Tuesday, May 19, 2009

Lear should follow Alcoa's example, to the extent possible.

Lear is in a precarious position. With annual run-rate US auto sales looking to be 9.5million per year, down from the 15million(ish) rate just 18months ago, a major restructuring is in the works. Foreign exchange has hurt them, and they've lost certain Dodge and Ford contracts. When it rains it pours:

From Lear's press release:

-Net sales of $2.2 billion, down 44% from a year ago
-Core operating earnings of negative $67 million
-Accelerated global restructuring and cost reduction efforts
-68% of net sales generated outside of North America
-Cash and cash equivalents of $1.2 billion at quarter end

AlphaNinja - Free cash flow at Lear was negative $219million, $200m worse than the year-ago quarter. Lear's common stock is pricing in a very high probability of bankruptcy, or at least a negotiated recapitalization that will hand debt holders most shares in a new structure. Currently the company has a waiver on its credit facility that allows it to break its debt covenant ratios through next month (June). Unfortunately, I'm not sure the company is going to be aggressive enough on the cost-cutting and capital structure as they need to be, suggested by this rather passive outlook:

What would be interesting would be an Alcoa-like capital raise.
On March 16th, Dow30 component Alcoa (AA) was trading at 4.37, down 90% from its 52week highs. The company was reeling from the horrible conditions in the Aluminum market, made worse by their debt situation. They took the actions listed below, some of the most aggressive I've seen out a company in trouble.

-$2 Billion in Procurement Efficiencies by 2010
-$400 Million in Overhead Rationalization by 2010
-Capital Expenditures Reduced to $850 Million Sustaining Rate in 2010
-$800 Million of Working Capital Cash Improvement in 2009
-Quarterly Dividend Reduced from $.17 to $.03, Saving More Than $400 Million Annually
-Public Offering of Approximately $1.1 Billion of Common Stock and Convertible Notes

Most important to me was the $1.1billion they raised selling common stock and convertibles. Yes, it was major dilution, increasing shares outstanding approximately 20%. But compare that to the stock's 90% drop, and the dilution was not as terrible looking. Combined with the overhead cost reductions, working capital diligence, and capex reductions, the company's future EPS and FCF(per shareowner) power look to be much improved, even with more common shares outstanding.

The point here is that Alcoa, now trading at double the price at which it diluted shareholders (normally a negative), did a capital-raise in a shareholder-friendly way. The market's view of an equity wipe-out went from maybe 80% to less than 20% (estimates) . Thus even though the aluminum market is still in terrible shape, the company's prospects have improved markedly. Alcoa's actions were bold and shareholder friendly - something people need to keep in mind when they look at the difference between a company's survival, and the survival of the common stock. The interesting part here is that an equity investor didn't have to partake in the guessing-game when the potential for bankruptcy was at its highest.

Round trip back to Lear - here's an exchange from the recent conference call:

Brian Johnson - Barclays Capital
Okay and in your release, can you tell us anything about the alternatives for Cap structure and when you say, you’re talking with lenders and others, is others just mean bankers and lawyers or would others include potential new sources of finance.
Matthew Simoncini, CFO
Well we’ve talked to a lot of bankers and lawyers these days, but what we mean by others certain potential and strategic and financial partners. All alternatives means quite frankly all alternatives. We’re looking at everything and I don’t want to talk about the specifics of those alternatives.
Brian Johnson - Barclays Capital
Have you been approached or are you approaching someone who might be willing to put new money into the company.
Matthew Simoncini, CFO
We’ve been approached.

AlphaNinja - C'mon Lear, respect the shareholders. Put a major turnaround plan together, and sell some common stock. With your stock trading at 1.42, the market sees little chance for a turnaround. With additional cash raised from a stock offering, the market may increase your odds of a turnaround, and bring the stock up into the high single digits.

I just got off the phone with Lear's investor relations. After suggesting that the company take actions similar to what Alcoa did, the response was "not at this stock price." Fair enough argument, no one likes to sell low and buy high. So when I ask about how shareholder-friendly the management plans to be in a potential turnaround/restructuring, the reply was (approximately) "the management and board's first responsibility is to the shareholder. But when we get in a potentially bad situation, our lawyers tell us that we have to take steps to protect the whole enterprise value, including debt holders and employees."

Now this is what's frustrating -when does the board and management decide that the line has been crossed, and that they now have to let shareholders get stiffed in order to protect other stakeholders. It is a very worrisome scenario to me - how can one feel comfortable investing money in common stock when their interest in tough times is subject to board and company management, who might prefer to hang onto their jobs and give debt holders control of the company, instead of taking drastic actions(liquidation) that would preserve/salvage shareholder value?

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