Blogvesting

A fellow Covestor member asked me what I thought about the Katy acquisition for CCIX. I decided to make use of the opportunity to do some more research and number crunching, and to crystallize my thoughts on CCIX.

CCIX is pursuing the classic strategy of consolidating a fragmented industry, hopefully achieving both operational synergies as well as greater control over the market price. Once a threshold scale has been achieved, smaller competitors will no longer be cost-efficient compared to CCIX, while the power of its brands should deter larger players such as Belden and General Cable from competing. The chief danger in this strategy is overpaying for assets, becoming over-leveraged, and subsequently imploding due to a slowdown in demand. I give management a lot of credit for their discipline in acquiring companies. In the Katy acquisition, CCIX is paying 4.5 times EBIT, which is a very reasonable multiple. That said, this very low valuation is possible only because there is widespread recognition that consumer expenditures on cable products in the near future is likely to stagnate or decline due to the weak housing market. I believe CCIX is betting that it can wring enough operating synergies out of the acquisitions in the near-term to offset the lower demand. The average interest rate on the revolving credit facility ranges from 7-8%, so the additional annual interest is around $3.6M, which is 36% of the expect additional EBIT, or a debt service ratio of 2.8. This compares with CCIX’s existing debt service ratio of around 2.6, so CCIX’s leverage will actually very slightly decrease upon the closing of the acquisition. The picture is even more favorable if management is indeed able to squeeze out $12-15M of permanent reductions in working capital within 3 months as it claims. The beneficial effects of this acquisition is counterbalanced by the fact that this is a rather small acquisition compared to the size of CCIX. Based on the numbers management provided, the acquisition should add about $6M to net income, giving a 10% increase to CCIX’s valuation, which is not earth-shattering news in the big scheme of things. The major risk of this investment is still that CCIX may not be able to achieve sufficient operational synergies in the short term to offset the lower demand for cable products should demand fall dramatically. That said, management is guiding third quarter revenues to the high end of its previous estimates, so thus far, CCIX’s diversified brand portfolio seem to be providing a measure of protection against the weakening housing market. The operating efficiencies that can be reaped seem obvious to even to an outsider like myself, and management is certainly well-incentivized to do so. If revenue does remain flat from last year, the savings from integrating the acquisitions should provide a nice short-term boost to earnings during the trough of the housing cycle, and once the recovery starts, earnings should really take off as the market position of CCIX will be very much improved.