALSN publicly increased its guidance and repurchased shares while the PE owners and executives sold their shares. In addition, while ALSN's executives increased public financial guidance, ALSN's board reduced executive incentive compensation targets.
Returns on equity and invested capital are low, while the returns on the capex since 2007 are negative. Furthermore, capex as a percentage of sales appears to trough in 2015 while capex as a percentage of depreciation also troughed in 2015 at 66%. Since 2008, ALSN's capex as a percent of depreciation is 82%, highlighting potential underinvestment.
ALSN's valuation analysis yields a fair value range per ALSN share of $14.43 to $18.82.
The ALSN's board of directors has destroyed significant ALSN non-private equity shareholder value through share repurchases while failing to successfully invest in growth initiatives. ALSN currently trades at 24x LTM P/E with a 2.4% dividend yield and 3.5x net unadjusted leverage multiple, highlighting significant potential downside risks as a shareholder.
Allison Business Overview: The Illusion Of Growth
In the final ALSN IPO prospectus, ALSN provides financial information from 2008 onwards, highlighting a top line growth rate and a net income growth of 600%. Carlyle, one of the private equity companies that acquired ALSN in 2007, provides the public with an ALSN investment case study highlighting: "Supported EBITDA growth from $544M to $712M, a 30% increase, despite a severe market downturn in the commercial vehicle industry".
Onex shows the exact chart above including LTM 3/31/12 EBITDA of $766 and the yearly EBITDA margin increasing from 26.4% in 2008 to 32.9% in 2011 and 34.1% for LTM 3/31/12.
However, Carlyle and Onex completed the acquisition of ALSN from General Motors in August 2007. None of the prospectuses offer an adjusted or unadjusted EBITDA for 2006 or 2007 (the financials which would have driven the transaction multiples).
The initial ALSN draft prospectus filed in March 2011 provides some financial information for 2006 and 2007, highlighting ALSN's 2006 sales, EBIT and net income were all greater than in 2011 or 2015. Under the PE ownership, ALSN's operations declined significantly. The PE owners selected 2008 as a starting point for the financial calculations to investors realizing that 2008 was the trough year and created "The Illusion Of Growth".
Expanding the time horizon through 2015 continues to highlight negative growth and margin contraction.
The chart below highlights that ALSN's net income declined substantially under the ownership of Carlyle and Onex.
Since 2006, ALSN's revenue, EBIT and net income all declined.
The operational declines at ALSN are not limited to the income statement and can also be tracked on the balance sheet.
It's also possible that ALSN has underinvested in recent years as the capex as a percentage of sales and the capex as a percentage of depreciation have declined to trough levels.
In addition, under PE ownership, it appears that from 2008 through 2011, capex was below depreciation in every year. A majority (>70%) of the 2012 capex was spent after the IPO (i.e. after the PEs had sold part of the business to the public markets).
How Did The Private Equity Owners Make $3.3B On Their ALSN Investment?
In August 2007, at the height of the economic boom, Carlyle and Onex acquired ALSN from General Motors. At the time, GM was in financial difficulty and was selling assets to immediately raise capital. GM sold ALSN to Carlyle and Onex for 6.4x EBITDA and 16.1x P/E without any leverage which allowed the PE owners to immediately add $4.2B of debt (4.7x net debt to EBITDA). ALSN went from being a business which was 100% equity financed to a business that was 25% equity financed and 75% debt financed. The change in the equity portion of ALSN reduced the P/E multiple from 16.1x to 4.3x.
In March 2012, Carlyle and Onex took ALSN public, selling approximately 26.1M shares for $23.00 a share. Subsequent to the offering, Carlyle and Onex held nearly 155M shares or 85% of ALSN. The remaining 155M shares were subject to a 180-day lock-up period. In 2013 and 2014, Carlyle and Onex sold all of their shares, a majority of which was through secondary offerings. The table below highlights ALSN's valuation and operations prior to the PE transaction, immediately post transaction, and at June 30, 2014, post the final secondary offering by the former private equity owners.
In brief, Carlyle and Onex sold ALSN at a 28.2x P/E multiple while they purchased ALSN at a 4.3x P/E multiple. The deterioration in net income between 2006 and 2014 generated ($649M) of value destruction while the expansion of the P/E multiple generated $4.7B in value creation, for a net value creation of $4.050B. Multiple expansion generated over 100% of the PE companies' returns in ALSN.
ALSN Helped Support the PE firms' 28x P/E Exit Multiple By Buying Back Shares In The PE Secondary Offerings
ALSN participated in the Carlyle and Onex secondary offerings purchasing 11.1% of the offered shares at a blended average price of $26.61 and P/E multiple 28.9x (3.5% yield) for a total spend of $349M. Public companies execute share repurchases as they are the best value creation method to allocate capital. In other words, the share repurchase has to provide the highest IRR to the company (the public share price is significantly less than the board's estimated intrinsic value per share).
In both 2013 and 2014, ALSN had $471M of senior fixed notes due in 2019 at a fixed interest rate of 7.125%. Repurchasing the senior fixed notes with a 7.125% interest rate would have provided more than twice the yield as repurchasing shares in the private equity secondary offerings.
At the time, 5 of the 9 ALSN board of directors were employed by Carlyle or Onex. In other words, a majority of the ALSN's board of directors who authorized repurchasing shares from Carlyle and Onex at 28.9x P/E were associated with Carlyle and Onex.
The table below highlights the number of shares ALSN repurchased every quarter between Q4 2012 and Q4 2015 and the LTM P/E multiple at the time. In Q3 2013, Q1 2014 and Q2 2014, ALSN repurchased all of its shares in the PE secondary offerings.
Since the total exit of the private equity owners, ALSN continued to repurchase its own shares. The largest quarterly purchase occurred in Q3 2015 at approximately 18.6x LTM P/E.
In total, ALSN spent $655M on share repurchases since 2013. At the current ALSN share price, the value of the shares repurchased is approximately $520M, representing a (3.2%) IRR.
The ALSN share repurchases benefited the prior PE owners; however, they are highly unlikely to benefit public ALSN shareholders.
The above table highlights:
- Assuming ALSN's GAAP EPS grows from $1.03 to $1.48 from 2015 through 2020 at a 7.5% CAGR, ALSN would need to trade above 17.6x LTM P/E for the share repurchase to generate a positive return.
- Assuming ALSN's GAAP EPS is able to grow at a 7.5% CAGR through 2020 and ALSN trades at a 27.1x P/E multiple, the share repurchase would generate a 5.3% IRR (below the debt repurchase IRR)
- Assuming ALSN's GAAP EPS is able to grow at a 12.5% CAGR, ALSN would need to trade at an LTM P/E multiple of approximately 25.0x to generate a 7.5% return on the share repurchase program to date. Repurchasing the 7.125% senior bonds instead of repurchasing shares in 2013, 2014 and 2015 continues to appear to have been a significant better creator of value for ALSN's public shareholders.
- Assuming a 12.5% CAGR and a 27.1x LTM P/E multiple at the end of 2020 would still imply a return on the share repurchase of less than 10%.
As ALSN Repurchased Shares, ALSN Reduced Executive Incentive Compensation Financial Targets
While ALSN highlighted the discount between its share price and its intrinsic value by repurchasing shares, it simultaneously reduced the ALSN executive compensation financial targets due to deteriorating market conditions in 2012 and 2013.
The 2012 Proxy (filed in March 2013) states the following:
"In early 2012, the Compensation Committee established performance targets for each of the performance factors outlined above. However, during the course of the year the Compensation Committee determined that the original performance goals established for the Adjusted EBITDA and Gross Adjusted Free Cash Flow factor were based on what turned out to be overly optimistic assumptions about industry conditions… given some of the sudden and unanticipated changes in several of our end-markets in the second half of 2012. As a result, the Compensation Committee determined to adjust the Adjusted EBITDA required to achieve threshold-, target- and maximum-level of achievement... In addition, the Compensation Committee determined to adjust the Gross Adjusted Free Cash Flow required to achieve target- and maximum-level of achievement"
In 2013, the uncertainty continued and the Proxy (filed in March 2014) states:
"In setting iComp targets for 2013, the Compensation Committee took into account the continued heightened level of uncertainty in our end markets outlook for 2013 including more modest than previously forecasted recovery in North American On-Highway truck end markets, as well as expected reductions in U.S. defense spending, continued weakness in our North America Off Highway end market attributable to continued low levels of demand in the energy sector's hydraulic fracturing market and lower demand in the North American Hybrid-Propulsion Systems for Transit Bus end market… Recognizing that 2013 performance was likely to be down from 2012, but desiring to motivate management to continue delivering solid Adjusted EBITDA and Gross Adjusted Free Cash Flow results, the Compensation Committee set 2013 targets for those metrics below 2012 results but above the Company's 2013 business plan budget."
ALSN's executives were paid to reduce adjusted EBITDA and gross adjusted free cash flow.
Immediately after the IPO (the marketing period/beauty parade), ALSN began to lower public guidance highlighting toughening end markets. Executives are supposed to earn incentive compensation because of exceptional performance.
The achieved 2012 adjusted EBITDA of $718M would have placed the executives within the original "threshold" range but below the original "target" range. Effectively, despite the fact that ALSN would have received the threshold incentive compensation for the actual 2012 performance, it appears the board ensured executives would reach the target level.
The 2014 adjusted EBITDA targets were 10.5% lower than the original 2012 adjusted EBITDA targets and highlighted no growth relative to the 2013 adjusted EBITDA targets. The 2014 gross adjusted free cash flow targets were 24% below the 2012 targets. However, during the course of 2014, management increased the adjusted EBITDA guidance by 9.3% and 5.9% (off of the low and high guidance) and increased the adjusted FCF per share guidance by 23.0% and 15.6%. Why weren't the 2014 executive incentive targets raised to meet the increasing demand from the recovering industry?
Were ALSN's executives paid by the board of directors to help the private equity owners exit (increase public guidance and buy back shares at elevated market prices and multiples while lowering and keeping executive incentive targets low)?
The trough or management's operational guidance to the public markets occurred in Q2 2013. Subsequently, the guidance across the key operational targets was continuously increased. As the guidance was increased, public sentiment in ALSN appears to have increased as the share price increased. Simultaneously, the PE owners and the executives were selling their shares in ALSN.
The large number of shares sold by the PE owners in Q4 2013 and Q1 2014 could also have created significant downward pressure on the ALSN share price (high supply of sellers); however, the share price increased during the time frame.
The Q3 2014 revenue and adjusted EBITDA guidance for FY 2014 were all below the Q1 2012 guidance for FY 2012; however, the ALSN share price was nearly 50% higher.
Between 2012 and 2015, the revenue, adjusted EBITDA and adjusted FCF CAGRs were (2.5%), 0.7%, and 8.1%, respectively, highlighting the limited growth potential.
In addition, while public guidance was increasing as a result of the return to "normal" market conditions and returning to the early 2012 levels, the board did not increase the executive compensation targets which were still approximately 20% to 30% below the initial 2012 levels (based on the deteriorating market conditions).
ALSN spent $349M repurchasing shares at an average of $26.61 (compared to the IPO price in March 2012 of $23.00) and at LTM P/E multiple of 28.9x, while on the one hand, recognizing negative growth and reducing executive compensation targets, and on the other hand, providing increasing guidance to the public.
As ALSN Repurchased Shares, ALSN Executive Sold Their Shares
Finally, ALSN's executives were selling their shares in ALSN throughout 2013 and 2014, alongside the PE owners as they provided public markets with increasing guidance. The ALSN executives and the former private equity owners (Carlyle and Onex) were thinking alike (sell ALSN shares).
ALSN CEO and Chairman of the Board Lawrence Dewey sold 81% of his shares from 2013 through 2014.
Executives also exercised and sold their options in Allison Transmission.
ALSN is the world's largest manufacturer of fully-automatic transmissions for medium- and heavy-duty commercial vehicles and medium- and heavy tactical U.S. defense vehicles. ALSN's transmissions are used in a wide variety of applications, including on-highway trucks (distribution, refuse, construction, fire and emergency), buses (primarily school, transit and hybrid-transit), motorhomes, off-highway vehicles and equipment (primarily energy, mining and construction) and defense vehicles (wheeled and tracked). ALSN estimates it sold 63% of global fully-automatic transmissions in 2015 for medium- and heavy-duty on-highway commercial vehicle applications.
The top 5 customers represented 48%, 45% and 52% of total sales in 2013, 2014 and 2015. In 2015, the top 3 customers Daimler (OTCPK:DDAIF), Navistar (NYSE:NAV) and Volvo (OTCPK:VOLVY) accounted for 21%, 10% and 10% of ALSN's sales (the 4th and 5th customers represented a total of 11% of sales or 5.5% each). Ford (NYSE:F) is one of ALSN's biggest competitors across almost the entire product line.
ALSN was founded in 1915 and was owned by General Motors between 1929 and 2007. 81% of revenues are generated in North America, although it has a global presence in Europe, Asia, South America and Africa.
In the last 12 months, the ALSN's shareholder base has become more activist oriented, with several large shareholders recently taking or pushing for seats on the board. ValueAct is the largest shareholder, with approximately 11% and signed a co-operation agreement with ALSN back in December 2014 and subsequently appointed a ValueAct manager to the board of directors (mid-2015). ValueAct is estimated to have acquired its stake in ALSN for approximately $17.28 per share (based on initial 13D filing from November 2013).
In the last 6 months, several investors, including Ashe Capital and Longview, have become more active recommending changes to the ALSN board of directors and bylaws. As a result, in early 2016, the board was increased from 9 members to approximately 12 members and 4 new members were appointed.
Valuation Considerations: Sticking To What Previous Owners Paid
Given the ALSN executive team cannot accurately predict its end market demand or its operations within a one-year period, it is unlikely forecasting the business operations will provide a distinct competitive advantage.
ALSN consistently provides North American production of Class 4 through 8 (less Class 8 tractor and Class 8 Straight with Sleeper) units over time as a big picture perspective on the industry. In the most recent ALSN investor presentation from March 2016, ALSN highlights a 2015-2018 North American production unit CAGR of 1.3%. In addition, historically, ALSN has consistently overestimated the growth in the market: (1) forecasted 2011-2014 CAGR in NA production units from 6/4/12 was 9.0% and 2016 presentation highlights a real growth of 7.9%; and (2) forecasted 2013-2016 CAGR of 5.6% and 2016 presentation highlights 3.4%.
The chart below provides the yearly management estimates for North American production units per the investor presentation (i.e. 6/4/12 is management's forecast for 2012-2014 NA production units). ALSN's management has historically highlighted that the 1998-2008 minimum, average and trough NA production units were 262, 337, and 427, respectively.
The current estimates highlight the 2009-2018 minimum, average and trough NA production units will be 151, 268, and 333, respectively, representing a significant deterioration compared to the 1999-2008 period.
The table below values ALSN across 3 valuation methodologies: (1) Historical P/E multiple; (2) Historical EBITDA multiple; and (3) ALSN executives' options weighted average exercise price. The tax assets are added back to the weighted average implied value per share.
The P/E analysis takes the GAAP EPS and assumes the private equity purchase multiple of 4.3x (after net leverage) and the 16.1x (pre-leverage multiple). Given that ALSN currently has significantly more debt than at the time of unlevered acquisition, the 16.1x multiple appears on the higher end.
The EBITDA analysis takes the adjusted EBITDA and starts with the PE acquisition multiple from GM at 6.4x. The high EBITDA multiple of 7.5x is an estimate based on a 20% appreciation from the 6.4x (relatively significant multiple expansion for no growth asset).
The executive option pricing is simply the exercise price of the various stock option plans.
The no growth valuation methodologies yield a range from $14.43 to $18.82 which represent a 44% and 27% discount to the current price.
Before shorting ALSN, additional work would need to be completed. However, buying shares in ALSN above $17.25 per share would imply significant operational growth expectations, which do not appear warranted, or significant multiple expansion which could occur as in 2013 and 2014 but may be less and less likely (i.e. no marketing power of the IPO). Finally, shareholders should recognize the significant risk inherent in ALSN given the historical actions of the board and the executive team.
Conclusion: Significant Transmission Concerns
We would encourage the board of directors to consider serious action regarding ALSN's executives, the historical ALSN executive incentive compensation, the current ALSN executive incentive compensation, the historical public guidance relative to the executive incentive targets, and the historical share repurchase activity. A great majority of the current corporate leadership team (including the CEO, CFO, VP of Finance, General Counsel, amongst others) have all been in place at ALSN since the PE ownership and IPO process.
ALSN's financial operations on the income statement, balance sheet and cash flow statement have all consistently declined since 2006.
Former PE owners exited the ALSN investment primarily through secondary offerings in 2013 and 2014 following a limited 2012 IPO. ALSN provided share price support in the PE secondary offerings by repurchasing shares in the secondary offerings at a blended average P/E multiple of 29x (3.5% yield). 5 of the 9 ALSN board members who authorized the share repurchases were part of/employees of Carlyle and Onex. At the time, ALSN could have repurchased its 7.125% bonds for twice the yield of the share repurchase. It is unlikely the share repurchase will provide an adequate return over time.
Former PE owners highlight a significant return of $4B on their initial $1.5B investment which stems from P/E multiple expansion from 4.3x (purchase multiple) to 28.2x (final exit multiple). The equity value of ALSN between the time of purchase and sale of the PE owners declined by approximately $20M(despite the increase in multiple). Currently, the equity value of ALSN is $1.2B less than it was when the sponsors acquired ALSN from GM.
There are significant concerns regarding ALSN's executives, board, and prior PE owners's actions. ALSN publicly increased its guidance and repurchased shares while PE owners and executives sold their shares. In addition, while ALSN's executives increased public financial guidance, ALSN's board reduced executive incentive compensation targets.
ALSN's valuation analysis yields a fair value range per ALSN share of $14.43 to $18.82.
The ALSN board of directors has destroyed significant ALSN non-private equity shareholder value through share repurchases while failing to successfully invest in growth initiatives. ALSN currently trades at 24x LTM P/E with a 2.4% dividend yield and 3.5x net unadjusted leverage multiple, highlighting significant potential downside risks as a shareholder.
Appendix: Labor Negotiations
Approximately 50% of ALSN's employees are represented by the International Union, United Automobile, Aerospace and Agricultural Implement Workers of America ("UAW") and are subject to a collective bargaining agreement. The former private equity owners highlight that in 2008, they were able to replace the hourly defined benefit plan with a defined contribution pension plan. The former PE owners highlight the new plan was "mutually beneficial". It would be interesting to compare the returns or the incremental wages/compensation the unionized workforce received compared to the returns/total incremental capital the former private equity owners received (i.e. $4B).
Source Documentation: All Publicly Available Online
1) ALSN SEC filings including annual reports, quarterly reports, definitive proxies
2) ALSN quarterly earnings presentations
3) ALSN investor presentations
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