A quick update on Core Molding Technology (CMT), which announced a new business award with Volvo last week. CMT was written up on the blog almost one year ago – check out the original post.

The major details from the press release are included below (emphasis is mine):

“Core expects the new business to generate annual revenues of approximately $26-$30 million and anticipates revenues beginning late in the second quarter and ramping up by the fourth quarter of 2013. Planning and staffing activities are underway as the Company is evaluating facilities to produce these heavy duty truck hoods, roofs and other molded parts for Volvo. This new business is expected to employ up to 140 additional people. Core plans to make an additional capital investment of approximately $12.5 million throughout 2013 and 2014 for equipment and infrastructure to support this and other business.”

The market responded positively, sending the stock price up more than 20% over the past two days. With $168m in TTM sales, $28m in incremental revenue (at the midpoint of the expected range) represents a 16.7% increase. The new business will reach full production by the end of the fiscal year.

While specific profitability information is not provided, estimates can be made based on CMT’s long-term business metrics:

Looking at the increase in hiring, $28m in incremental revenue with 140 new workers translates into sales/employee of $200k for this new business vs. $110k sales/employee for the company as a whole. This makes sense (few if any admin personnel will be need to be hired at HQ for example), and should provide some leverage on the SG&A line.

However, the biggest risk is that management sacrificed pricing in order to win such a significant award, which would impact gross margins. A sensitivity analysis is included below:

If the long-tern economics hold true, it seems reasonable to assume that the new business will add $0.15-$0.19 EPS. At a 10x multiple on the mid-point, this Volvo award is worth $1.66/share in value to CMT, close to the $1.59/share added to the stock price in the last two days.

On the investment side, the company is planning to spend $12.5m in capex to “support this and other business.” If 90% of the planned capex is for Volvo, it would equal capex/share of $1.52 and an acceptable ROI of 11.3%.

Other Thoughts

Prior to this announcement, the stock had struggled since May (hitting a low of $6.35 in January).

One part of the original thesis was that record backlog would boost the top line. While Q1 and Q2 sales were up 54% and 26% YoY respectively, sales growth stalled in the second half of the year (Q3 was flat).

Most important, profitability did not follow the sales growth – gross margin fell materially due to a combination of production inefficiencies, change in product mix to lower margin products, increased tooling sales, and start-up costs for the Kentucky subsidiary:

A major contributor to the margin compression was costs for the Kentucky subsidiary, a short-lived and disappointing initiative. The facility was created in July 2011 to diversify away from trucking-related subsidiaries, with an expectation of $5-8m in annual revenue at full production.

However, the facility’s major customer reversed course suddenly, terminating the relationship in June 2012. The facility was closed in October 2012. This failed project impacted margins throughout the year, in addition to consuming $1.2m in leasehold improvements.

With the facility now closed, this drag on earnings and management attention will go away and gross margins should revert to the long-term average (pending pricing terms on the Volvo deal of course).

Conclusion

Ultimately, the Volvo business helps mitigate one of the biggest risks associated with CMT: customer concentration. Sales to Navistar and PACCAR represented 80% of sales in 2011, especially troubling considering the difficulties at Navistar.

Therefore, the addition of a 3rd major customer is great news for the long-term stability of the business.

The trucking cycle continues to improve (225k units in 2012, up from 197k in 2011; 210-240k expected for 2013), as the age of the fleet remains near all-time highs.

Despite the operational missteps, CMT will likely report record results in 2012 and is still priced like a no-growth business despite long-run evidence to the contrary.

Disclosure

Long CMT

After lagging the indexes for most of the way, a strong finish helped the portfolio outperform the index during the first quarter of 2012.

In fact, the 15% return was my third-best quarter ever, trailing only two mammoth quarters during the stock market recovery in mid-2009.

As I mentioned in my 2011 year end-review, many of my holdings are extremely illiquid and volatile, and price swings on or near the period closing date can have a big impact on the portfolio’s final performance number.

Portfolio Breakdown

I continue to examine each holding in the portfolio, and have closed out or substantially reduced a number of legacy positions which have hit price targets or no longer fit into my investment philosophy.

The cash position will almost certainly increase due to buy-outs of several existing positions, so I’m on the hunt for new names and always open to hearing ideas from readers.

Position Updates

International Baler (IBAL) enjoyed a nice run-up after reporting a huge Q1. Sales were up more than 130% QoQ, and total backlog has increased to $7.8m compared to only $3.295m in the prior year. The stock is now up almost 400% since my initial post.

I’ve trimmed back my position significantly over the past quarter, but plan on holding onto the remaining stake – 2012 should be a record year.

Access Plans (APNC) announced a merger agreement with AON Corporation for $3.30/share, subject to certain revisions at closing. The preliminary proxy was filed on March 27, and it shed light on an interesting part of the agreement (emphasis mine):

“Prior to the closing of the Merger, Access Plans may declare a one-time cash dividend of up to $0.10 per share of Access Plans common stock then outstanding payable to Access Plans’ shareholders immediately prior to the closing (the “Special Dividend”). However, the Special Dividend is only permitted if (i) prior to the closing the full amount of the Special Dividend is paid to Access Plans’ transfer agent (for subsequent payment to the Access Plans shareholders) on terms and conditions acceptable to Affinity and (ii) the payment of the Special Dividend does not cause the net cash amount immediately prior to the effective time of the Merger to be less than $15.025 million.”

Merger and closing related expenses are estimated at $2.2m, so the ‘trigger point’ for a special dividend would be $17.225m.

As of 12/31/2011, APNC held $15.64m in net cash. In the previous year, the company generated roughly $8m in cash, or $2m per quarter.

If APNC continues to throw off the same amount of cash, and the merger closes at the end of Q2, those 2 quarters would give the company a cash balance in the $19m range.

If so, it’s likely that at least some (if not all) of the $0.10 dividend will be paid before closing, providing a nice boost even if another suitor does not emerge.

Access Plans is not the only holding that is ‘in play:’ New Frontier (NOOF) is the subject of an apparent bidding war.

The bidding started with an offer of $1.35/share by Longkloof Limited, which owns 15% of NOOF’s shares. Several weeks later, another potential acquirer emerged, with Manwin Holdings offering $1.50/share.

The interest caused NOOF’s management team to hire Avondale Partners to evaluate all alternatives:

“Our Board of Directors remains very enthusiastic about New Frontier Media’s future prospects and has made no decision to sell the Company. However, in keeping with our commitment to act in the best interests of all shareholders, we have decided to undergo a thorough review of strategic alternatives to determine the best opportunities for maximizing shareholder value at this time”

The stock is trading at a premium to the latest offer, so the market is certainly pricing in further action.

Finally, an activist investor emerged at Gaming Partners (GPIC), as Enclave Asset Management wrote a strongly-worded letter to the management team and proposed new board members at the upcoming annual meeting.

The company posted disappointing results for the fiscal year, with EPS falling from $0.54 last year to $0.45.

If nothing else, the quarter was certainly entertaining.

Disclosure

Long IBAL, NOOF, GPIC

Yesterday, Access Plans (APNC.OB) announced a definitive merger agreement to be acquired by AON Affinity, a subsidiary of AON Corporation (AON), for $70.1m in cash.

Here is the press release and merger document.

The purchase price is subject to a downward adjustment based on the net cash position of APNC at the closing of the merger, but is currently estimated at $3.30 per share.

This $3.30 consideration was an 18% premium to the latest closing price, and a 24% premium to APNC’s average price over the past 30 days.

In my view, AON is getting a steal with this transaction.

A $3.30 purchase price on $0.30 in diluted EPS (ttm), translates into a P/E of 11x or a rough EV/EBIT of 4-5x.

These are very low multiples for a business whose remaining two segments are generating 30%+ operating margins and steady revenue growth (and throwing in a $15m pile of cash as well).

According to Danny Wright, Access Plan’s Chairman and CEO:

“This sale represents a natural step for us. Becoming a part of the leading risk advisory firm translates into a positive outcome for our shareholders, greater options and value for our clients and increased opportunities for our employees.”

The negotiations are private, so it’s useless to speculative on how the final price was determined, but the management team and insiders hold 66% of shares outstanding, giving them effective control over such merger decisions.

APNC is in a unique business, so maybe the pool of suitors was limited for such a niche offering? Or maybe the management team just wanted to cash out and therefore took the first deal available?

It’s hard to say, though I’d be interested in hearing what RENN Capital (the largest institutional investor, with 11.5% of shares) thinks of the sale price…

Investment Review

It is hard to complain however, as my investment in APNC has turned out well:

I decided to sell some after the initial spike back in February 2011, but held on to a significant amount of my initial holding – APNC is the second largest position in my portfolio.

Although I have substantially changed my investment process and valuation methodology over the past two years, I thought it was interesting to look back at my initial forecasts from two years ago (February 2010): 

Averaging the aggressive valuations yields a price target of $3.27 – pretty darn close to the $3.30 merger price.

Final Thoughts

I do think there is a some possibility (15-20%?) that another offer emerges or the merger price is raised before the deal closes in the second quarter.

AON is a $15B company, and swallowing a $70m acquisition has relatively little risk, so I think that it’s unlikely the deal falls through outside of drastic circumstances.

However, APNC is a microcap and liquidity can be a concern, so I’ll look for an opportunity to reduce my position if nothing appears soon.

In a similar circumstance, I made the mistake of selling AMLJ after its buyout offer of $2.15, and missed out when another offer came through at $2.50.

Disclosure

Long APNC, for now