— ValueWalk (@valuewalk) November 12, 2014
What can past market crashes teach us about the current one?
Spruce Point is pleased to release a 140+ page investment research opinion on AMETEK Inc. (NYSE: AME) an S&P 500 Company with a ‘Strong Sell’ opinion and a $27- $36 price target, or 30 – 50% Downside
In Spruce Point’s Opinion, There Are Numerous Reasons To Be Extremely Cautious of Investing in AMETEK. We Are Short the Stock for the Following Reasons:
1. Ametek Is An Aggressive Roll-up Hitting A Wall: With structural changes facing its core vacuum motor market, Ametek embarked on a 14yr+ long aggressive diversification strategy, and has acquired over 60 companies in various electronic test and measurement industries. Ametek appears to be getting desperate to find new targets. In our opinion, they are beginning to overpay for lower quality deals (eg. Zygo and Amptek). Ametek’s goodwill and intangibles is a staggering 69% of its total assets – dramatically higher than its industrial peers. It appears to underinvest in R&D and capex, and acquires what it cannot internally develop. Having spent over $4.6 billion on deals, Ametek has burned -$691m after adjusting its operating cash flow for recurring acquisitions and capex. Ametek’s acquisition binge yielded virtually no organic revenue growth in 2012/2013. However, we believe Ametek’s acquisition strategy and aggressive accounting inherently overstates its EBITDA margins and EPS. One such tactic Ametek uses is to amortize intangible costs such ‘customer relationships’ over an excessively long period such as 20 years. However, our most pointed evidence of margin and earnings overstatement comes from the public filings we’ve obtained from 17 operating entities across 10 countries, which suggests its EBITDA margins may be overstated by 400-600 bps.
2. Superior EPS and Operating Cash Flow Appears Too Good To Be True: In the past 10 years, Ametek has missed Wall St’s EPS estimates just once – a remarkable accomplishment given its exposure to cyclical end markets. Furthermore, its ‘superior’ operating cash flow benefits substantially from its acquisition strategy: neither its EPS nor cash flow can be taken at face value. We note that in addition to evidence of gross and EBITDA margin contraction at its foreign operating entities, dividends paid from these entities have also been falling. We note that Ametek recently raised $700m in a private placement to pay down its credit facility, which had been utilized by approximately 75%. We believe this capital raises, along with foreign filings from its main European and Asian entities, illustrates its struggle to pay down debt from operating cash flows. We believe Ametek has been touting its superior supply chain procurement initiatives as a cover for its ever-expanding margins, when in reality its filings suggest its margins are at best stagnant, and at worse declining. Ametek pays a small dividend and repurchases a token amount of stock to offset dilution, but we view this as entirely debt-funded and not supported by its operating cash flows.
3. Multiple Signs of Inventory Accounting Shenanigans: In 2009, an employee whistleblower case (Matthews vs. Ametek) claimed that Ametek was manipulating its revenue and inventory valuation at Chandler Engineering, one of its subsidiaries. Oddly enough, the head accountant and controller at Chandler was later charged by the FBI and convicted of embezzlement from submitting phony travel expenses in 2013. We observe that Ametek explicitly dropped the “lower of cost or market” inventory valuation language from its SEC filings, and has quietly been changing its inventory accounting from LIFO to FIFO, a change which enables enhancement to EPS. In 2013 in India, where Ametek markets many of its global products, its local auditor raised a qualified opinion and noted continuing failure to address inventory valuation issues, and bad internal controls for sales of goods and services, as well as travel claims! This doesn’t appear to trouble Ametek’s management, which has quietly adjusted its operating income bonus targets for unspecified “tax benefits related to the disposal of excess/obsolete inventory,” despite it never revealing an inventory charge to investors in its SEC filing. Lastly, we observe that in recent years Ametek’s inventory turnover has been declining, and aggressive inventory consignment strategies may be enabling the understatement of inventory on the balance sheet, thereby flattering working capital metrics, which drive management’s year end bonuses
4. CFO Jumps Ship After Its Largest Acquisition Announced: Ametek’s largest acquisition was Dunkermotoren, a German company acquired for ~$320m in May 2012. We pulled the filings for this company, and it appears that Ametek shamefully mislead investors about its performance. While Ametek led Wall St. to believe Dunkermotoren would produce EUR 200m of revenues for 2012, the German filings indicate that it missed this revenue target by 12% and that Ametek may have known that its performance was already deteriorating after Q1’12. Nonetheless, Ametek described that it was ‘very pleased’ with Dunkermotoren’s performance in response to questions from analysts. We have uncovered a disturbing and recurring pattern of Ametek misinforming investors about the revenue expectations of acquired targets. It may come as no surprise that Ametek’s CFO retired shortly after the Dunkermotoren acquisition. The departure also coincided with changes to Ametek’s equity clawback policy, which now encompasses a clawback due to financial restatement from fraud or intentional illegal misconduct
5. Concerns With the “Asia Growth” Story: With virtually no organic revenue growth across its operating businesses, Ametek has often deflected investor attention to its success and growth opportunities in Asia. However, we believe this may be nothing more than a red herring. We note that its Head of Asia recently resigned in early 2014, and its main Singapore operating subsidiary (which conducts business in Singapore, China, Malaysia, India, and Taiwan) was delinquent in its finical filings for most of 2014. Recent operating results indicate a disturbing trend of revenue, profitability, operating cash flow and dividend contraction. Its long-standing Taiwanese JV called Amekai appears to have gone dark and is technically insolvent with liabilities > total assets according to filings. In India, where Ametek entered in 2009 via an acquisition, its losses grew by 31% from 2012 to 2013!
6. Concerns with Ametek’s Cozy Auditor Relationship: Ametek has enjoyed a special relationship with its auditor E&Y – dating back to the 1930s. As a sign of how close the relationship appears to be, E&Y recently lavished its “Entrepreneur of Year” award on Ametek’s CEO, and has barely increased its audit fees in the last 6 years despite the tremendous growth in size and scale of Ametek’s business. In the whistleblower deposition, E&Y admitted that it doesn’t even audit all of Ametek’s operating entities. Ametek’s structure, which is comprised of dozens of small and diverse business units, provides an audit loophole to allow E&Y to examine only entities deemed ‘material.’ From this perspective, virtually none of Ametek’s units appear individually material to the whole. Ametek recently tasked a new VP of Audit Services to work with E&Y, however, according to our background check, the company has misrepresented him as a CPA, even though he has not been licensed in over 12 years! Ironically, in three foreign operating entities where we found E&Y was not the exclusive auditor, we found two auditor resignations and one qualified opinion!
7. Concerns with Ametek’s Board Oversight: In our opinion, relative to Ametek’s size, its Board is too small with just 9 members (8 excluding the CEO). The average age and tenure of the current Board is 65 and 13 years, respectively. These figures are very high compared with other industrial peers. The last person to leave the Board was Mr. Gordon Sheldon, who was the Head of the Audit Committee. In 2011, he mysteriously retired and resigned and did not stand for re-election, yet Ametek appears to have intentionally obscured his departure, and did not file an 8-K related to his resignation.
8. Follow the Money, Insiders Are Dumping Stock Fast: Alignment of insiders’ interests with public shareholders’ interests is almost non-existent. Insiders (management and its directors) own just 2% of the company. Of this amount, current directors own an inconsequential 0.36%. Insiders sell stock year after year, and will soon own virtually none of the company. This year alone, insiders including the SVP of Corporate Development, and two division heads each sold shares. Directors sell stock even more aggressively than management! We estimate insiders have unloaded over $100 million of stock since 2006.
9. Ametek’s Shares Are Dramatically Overvalued: Ametek trades at an absurd premium to the value of its acquired private businesses. We estimate it has paid 1.7x and 9.0x EV/Sales and EBITDA for its 60+ acquisitions, yet its shares currently trade at 3.5x and 13.5x 2014E results, respectively. Investors seemingly believe that Ametek’s conglomerate-like structure can add superior lasting value to acquired businesses, above and beyond what private ownership can achieve. Ametek often touts its ability to achieve greater-and-greater, seemingly never-ending cost and procurement savings. However, in our opinion, it may just be a cookie-jar to cover-up its struggles, and to keep its earnings growing. Furthermore, we observe that many of Ametek’s acquired companies were flipped from private equity; these prior owners are supposed to add value through cost cutting and supplying growth opportunities. What lasting incremental benefits Ametek can add above and beyond private ownership are a question open for debate. In light of our countless concerns about Ametek’s earnings quality and EBITDA representations, we believe that if it were to trade at the average peer multiple of approximately 2x revenues and 10-11x EBITDA, its stock would trade between $27-$36 per share. This represents downside risk of approximately 30 – 50%!
About Spruce Point Capital Management LLC
Founded in 2009, Spruce Point Capital Management is a boutique firm that specializes in short-selling and special situation investment opportunities, and takes an activist approach to its investments. Our forensic financial research challenges conventional thinking with deep fundamental analysis, analytical rigor, and a passion for investing. For more information visit us atwww.sprucepointcap.com and follow us on Twitter @sprucepointcap.
This research expresses our opinions as of the date hereof regarding AMETEK Inc. (“AME”). As of the date hereof, we have a direct or indirect short position in AME, a position we have taken based upon the bearish investment thesis that we set out in the attached report, and our firm, along with our subscribers, members, partners, clients, affiliates, employees, and/or consultants, will profit in the event that the share price of AME declines, and will lose money in the event that the price of AME increases. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation.