Halonix – Special situation – multiple triggers to unlock value

Stock Opportunities Special Situations
1

Halonix (EV 300crs, debt 160crs) is owned by Private equity [66%]. Auto lighting [Halogen bulbs] and general lighting [CFL bulbs] contributed equally to FY12 sales. Halonix is a market leader in automotive halogen bulbs in India with over 50% market share in passenger vehicles and over 80% in motor cycles for OEM segment. The single most reason for the company downfall in last couple of years is their ADVENTURE in highly competitive CFL bulb field, which is continuously making operating losses and draining cash flows of the company by way of increased inventory and receivables. Download company presentation for additional details http://goo.gl/YPc47. On the face of it, it might appear to be worst business to own. Frequent changes of MDs, high leverage for a cyclical company [1.2x], losses to low single digit operating profits and a company which is sued by minority shareholders [Unifi capital, a Chennai based firm http://goo.gl/J16Pi]. Reported numbers hide the fact that Auto lamp business made EBITDA margins of more than 20% during FY09-12. Off late due to steep decline in exports and slowdown in local market sales and margins are in pressure [Though possibility of accounts cleaning on appointment of big four auditor cannot be ruled out and to a certain extent steep depreciation of INR which increased raw material cost [50% imported], but owing to market slowdown ASP is flat]. This is not a long term story but a special situation, in which the value unlocking will happen on occurrence of specific events and market price will be less correlated to general market movements. In other words, unless the specific events occurs stock price will most likely be range bound.

**Investment theme: **PE group Actis owns 66% stake [acquired in May 2006]. Life of a PE fund varies between 7-10 years with option to extend it by another 1-2 years. Actis Fund which closed in Aug 2005, is estimated to be due for redemption by end of 2015. Actis most probably HAVE TO EXIT in another 2-3 years. There are multiple trigger for re-rating a) after completion of hive-off of general lighting business a time period next 3- 6 months [announcement on 21 Jan see here http://goo.gl/lXFjb b) After turnaround of auto lighting business 1-2 years c) after exit of PE [2-3 years]. The extent of upside will vary in each event. It will be maximum after the exit of PE fund is announced. Valuation is quite subjective, one may take individual call. For me, at current price it looks CHEAP.

_Valuation: _

Current enterprise value is around 300 crs [debt is 160 crores]. During Aug-10, promoters agreed to buy general lighting business at EV of 140 crs [roughly equal to book value plus debts]. Assuming that the current transaction will be carried out at similar valuation, auto lighting business is trading at EV of 160 crs. As per newspaper report (29 Nov 2010) in economic times, Philips offered to buy its auto lamp business at around 300cr (I assumed at to be equity value, adding debt of 65 crores we get EV at 365crs. According to my calculation, market is factoring worst case scenario which is a very low probability event. [Using reverse engineering with the help of DCF you can arrive at your own nos].

_What can kill the idea _

o PE exist does not happen for next three years and the current promoters spend excessively in promoting CFL business and/or auto exports decline prove to be permanent [at peak exports contribute 58% of auto lamp sales].

o Promoters try to sell the Auto lighting business to their related entity leaving CFL business with the listed entity.

o Value is highly sensitive to EBITA margins. Last three years average was around 18%. My assumption is that 16-8% will continue to be sustainable margins. This is based on the assumptions that a) Decline in exports are a temporary phenomenon and acquisition of its European distributors will fix it b) Ram material hike is more because of FX depreciation and is cyclical and there are no structural problems with Halonix pricing power for Auto lighting. Expect downside if EBITA margin of Auto lighting remain stuck below 6% for extended period of time.

S**ee the attached note for detailed analysis. This is not in the form of a structured report, but should be useful for detail oriented investors. http://goo.gl/YmBjp. **

Disc: invested in stock

PS: Going by frequent spikes in the share price in the last one year at very low volumes [20-30% deliveries, it appears that some operator is indulging into frequent pumping and dumping operation for this stock. So be careful and donat take jump in volumes or price as any breakout

2

Hi Anil,

As promised I am making a start on understanding special situations. Think this is an area all serious investors should give more attention to. Also this is a neglected/blind spot in ValuePickr (just like the large-caps situtation) which we must strive to bolster, with help from lead members like you.

Some top-of mind questions (based on your write-up, I haven’t done any independent study). I may be asking naive questions, but it will help if you can patiently answer, to establish why there is Value. (Also I will be reading up Prof Bakshi’s lectures for direction)

Trying to understand the CONS first: (How bad is the situation really)?

1). When exactly was the CFL diversification? Business seems to be on a continuous downslide since last 4 years

2). Your argument - once the CFL business gets hived off - business will be back on solid ground. Where did you pick up the 3-6 months tome period for hive-off? BSE announcement mentions Board has formed acommitteefor options - include hive off to a subsidiary - leading to eventual sell off.

a) Considering its a dud business - and am assuming not huge volumes - why would they find a buyer so soon (within 3-6 months), they haven’t even transferred to a subsidiary yet. If the Prometers had agreed to buy in 2010, why has it taken so long to even consider the hive-off? Can you educate on this aspect.

b) With ACTIS in control for last 6-7 years, it looks like its more of a Management disaster (deworsification and then inability to turn things around), so ACTIS exit isn’t going to suddenly turnaround things. It will require re-building time, say 2 years for things to get back on track - post the sell-off when it does happen.

c) How long has the current Executive Management been in charge? Till 2011, there was positive 25-30 Crs cashflows, but losses at net level. 2012 shows negative operative cash flow, with some profits at net level. 2013 looks worse going by results so far with Auto Lamps business contracting to ~40% of Revenues (~CFL 60%), and EBIT declining to 7.8 Cr vs 34 Cr(1H) . Situation seems hopeless currently

Now for the PROs (How much of Tangible Value exists in the Business/Assets):

Valuation exercise key to whole special situation I guess; But IHave no clues here:(

just adding some notes to see where this is headed

1). Market Cap 124 Cr. Debt 160 Cr. , say 280 Cr of EV for combined entity

2… Auto Lamp EBIT 7.9 Cr, add dep (50% 6.68 cr) 3.32 cr, ~11 Cr 1H; annualise 22 Cr

3). Auto Lamp Sales of 86 Cr for 1st half, 180 Cr FY13

4). Auto Lamp EBITDA FY13 22 Cr (FY12 57 Cr), EBITDA margin of 12%

What valuation measure can we use? Applying DCF for a business in severe decline seems counter intuitive

5). Net Block =97 Cr

-Donald

3

There are some negatives point about management, which though is contained in my detailed note, I thought I will summarise it on blog for the benefit of everyone.

o During FY10 restructuring, company proposed to sell its general lighting business of the company at book value (76 crores) to its promoters without even inviting bids from potential buyers. Havells India did expressed interest in buying the business (as per newspaper reports).

o Company had not given any proper reason for calling off restructuring of the business after it had been approved by board and shareholders in 2011.

o There are allegations of fraud from Unifi Capital against the company.

o Before the warranty expenses were first recorded in 2009, Mgt never discussed about the risk from warranty nor made any provision in the books. (same is the case with Havells India, even its provision increased multiple times in 2012 compared to 2010).

o No conference call and no presentation posted on website.

o Despite repeated mails, company did not respond to any of my mails.

On the positive side, annual report is reasonably detailed to understand major risks, though it could have been much better. Being a PE owned company, I presume they will do any outright fraud because that will jeopardise their reputation. But having said that, definitely management comfort is less than desired and one may take his own call.

4

Thanks for excellent questions. Many of the stuff which I have discussed is more judgemental. In the absence of any discussion with management and recent steep decline in companyâs fortune we need to make our best estimates. Find my replies in Blue.

  1. When exactly was the CFL diversification? Business seems to be on a continuous downslide since last 4 years

They are in CFL business for long, infact even before Actis took over management eg even in 2006 they derived around 40% of sales from CFL bulbs. Actis expanded this business aggressively and I GUESS betting on carbon credits, which after financial crisis totally failed. Chinese started dumping CFL bulbs in middle of 2007 and finally in Nov 2008 GoI imposed anti-dumping duty. Again Actis continuously changing its strategy on CFL from private labelling [manufacturing for third party] to selling under own brands. They are spending aggressively on Advertisement and unable to control quality, high returns.

2). Your argument - once the CFL business gets hived off - business will be back on solid ground. Where did you pick up the 3-6 months tome period for hive-off? BSE announcement mentions Board has formed acommitteefor options - include hive off to a subsidiary - leading to eventual sell off.

If you look at segmental accounts for last 3-4 years, Auto lamp section is doing well and cash drain and losses are mainly on account of CFL. According to my understanding Auto lamp business enjoys strong entry barriers [only player with manufacturing facility in India] and OEM cannot depend on imports. If you go through the news items between Feb 2010 to May-2011, within 6-7 months they announced that promoter themselves are buying CFL lamp business at EV of 145 cr (debt 69 crs). I have no doubt even this time promoters will be ready to buy it. Last time they need to spend time in segregating Auto and CFL facilities and account, but this time that activity is already done. Hiving off [or more appropriately sale] under section 293 of companies act do not require any court approval. Last time Havells India did show interest in buying their facility. Lets not forget till last year they were doing private labelling so its only a question of improving quality.

a) Considering its a dud business - and am assuming not huge volumes - why would they find a buyer so soon (within 3-6 months), they haven’t even transferred to a subsidiary yet. If the Prometers had agreed to buy in 2010, why has it taken so long to even consider the hive-off? Can you educate on this aspect.

Partly explained above. Last time they cancelled the whole process without giving any reason. Infact as per newspaper reports, promoters were planning to sell their entire stake. Going by current market situation, I GUESS the current decision to set up a committee is preclude to eventual sale of their entire stake. Even if that does not happen so soon, sale of CFL division to Actis should be beneficial. Having said that, whether it will be 3-6 months or more is anybodyâs guess.

b) With ACTIS in control for last 6-7 years, it looks like its more of a Management disaster (deworsification and then inability to turn things around), so ACTIS exit isn’t going to suddenly turnaround things. It will require re-building time, say 2 years for things to get back on track - post the sell-off when it does happen.

If Actis plans to exit, it will exit at PRIVATE VALUE and not current market price. When a new investor buys more than a specified %, he has to come with open offer to buy additional shares from public. [An open offer is triggered when an entity acquires more than a certain percentage of the shares of a listed company. Once acquiring entities have bought 25% of a company, they will have to launch an open offer for an additional 26%.]So this is how value will be unlock. And mind you, their Auto Lamp business has always generated best EBITA margins except for the last 3-4 quarters, which to my understanding is more because of steep depreciation of INR and cyclical slowdown in automobiles.]

c) How long has the current Executive Management been in charge? Till 2011, there was positive 25-30 Crs cashflows, but losses at net level. 2012 shows negative operative cash flow, with some profits at net level. 2013 looks worse going by results so far with Auto Lamps business contracting to ~40% of Revenues (~CFL 60%), and EBIT declining to 7.8 Cr vs 34 Cr(1H) . Situation seems hopeless currently.

Here is a tricky part. There is no way to exactly prove or disprove whether they can regain profits in auto lamp division. My hypothesis is a) Export decline more because of macro events in Europe and/or failed acquisition of their European distributors. B) current slowdown is exacerbated by slowdown in both two wheelers and four wheeler segment. This is what I have noted in my detailed note âExports in general had remained in the narrow range of 90-100 crs during 2004-12, except for 2010 & 11 when it jumped to 125crs only to fall back again to 100crs in FY12. So it seems highly improbable that decline in exports might have put pressure on margins. Moreover, company claims to have 15% market share in after market in Europe and after market should be more stable than OEM. Itâs also possible that because of the cancellation of the acquisition of distributor, there are some unresolved issues due to which company exports have taken a hit. But more probable is that company is writing off the advances paid at the time of proposed acquisition through trade discounts etc. Company had recently concluded purchase of European distributors, so things might get sorted out soon. Company had appointed one of the big 4 audit firm as joint auditor in the middle of the year (2012) âto strengthen the audit systemâ.â Read my comments on impact of INR USD on raw material as to how its quite possible that margin erosion is more because of steep depreciation of INR.

Now for the PROs (How much of Tangible Value exists in the Business/Assets):

Valuation exercise key to whole special situation I guess; But IHave no clues here

To be fair, I do not have any special knowledge in special situation and whatever I have learned till now is only theoretical. Thatâs why I have not commented anything on valuation front. According to my calculation downside/ upside can be anywhere between -20% to more than 2x the current valuation, depending what call once take about sustainable margins for Auto Lamp division and sales going forward.

just adding some notes to see where this is headed

1). Market Cap 124 Cr. Debt 160 Cr. , say 280 Cr of EV for combined entity

2… Auto Lamp EBIT 7.9 Cr, add dep (50% 6.68 cr) 3.32 cr, ~11 Cr 1H; annualise 22 Cr

3). Auto Lamp Sales of 86 Cr for 1st half, 180 Cr FY13

4). Auto Lamp EBITDA FY13 22 Cr (FY12 57 Cr), EBITDA margin of 12%

What valuation measure can we use? Applying DCF for a business in severe decline seems counter intuitive.

Here lets think from the perspective of buyer. Once we agree CFL business is out of picture and even agreeing that exports cannot recover from here, then company will be left with huge unused capacity. So no more capex for extended period. More than 60% of expenditure is on raw material and majority of SG&A I GUESS is on CFL business mainly on advertisement. In addition to this provision for bad debts, inventory losses are again on CFL business. Rather than valuing this company using DCF, use DCF to estimate what market factors into current valuation of Auto lamp division on a standalone basis. Here you have to take some important calls a) sustainable sales going forward b) sustainable EBITA margin going forward c) EV of CFL business and the discount rate. Though many people use very high discount rate, I THINK pre-tax yield on government bonds should be fair, otherwise you can add your own premium to pre-tax yield on government bonds.

Second approach directly apply some multiple to sustainable EBITA of auto lamp division, assume company will pay somewhere closer to what they have paid last time. There are no similar transactions to compare with. Again be consistent, whatever discount rate you use in DCF, inverse it and apply to get target multiple. Eg if you use 10% discount rate in DCF, 1/10% = 10x, use 10 multiple in EV/EBITA valuation.

5). Next Block =97 Cr

-Donald

5

Anil,

Looking at it another way, for anyone to invest in a special situation there has to be substantial rewards for it to be meaningful/viable. Perhaps even higher than normal returns.

So if one has to wait in a special situation opportunity 2-3 years, it better give 2x returns, or say a 25% CAGR. Else why take all that uncertainty? and the opportunity cost till the event triggers?

If that is a fair comment, do we foresee a situation where the leftover business will be valued at 2x (from current levels) in 3 years? How likely is that?

What EV/EBITDA multiple (or any other proper metric) is that from your evaluation?

-Donald

PS: now that I have thought aloud, I better read Prof Bakshi’s pointers!

6

Interesting pick anil kumar.

Problem with this kind of situations is blockage of capital for long periods of time without any return or often some loss of capital.

But to its credit, these kind of situations can offer multibagger returns and that too even if markets may be weak.

Looking at charts, levels close to 36 seem to be very important in terms of support.

regards

hitesh.

7

attaching monthly chart of halonix.

as mentioned earlier the 36 levels seem to be sacrosanct. it makes sense to buy as close to 36 as possible and hope for the best.

8

FORGOT TO ATTACH CHART.

HERE ATTACHED.


9

Thanks Hitesh

I know very little bit of technical analysis, so not sure whether this point will be helpful to you. But off late, my GUESS is many times this stock was in the hands of operator. over the last one year you can see frequent spike in prices at a very low delivery. Further during this time there is no material change in shareholding of top two public shareholders.

10

Valuation:

As per newspaper reports Philips offered to buy Halonix Auto Lamp division for INR 300crs. I am presuming that its equity value. As per companies presentation [see link in earlier section] auto segment had debt of INR 65crs and EBITDA for FY10-12 was around 50 crs. Lets allocate 50% of depreciation of the company to Auto segment. Below is the implied valuation at the multiple quoted by Philips

EBITDA of Auto segment

50.2

Less: Depreciation @ 3% of sales

-6.6

44

EV/EBITA of 8.2x

358

Philips quoted EV of 365 crs in 2010

50% Book value of General lighting segment

50

 at that point of time promoters offered around 75 crs equity value

Enterprise value

408

Less: Loans

-165

Implied value of Helonix Auto segment

243

Am not implying that it MAY GET THE ABOVE valuation again. One can make own assumptions of sustainable EBITA margins and sales going forward and arrive at expected value.

11

Above I was talking about Philips offer during Nov 2010. See the link herehttp://articles.economictimes.indiatimes.com/2010-11-29/news/27601373_1_lighting-business-actis-automotive-halogen-lamps

12

Great pick Anil

I have 3-4 names which are a bit off track turnaround kind

A bit confused as to which one should I buy

Halonix, BILT, zuari agro, sintex or Phillips carbon

13

Add jayshree tea to the above list

14

Thanks Excel

On Philips Carbon, I have posted detailed note in the relevant thread.Comparatively, From the risk perspective I would put less in Philips Carbon [more concerns on mgt, many moving parts and overall market risk] but in Halonix, there is atleast comfort factor that PE has to exit and my gut feel says it will be sooner than later, just by going by the recent news that LPs are putting lot of pressure on PE funds to get the money back when the markets are doing good. Having said that be prepared to wait for 2-3 years in case of Halonix and philips carbon is more of short term 6-9 months. No idea on others

15

The risk here is that they are unable to find a buyer and therefore transfer their holdings to the new fund under the same series and the story drags

thread.Comparatively,

16

Hi Excel

What you are saying is possible for CFL bulbs but quite remote possibility for their Auto segment. They are the only producer of Halogen bulb in India with a manufacturing facility. To my knowledge [confirmed with a wholesale distributor], other companies import it from China. Their tie up with OEM is like a strong networking advantage for a prospective buyer.

If they really do that, it will be providing exit to old LPs at the cost of new LPs and will become a corporate governance issue and will tarnish their image and make it difficult for them to raise funds. But I agree with you, that remains a risk…

17

Hi anil,

The transfer could be done at an agreed on price beneficial to both the funds. I don’t see any corporate governance issue here. It is all about time the old fund is out of time and the new fund has the time.

18

From Capital Market

Halonix reports net loss of Rs 1.46 crore in the December 2012 quarter
Sales decline 5.26% to Rs 114.58 crore

Particulars Quarter Ended
Dec. 2012 Dec. 2011 % Var.
Sales 114.58 120.94 -5
OPM % 4.2 9.34 -55
PBDT 1.49 6.13 -76
PBT -1.46 2.69 PL
NP -1.46 2.79 PL
19

  1. Auto segment sales finally seem to have stabilised at around 45 crores for last four quarters. Profits have sharply rebounded compared to last three quarters. Even adjusting FX [50% each to both segments] operating margins for Auto segment have improved from 7.5% in earlier quarter to 13% in current quarter. With the completion of European acquisition of distributors, I think exports should rebound from next quarter. [presuming slump in exports was because of acquisition related problems after cancellation of acquisition in May 2011]

  2. RM as % of sales declined by 3% points to 67% [for last five years avg was around 60% and for FY12 it was 58%. I agree that with two diverse segment this may not be correct method to look at RM cost, but atleast it gives rough approximation]. Decline in RM cost appears mainly because of stability in USD/INR and pass on of RM cost.

  3. General lighting loss have declined by almost half on Q-o-Q basis but remains flat on Y/Y basis albeit sales have increased by almost 50%. Here profits can always surprise on negative side on any increase in warranty provision which is totally discretionary. This is most unpredictable segment and huge negative surprises cannot be ruled out.

Immediate trigger is announcement of hive-off of General lighting segment, which I GUESS should happen in another 2-3 months [though the actual hive-off may take upto a year]. If auto segment profit margins are maintained in next quarter, then stock should rebound from 52 week low levels.

20

Halonix announcement on BSE today:

“Halonix Ltd has informed BSE that the Board of Directors of the Company at its meeting held on March 04, 2013, has noted the progress made on the Restructuring of Business of the Company and after discussions noted that more deliberations are needed by the Committee formed for exploring options on Restructuring of the Business and therefore decided to defer the decision in the matter till the next Board Meeting of the Company.”

I expected some concrete measured will be announced today, but it seems wait will get little longer. At current valuation, little risk of permanent loss of capital but share price will remain range bound till some clarity emerge on restructuring. But over a period of 3 years upside remains substantial [INR 70-80 is easily doable]