Business

Spruce Point “Strong Sell” Opinion On Gentex, Sees 40% – 80% Near Term Downside

Gentex (Nasdaq:GNTX) is a supplier of dimmable mirrors for the auto and airline industry. Its products are commoditized and require nothing more than plastic moldings, mirrors, chemicals, printed circuit boards, and other inputs such as compasses. Its financials suggest it to be a wildly profitable company, yet our forensic analysis uncovers numerous red flags to suggest otherwise.

Gentex’s IPO in the early 1980s is littered with red flags. Its dimmable mirror was a carrot to bail out its struggling smoke detector business, and its management put no capital at risk. Gentex’s success has defied all the odds: it now commands a $5bn market cap and claims >90% market share. Its lead IPO underwriter and banker, OTC Net founded by Juan Carlos Schidlowski, was a notorious penny stock promoter who was later charged by the SEC and fled the country.

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Gentex’s 40% gross margins are vastly superior to all global auto suppliers and are likely overstated by 2x. We believe it’s aggressively leaving costs in inventory (inventory growth is 3x revenue growth) while inflating capex through nonsensical projects (e.g. its North Riley Campus is 90% over initial budget). We commissioned a product tear down by IHS, an automotive expert, to examine its components. In our view, Gentex’s rhetoric pertaining to its mirror’s level of proprietary components and vertical integration is likely exaggerated. We also have documented proof of capex misstatement.

Despite margins and profitably that dwarfs auto supply peers, Gentex policies that are touted as shareholder friendly are not what they appear. Its dividend growth has been well below the rate of its reported free cash flow growth, which is likely overstated, and its share repurchases are mostly to offset dilution. Gentex has amassed an abnormal amount of cash on its balance sheet, and has irregular Level I and II classifications. We believe Gentex has shunned M&A to avoid outside scrutiny. The only acquisition of note in its history was of HomeLink, a related-party deal where we find issues.

A Story Too Good To Be True

Gentex's IPO in the early 1980s is littered with red flags. Its dimmable mirror was a carrot to bail out its struggling smoke detector business, and its management put no capital at risk. Gentex’s success has defied all the odds: it now commands a $5bn market cap and claims >90% market share. Its lead IPO underwriter and banker, OTC Net founded by Juan Carlos Schidlowski, was a notorious penny stock promoter who was later charged by the SEC and fled the country

Signs of Earnings Over-statement

Gentex’s 40% gross margins are vastly superior to all global auto suppliers and are likely overstated by 2x. We believe it’s aggressively leaving costs in inventory (inventory growth is 3x revenue growth) while inflating capex through nonsensical projects (e.g. its North Riley Campus is 90% over initial budget). We commissioned a product tear down by IHS, an automotive expert, to examine its components. In our view, Gentex’s rhetoric pertaining to its mirror’s level of proprietary components and vertical integration is likely exaggerated. We also have documented proof of capex misstatement

Irregular Financial Policies

Despite margins and profitably that dwarfs auto supply peers, Gentex policies that are touted as shareholder friendly are not what they appear. Its dividend growth has been well below the rate of its reported free cash flow growth, which is likely overstated, and its share repurchases are mostly to offset dilution. Gentex has amassed an abnormal amount of cash on its balance sheet, and has irregular Level I and II classifications. We believe Gentex has shunned M&A to avoid outside scrutiny. The only acquisition of note in its history was of HomeLink, a related-party deal where we find issues

Governance Weaknesses

Gentex was audited by Arthur Anderson (Enron + WorldCom auditor), and its former Michigan partner has sat on Gentex’s Audit Committee as chairman for 14yrs. Gentex’s audit fee is by far the lowest in the auto supply industry. Its Chairman/CEO is 74yrs old and no longer participates in conference calls, yet keeps a tight grip on its financials by having to approve invoices over $5k. The Chief Accounting Officer acts functionally as the Treasurer and signs checks, a major financial control red flag. Insider ownership declines every year and is just 2.5%. The only executive getting special bonuses is the Chief Accounting Officer

In addition to material concerns about Gentex’s financials and credibility of management, Spruce Point believes investors will also have to look beyond myriad fundamental challenges on the horizon

Key Modules are in Decline

Our field research indicates that SmartBeam revenues (10% of total sales) are already in decline as cost of traditional driver assist packages continue to come down in price and OEMs look to avoid redundancies. HomeLink now faces competition for the first time from a comparable Magna product and various phone apps with additional functionality.

SAAR Decline & De-Contenting Cycle

The past cycle of surging auto sales, high levels of affordability and the gradual digitalization of the auto user experience presented the ideal backdrop for Gentex. We believe the current dynamics of the used car market have set the stage for a dramatic reversal in auto sales and affordability. We believe that reduced affordability will lead to de-contenting, magnifying the challenge of the downturn for Gentex.

Full Display Mirror (FDM) Is A Big Problem, Not the Answer

Gentex’s moat historically has been the auto-dimming feature of its mirrors. The fact that the FDM functions primarily as a display, rather than a mirror, makes the auto dimming feature almost irrelevant. This opens up the FDM product to a much wider range of competitors, including display suppliers attempting to make mirrors and traditional mirror companies that have strategically partnered with display companies. We believe that Ficosa (Panasonic) will be offering their own version of the FDM at a 50% haircut to the Gentex FDM price of $200. Gentex’s inability to rely on an auto dimming premium and reliance on Kyocera as a display supplier will limit margin and their ability to compete on price.

Long-term Viability of Mirror in Question

The convergence of the connected car and assisted driving are rapidly reshaping the technology user experience of the automobile, particularly vehicle navigation. We believe that the future of vehicle navigation is cameras, sensors and displays, not mirrors. Over the past several years’ multiple world class technology companies (e.g., Samsung,

Panasonic, Intel, Google) have entered the space via strategic investment and acquisition of existing auto navigation suppliers. All of these players are focusing their efforts on the user experience and to date almost all of them are focused on Heads Up Display (HUD) or the center console. Gentex appears to be on an island, having not forged any strategic partnerships of meaning to date and linking their future to the likely ill-timed near-term solution of the FDM.

We believe Gentex offers a terrible risk/reward. Gentex investors believe it to provide growth at a reasonable price (GARP) while trading at 7.5x and 14.5x ‘17E EBITDA and P/E and 10% EPS growth. However, our view is that its cheapness is a function of its precarious position in a cyclical auto industry about to turn, its potential to be displaced by new technology, and its high risk of financial misstatement. Listen carefully to the Bofa/ML analyst who has an $11 price target

Gentex (GNTX)

Capital Structure and Valuation

Gentex’s valuation looks “cheap” and appeals to many GARP investors. Analysts expect sustained 7-8% sales growth and 8-10% EPS growth in the coming years. These expectations rest of the tenuous assumption that Gentex’s financials are fairly stated and that the auto cycle and mirror use can be sustained. We adjust Gentex’s financials for below market revenue growth, and normalize its margins for the extreme capitalization of expenses and overstatement we have documented in this report.

Gentex (GNTX)

Our Gentex Research Process

Spruce Point has spent many months and invested significant resources to conduct proper due diligence on Gentex as basis to form our Strong Sell opinion

Gentex (GNTX)

Article by Spruce Points Capital

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