Description

Allied Motion (AMOT - $207mn cap) - Under-the-radar “compounder” at a relatively cheap valuation. For more detail on the business, please see roc924’s writeup on 11/19/2011

Brief Company Overview:

Allied Motion designs, manufactures, and sells specialty motion control components and systems. Their products are sold into a variety of end markets, including motor vehicles (50% of sales but autos are 0%), industrial, medical, A&D, and electronics. Major products include motors (DC, servo, and torque), optical encoders, and gearing. The company is headquartered near Buffalo, NY, and 34% of its sales are generated from outside the US (primarily in Europe).

Investment Thesis:

I am betting that proven money-maker Dick Warzala (and other former employees of APR & DHR’s motion control group) can continue adding value in a fragmented industry through superior operational execution and deal-making. AMOT has an  impressive/accomplished management team for a company of this size, and is repeating a strategy that has created significant value for their shareholders in the past. Specifically, CEO Dick Warzala helped American Precision Industries compound EBITDA at a 35% CAGR in the 1990s (until its sale to DHR) and Allied Motion grow from $15mn in 2002 to >$200mn today. Over the next 7-8 years, as AMOT expands (and moves up the value chain) in motion controls (both organically & inorganically), it is reasonable to envision AMOT being a $1bn revenue company with double digit EBIT margins.

What am I playing for?

• In my 3YR base case, shareholders will continue to compound wealth at a 15-20% rate. In this scenario, this team continues to execute a playbook (buying/integrating small privately-held players in a fragmented industrial niche) that has created a lot of shareholder wealth over the past ~20 years.

• In a bull case, the stock could return ~200% in ~2-3 years. In this scenario, AMOT’s multiple expands as management “gets credit” for future good capital allocation (similar to DHR, ROP, APH, AME), and its EBITDA multiple re-rates above larger and slower-growth peers and lower quality smallcaps as its business becomes more diverse and margins expand.

• Barring a recession, I believe our downside is somewhat limited (~$17 stock). While the industry is cyclical, it is worth noting that the company generated FCF in both 2008 and 2009. Leverage is reasonable at ~2x net debt/EBITDA. My downside assumes a continuation of end-market weakness, but not a large scale customer loss.

Investment positives:

(+) Motion controls is an above-average industrial niche. Motion controls is a good business because once you are designed into a product, the business lasts a long time due to high switching costs. There is a significant engineering component to each product, and suppliers typically work closely with customers to design solutions that meet specifications/standards for size, voltage, noise, vibration, and other considerations. Demand should benefit from secular trends towards automation, robotics, and the increasing proliferation of electronics in vehicles. AMOT sells into a relatively diverse set of end-markets, and avoids the worst customers (like passenger auto OEMs). AMOT wins business over mom and pops because they have global manufacturing and local engineering talent and relationships, along with a broader product capabilities.

(+) Fragmented market. Large pipeline of attractive acquisition candidates. AMOT can be more nimble than larger competitors with deal-making – it can pursue small deals that are not needle-moving for larger industrial companies like Danaher, Ametek, or Parker Hannifin. AMOT has generally purchased motion control companies at 0.6x revenue and ~4-7x EBITDA.

For reference, DHR spent over $1.3bn buying motion control companies from 1998-2002 at multiples 2-3x higher, as seen below.

(+) The company is led by proven operators. This company is led by a CEO who profitably grew a motion business from $12mn to $150mn during the 1990s, led a division at Danaher, and has grown another motion business from $15mn to $230mn over the past 12 years (while rewarding shareholders handsomely along the way). Many other key employees at AMOT have worked with the CEO throughout his career (reportedly 25+ people at AMOT that used to work at Danaher’s motion control division), including Ken Wyman (VP of Marketing & CTO) and Rob Maida (VP of Operational Excellence). Danaher is one of the best-managed industrial companies in the world (with regards to cost efficiencies & culture of caring deeply about the stock price), and Dick’s stint at DHR helps give me confidence in his operational acumen and cost-consciousness.

(+) Management’s incentives are aligned with shareholders. The current CEO & former CEO collectively own >18% of company.

(+) Fundamentals should accelerate over the next 12 months due to (1) acquisition integration, (2) ag end markets bottoming, (3) FX headwinds abating, and (4) interest expense declining. Fundamentals should accelerate as the revenue synergies (cross selling more complete systems) should benefit in 2016 and 2017. For example, AMOT did not have a local presence in Germany, and the Heidrive acquisition should open up many opportunities for legacy AMOT products. Additionally, FX headwinds, which negatively impacted 2015 revenue growth by 620bps and EPS by $0.11 (8%), is moving from a headwind to a tailwind. Simply by refinancing high-cost 14% debt in October will help save $3mn in interest expense (~20% EPS tailwind on an annualized basis).

(+) Margins should expand over time as its products become more value-add to customers. Allied has acquired several companies in an effort to shift from a components supplier to a solutions supplier (the majority of AMOT’s latest deals now utilize multiple AMOT technologies). Similar to Danaher Business Systems, Allied has Allied Systematic Tools (AST) initiative of continuous operational improvement in quality, delivery, and cost.

(+) Investor awareness should start to improve. The company is planning to attend 3 investor conferences this year (Houlihan Lokey, Craig Hallum, and Doherty), and it picked up its first sell side coverage (Craig Hallum) in April.

(+) Valuation is compelling on a relative basis. Despite growing revenue/EPS/FCF at a 25%+ CAGR over the past 5 years, AMOT trades at 13.5x EPS and 8.5x TTM EBITDA (a ~15-30% discount to slower-growth peers). Additionally, AMOT has solid return metrics, and like DHR, typically looks even cheaper on FCF measures (as amortization of acquired intangibles consistently drives FCF > net income).

Investment risks:

(-) High level of customer concentration. AMOT’s largest and second-largest customers accounted for 24% and 15% of sales in 2015, respectively. From what I gather, it has big exposure to a manufacturer of ORVs and ATVs (like Polaris or Bombardier) and heavy agricultural equipment (like Deere). They are sole sourced in many applications with these customers, and the business appears relatively sticky. I am less concerned about “losing” these customers, and more concerned about “the cycle” for agricultural equipment and recreational vehicles (I believe ag spending could remain depressed for some time).

(-) Demand for motion controls is cyclical. Demand is highly cyclical, and with 10% of sales tied up in fixed manufacturing overhead, AMOT’s gross profits can decline at ~2x the rate of sales in the event of a slowdown. In 4Q01, DHR’s motion platform experienced revenue declines of 20% y/y.

(-) Management could make a bad deal. The long-term shareholder value created/destroyed in AMOT will largely hinge on future deal-making. I have admittedly not spent much time understanding the financial drivers for AMOT’s business at the current snapshot in time, but more time understanding (1) the people involved, (2) the industry, and (3) the deal-making strategy. Management has not ruled out shareholder dilution for the “right deal.” Management has not ruled out some share dilution for the “right” deal. It has indicated that the maximum level of debt it is willing to take on is ~4x EBITDA, which mitigates some of the risk.

(-) Disclosure is not great. AMOT does not report historical organic revenue growth, or profitability by segment.

History of Dick Warzala & team:

ACT I - APR & DHR: From 1993-1999, Dick Warzala grew the motion control subsidiary of APR from $12mn to $152mn. When APR was purchased by DHR, Mr. Warzala became President of Danaher’s $315mn Motion Components Group.

• Dick Warzala (the current CEO of AMOT) began his career in the motion business in 1983 when he was named GM for a motion subsidiary of APR in 1983. Ten years later, in 1993, Dick became President of API Motion, a $12mn subsidiary of APR, where he led the growth of the business to over $152mn in sales by year-end 1999 (a 53% CAGR!).

• APR was a solid smallcap industrial stock in the 1980s-1990s, until it sold to Danaher in 2000. As seen below, it rose from a ~$1.80 stock in 1980 to >$20 by 1997 (a 15%+ TSR CAGR).

• After seeing APR at an investor conference, DHR’s Dan Comas called APR to gauge their interest in being bought. According to my checks, Dick Warzala viewed selling APR to Danaher as necessary for shareholders, but it interrupted his longer term plan and vision. Dick remained at Danaher as the President of its $315mn Motion Components Group for roughly 1 year.

ACT II - AMOT: When Mr. Warzala joined AMOT as President in 2002, the company had $15mn in revenue and an enterprise value of $7mn. Today, the company has revenue of ~$230mn and an enterprise value of $290mn.

• After leaving Danaher in 2001, Dick Warzala began working with AMOT (FKA Hathaway Corporation) on a consulting basis. Mr. Warzala advised the former CEO (Dick Smith) to divest lower-quality non-core businesses, and the company subsequently sold its power and process instrumentation business. Mr. Warzala joined the company as President and COO in 2002, and the company changed its name to Allied Motion. Mr. Warzala was critical to deal-making at AMOT (see below), and was groomed to succeed Mr. Smith as CEO (officially appointed in 2009). He had reportedly been working on the transformative acquisition of Globe 4 years prior to the deal’s consummation. Since Mr. Warzala joined AMOT, shareholders have compounded at a 16.5% CAGR (vs. ~7% for R2000).

• As seen below, the early days of AMOT look very similar to the early days of APR. However, AMOT has traded at a lower multiple despite (1) higher returns, and (2) a higher market multiple.

Catalyst

*Refinancing high-cost debt in Oct '16

*Re-acceleration of fundamentals

*Increased investor awareness with attendance at conferences