THESIS: Limco-Piedmont Inc. (LIMC), trading at less than 50% of book value and about 55% of net tangible assets, offers both a compelling merger arbitrage opportunity and the potential for long-term gains. However, this opportunity is not viable for larger funds, as Limco has a market capitalization of $33.5 million (as of 5/1/09), and in the last three months, has averaged about 26,000 shares traded per day.
BUSINESS: Limco has two business segments—a MRO (“Maintenance, Repair, and Operations”) service for the aerospace industry, as well as a parts supply service. Their FAA certified repair stations provide aircraft component MRO services for airlines, air cargo carriers, maintenance service centers and the military. In conjunction with their MRO services, they are also an OEM of heat transfer equipment for airplane manufacturers. The parts services division offers inventory management and parts services for approximately 600 commercial, regional and charter airlines and business aircraft owners.
Both segments appear to have relatively similar margins, though the parts customers are less ‘sticky’. With credit tight and likely tightening, one tailwind for Limco’s businesses in the next few years will be those carriers who lengthen their fleets’ useable life, electing to maintain and repair older craft rather than replace them with new.
HISTORY: Limco had its IPO on July 18, 2007. Previously it had been a wholly-owned subsidiary of TAT Technologies (TATTF). The IPO raised about $46.2 million, placing 4.2 million shares at $11 per share. TAT retained a majority stake in Limco, which currently has 13.2 million shares outstanding. As of December 31, 2008, TAT held 61.7% of Limco’s outstanding shares.
BALANCE SHEET: Limco has a fortress balance sheet. As of 12/31/08, they had $21.3 million in cash and equivalents, and short-term investments of $11.3 million, consisting primarily of government and corporate bonds and auction rate tax exempt securities. As you would expect, the auction rate securities are currently illiquid, but only amount to $2.25 million of the short-term investments.
Inventories stood at $19 million at 12/31/08, accounts receivable at $11.8 million, and other accts receivable and prepaid expenses at $1.3 million. Total current assets then were $64.8 million, or $4.91 per share. PPE less depreciation was $6.0 million at year end, for $5.36 total in tangible assets per share. Intangible assets and goodwill totaled $6.2 million, which brings total assets to $76.9 million, or $5.83 per share.
Total current liabilities were $9.483 million, and the only long-term liabilities were deferred taxes of $0.8 million. Total liabilities then were $10.3 million, or 78 cents per share.
INCOME STATEMENT: Limco earned $2.7 million in 2008, or 21 cents per share vs. $5.2 million in 2007, or 47 cents per share. A large portion of 2008’s decline came from two one-time items: 1) $1.4 million in scrap expense, related to a “new program start-up in the OEM division [that] we believe should not be recurring,” and 2) an increase in general and administrative expenses “primarily attributable to approximately $837,000 in one-time SOX and public company costs.” (10-K)
MERGER ARBITRAGE: On April 3, Limco announced that it had entered into a definitive agreement and plan of merger with TAT Technologies for one half share of TAT for each share of Limco. For the week April 13-17, Limco traded between $2.32 and $2.48, and TAT between $5.12 and $5.51. If one were to set the long LIMC/short TATTF trade well, that spread has ranged between 5-20% since the announcement.
However, it is my belief that there is a better than 50% chance that TATTF will have to come back with a higher offer to close this deal, as at least a handful of litigious types have been trying to organize shareholders to block the “unfair price” (e.g., Levi & Korsinsky, LLP). So what’s a fair price?
VALUATION: At the highest end of the range, one could argue for a buyout at the original IPO price of $11 per share. Book value and cash have increased since the IPO, and Limco has added some valuable capital expenditures to generate future earnings power. In effect, $11 per share could represent paying book value of $5.05 per share, plus a 11x multiple of $0.55 per share annual earnings power. Though $0.55 exceeds 2007’s numbers, TAT could realize such earnings fairly easily through the additional cost savings that Limco would gain if it no longer publically reported and filed under Sarbox. For TATTF and other potential buyers, the regulatory cost savings for a company this small will significantly impact its future earnings power.
At the low end of a valuation range, one could value LIMC’s assets in liquidation. A conservative liquidation analysis would value cash and short-term investments at 100%, the auction rate securities at 75%, accts receivable at 75%, inventory at 50%, PPE at 20%, and liabilities at 100%. This would yield a liquidation value of $32.44 million ($30.35 million+$1.69 million+$9.5 million+$1.2 million-$10.3 million), or $2.46 per share.
However, in my lights, the liquidation value of LIMC understates its intrinsic value, given its demonstrated earnings power. Thus, a fair price for Limco as a going concern would likely include paying for their net tangible assets, plus an additional multiple for the earnings power. For a business with high capex costs, the same approach may overstate its value (see, e.g., Buffett’s reflections on overpaying for Berkshire Hathaway though it traded below its net tangible assets). Yet, Limco’s capex in 2007 was $2.9 million, and $1.7 million in 2008; both of which included some one-time items. Maintenance capex for Limco is likely close to its $1 million depreciation expense over the last three years.
With net tangible assets of $60.5 million, or $4.58 per share, and a 5x multiple of what I estimate to be their average annual free cash flow of $4 million, you get a value of $80.5 million, or $6.10 per share.
Of these three values, the last I find most reasonable, and representative of what a knowledgeable buyer should be willing to pay for the whole business.
Were shareholders able to get a better price, the upside could be substantial. Even an offer of $4 per share (still below net tangible assets) would represent more than 50% upside at these prices. Yet, even without a better offer, the long/short arbitrage should return 5-20%. In the event that the merger does not close, Limco at these levels offers a significant margin of safety to my estimate of its private party value.
Disclosure: I, or persons whose accounts I manage, own shares of Limco-Piedmont at the time of this writing.