International Wire Group Is Cheap, But Is It Safe? – ITWG

My series on investing strategy will continue next week. Until then, let’s examine an aggressive manufacturing company, International Wire Group.

International Wire is the largest bare wire and copper wire products manufacturer in the United States with revenues of $870 million in 2011. International Wire is an aggressive acquirer. Beginning in the late 1990s, International Wire began acquiring numerous smaller companies and divisions in the US and Europe. Unfortunately, this acquisition spree lead to lead to excessive debt and the company was forced to seek bankruptcy protection in 2004.

International Wire Group shed hundreds of millions in debt in the bankruptcy process and emerged from bankruptcy in 2005. Since then, the company has been on a tear. From the beginning of 2005 to the end of the third quarter of the 2012, the company produced total net income of $84.5 million and free cash flow of $218 million. The company has used its staggering free cash flow to pay multiple large special dividends and repurchase stock, paying out nearly $250 million to shareholders since emerging from bankruptcy. (This $250 million is nearly 2.5 times the company’s present market capitalization.

While it has been extremely successful and generous to its shareholders, International Wire has taken on more and more debt to fund distributions. Since hitting a low of $80.25 million in 2009, International Wire has tripled its debt to more than $250 million. In December, the company used $60 million to repurchase 3.67 million shares of its stock, fully 37.4% of diluted shares outstanding.

After the repurchase, International wire has about 6.37 million shares outstanding and trades with a bid/ask mid-point of $17.75 for a market capitalization of about $109 million. Trailing net income is $21.6 million for a trailing P/E of 5.0. Present net debt is around $270-$275 million, per estimates by Standard & Poor’s. (Subsequent to quarter’s end, the company issued $250 million in debt due 2017 at an 8.5% coupon and used the proceeds to redeem all previously outstanding term debt and fund the stock repurchase. The company is expected to have funded debt redemption beyond the limits of the new debt issue by drawing on its revolving credit facility. The company also is expected to have $10-$15 million in cash on hand at the end of 2012.) The company’s enterprise value is about $379-$384 million, or about 5.0 times trailing EBITDA.

On current earnings and EBITDA, International Wire seems attractively valued. After all, a 20% earnings yield is nothing to scoff at. Net debt is worryingly high at 3.8 times EBITDA and 4.9 times operating income, but the interest payments are still easily covered. Unfortunately, International Wire Group operates in a cyclical industry and extrapolating current levels of revenue and income would be foolish. As recently as 2009, the company managed revenues of just $450 million and adjusted operating income of just $18.7 million. $18.7 million is not enough to cover the interest expense of the company’s new $250 million debt issue. Should economic conditions take a multi-year turn for the worse, International Wire might quickly find itself in some trouble. Standard & Poor’s apparently agrees, having assigned an extremely speculative rating of “B” to the company’s new debt issue.

So why does International Wire Group choose such an aggressive capital structure policy? The reason may have something to do with Chairman of the Board Hugh Wilson. In addition to being chairman of International Wire, Mr. Wilson is a managing partner of Tennenbaum Partners, an investment company that focuses on debt financing for small and mid-tier companies. Tennenbaum Partners is the investment advisor for publicly-traded TCP Capital, a business development company that held International Wire’s older debt securities and now owns a portion of the 2017 8.5% notes. TCP Capital also owns 1 million shares or 15.7% of International Wire’s shares outstanding. With Mr. Wilson at the board’s helm, International Wire would perhaps chart a more conservative path in regards to its capital structure having seen the effects of excess debt in 2004.

Depending on pricing and demand for its products, International Wire may perform exceptionally well, gracing its shareholders with additional large special dividends and continued share repurchases. Highly-leveraged companies usually do extremely well in strengthening economies.

On the other hand, the company may struggle if the economy retrenches and interest expense takes a bigger bite out of operating income.

Being right could make an investor a lot of money. However, I am simply not confident enough in the company’s ability to withstand adverse conditions should they arise. Yes, the prospect of buying into a company with a history of large distributions to shareholders at 5 times earnings is attractive. But I have a list of other growing companies trading at 5-7 times earnings without a giant debt load. Knowing that, International Wire goes on the watch list for now. The company might be a great buy in the middle of the next recession when the market is acting like no one will ever buy copper wire again. In late 2008/early 2009, International Wire Group traded all the way down to $8.50 per share, only to distribute $15.52 per share in the dividends in the three following years!

 

Disclosure: No position.

2 Comments

  1. Dear OTC Adventures,

    I love your site, but for you to steal one of my best value ideas…;-)

    The current actions with the massive buyback of shares by issuing new debt is very accretive to shareholders, if indeed the company remains capable of paying it’s interest cost. As you said the operational income of 2009 is not sufficient to pay the interest cost of the new $250m debenture. I say I have to disagree with you. Based on the income and cash flow statement of 2009 if I (very roughly) calculate cash flow available to pay the interest cost:

    Net income $ 4,394
    Interest cost $ 8,732 (this amount will now be replaced with the 8,5% on the new debt)
    Depreciation $16,908
    Amortization $ 2,916
    Capex $ 5,834
    Cash Flow $27,116

    Interest cost full 2013 is:

    Debt $275
    Interest rate 8,5%
    Interest cost $23,375

    Interest cover 27,116/23,375= 1,16

    I think your calculation of operational income double counts the interest cost by not adding the interest cost of 2009 to operational income.

    Not a big margin of safety, but then again 2009 was their worst year performance wise and if they use (at least) a part of their cash flow to pay down debt the margin of safety should increase. If push comes to shuffle they could also postpone a part of their CAPEX as this creates a bit of additional headroom.

    I looking forward to your response and if you agree with my calculation if this would change your opinion of not investing in ITWG. If not I would like to see your list of growing companies that you think are more interesting…;-)

    Regards,

    Sjoerd

    • Hey, thanks for the kind words! I do think ITWG is a pretty good investment and you make a lot of good points about its resilience during an economic trough. You are correct that 2009′s operating income understates the company’s true cash generating ability. I’m fairly sure I did not double count the interest payments, but I also did not add back the large depreciation/amortization in excess of capital expenditure figures. It’s clear that the company has the ability to defer some capital expenditures during leaner times. I also did not account for the fact that working capital investment in cyclical manufacturers tends to be counter-cyclical. Both inventories and accounts receivable tend to be drawn down during economic contractions, juicing operating cash flow.

      I am staying out of ITWG, but that just leaves more shares for you to buy! I’m picking up more shares of cheap de-leveraging companies like GLUX and LICT, and cheap growers like AUTO, REPR, AMNF and others.

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