Is This Auto Company About to Be Bought Out?

Private equity is taking a strong interest in this transmission company.

Purchasing a car is one of the worst investments you can make, because all it does it decline in value over time.  It also costs you more and more money to maintain it as it ages.  That’s why you should buy certain stocks to help finance all those expenses.

auto-company

There are stocks I refer to as “infrastructure plays”, because they provide essential elements towards making some other business run and be successful.  You can buy real estate, for example, but buying a company that offers home repairs would be a great choice.  Maybe that’s why IAC/InterActiveCorp (NASDAQ:IACI) purchased ServiceMaster a few years ago.

In the automotive arena, you can buy the parts companies, all of which are great growth plays.  However, there’s another great play I just discovered called Allison Transmission Holdings, Inc. (NASDAQ:ALSN).  It designs, manufactures, and sells automatic transmissions for heavy-duty commercial vehicles, and heavy-tactical U.S. defense vehicles.

So it has nothing to do with YOUR car, but it has everything to do with really big things that need really big transmissions to move.

The company offers 13 transmission product lines along with replacement parts, support equipment, defense kits, engineering services, and extended transmission coverage services.  It has a massive independent network of 1,400 distributors all over the world.

This is a good cash flow business.  The company’s cash flow is pretty regular, with operating cash flow at $469MM for FY11, $498MM for FY12, $453MM for FY13, and $241MM year to date.  Capex tends to be relatively low, at $97MM, $124MM, and $74MM, respectively.

Who loves cash flow besides investors? Private equity.  PE firms go crazy for businesses that have regular cash flow.  They swoop in and try to take the company private, then institute cost cuts to boost cash flow, and sit back and let it flow into their bank accounts.

Eight of the top ten shareholders, representing 36% of the company, are private equity firms.

These firms have been purchasing a lot of shares. ValueAct Holdings has purchased over a million shares in October alone.

If any company screamed “buyout candidate”, it’s Allison.

And why not?  Operating margins are strong at 23%, with net margins of 10%.  It has a manageable debt load of $2.65 billion offset by $126MM in cash.

The company is poised to grow earnings from $0.88 last year to $1.17 this year, and then to $1.42 next year.  That’s 30% this year, and then 22% next year, but long term projections are for a five-year rate of only 12%.  It’s odd because there are 14 analysts covering the stock and for the rate to be that low, it suggests they are expecting a slowdown.

So you have to decide if paying 21x next year’s earnings for ALSN is a good idea.  Given the company’s consistent cash flow, and the heavy pursuit by private equity, I think there’s a floor on the stock that’s close to its current price.  I think there’s limited downside and buyout upside of as much as 30%.

Lawrence Meyers does not own shares of any company mentioned.

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Published by Wyatt Investment Research at