Investors were shocked when Superior Industries International (SUP on Nyse) announced a $760 million acquisition. Up to that May 2017 dispatch, Superior was considered a conservative, docile company run by straight -laced, prudent management. The company had zero long term debt, showed a leverage ratio of less than 25% and was not paying interest expense. To put in perspective - the size of the company acquired, Uniwheels, represented 140% the size of the buying company, Superior that is.
Shocking was not only Superior's Animal Spirits but also the price management had paid. To buy Uniwheels, management booked $286 million in goodwill (read: the premium paid over the fair value of the assets) and $205 million for intangible assets: the brand ($9 million), technology ($15 million), trade names ($14 million) and customer relationships (a whopping $167 million.)
Shareholders immediately questioned the deal. The monstrous size of the transaction was wrong. The price paid for the acquisition was wrong. And surely how the acquisition was financed was wrong too. To acquire Uniwheels, Superior borrowed $669 million and agreed to pay a weighted interest of about 6% per year.
Lenders, I speculate, must have required a fat equity base, so Superior raised preferred equity too. It sold $150 million of preferred stock, redeemable at a conversion ratio of $28.162. The preferred stock holder (TPG Growth II Sidewall LP) was promised a 9% dividend rate per year. Common shareholders were unhappy.
"I wish we weren't holders of 1.4 million shares," lamented Steven Borick in the last earnings call. "We're highly disappointed in the stock price and certainly the cut in dividend. And I'm voicing this opinion on this line for those that are listening that we feel the acquisition was very poorly timed." Borick knows the business. He was Superior’s Chief Executive Officer (his father founded the business 60 years ago.)
Since that May 2017 announcement, the market discounted the price of the stock by over 75%. Prior to the acquisition, the company traded as low as $20 and as high as $30. A year after the announcement, the stock traded as low as $15 and as high as $22. It now trades at less than $6 a share.
The penalty was warranted. And a comparison of 2018 operations to 2015 operations explains why. If we go back in years, in 2015 the company reported pre-tax earnings available to common shareholders of $35 million or $1.39 per share.
Fast-forward to 2018 and the company reported pre-tax earnings of $32 million or $1.42 per share. The company reduced the number of outstanding shares from 26.1 million to 25 million during this time. All well.
But in 2015, Superior did not carry any preferred equity. TPG Growth, the current preferred stock holder, is now paid prior to common shareholders. And so, $32 million in pre-tax earnings went to TPG's bank account. The common stockholders were left with a minuscule pre-tax earnings of $3.6 million, or $0.14 per share.
The timing of the capital allocation decision was questionable. As Superior purchased Uniwheels, more uncertainty prevailed in the Euro zone. The key word "trade wars" is now googled 10 times more compared to five years ago, when the word “Brexit” was yet to be coined.
Fully aware of the above risks, I went ahead and bought Superior's stock. First: On a per share basis, I paid less than what Superior paid for Uniwheels. Superior paid 1.5 times the Uniwheels sales. I paid one tenth of the 2018 sales. The same applies to the pre-tax earnings multiple. Superior paid 4 times the pre-tax earnings of Uniwheels. I paid 1/2 times the multiple of the two companies.
While Superior reported $0.29 in earnings per share for 2018, an earnings multiple of 20 times, the careful reader would note that Superior’s operating expenses included a non-cash item called amortization for intangibles.
This non-cash amortization expense was $26 million or $1.03 per share. I added back the expense and the adjusted price to earnings ratio was less than 10 times (management projects to amortize of $20 million each year until 2023).
Second: the company's management is buying back the stock. Stebbins, the prior CEO, recently bought 31,249 shares at a price of $8 per share. Matti Masanovich, Superior’s CFO, bought 29,050 shares at $8.34 per share. James Strauss, a director, bought 69,757 shares at $8.53 per share.
Third: Mario Gabelli is a shareholder too. His fund, GAM Investments, disclosed last year that it owned 375,000 shares of Superior, which cost the company a total of $6 million or about $16 per share. In short, I am in good hands.