Regal Beloit (RBC) - Buy at less than $30.26

Enterprise Value approx $1.2 Billion ($39 per share )

Buy at less than $30.26


Background:

Regal Beloit used to be a quiet company; humble, but profitable with an 18% operating margin. No Debt. Solid dividends. 3 Midwestern plants, making small gears. A great company for Owners.

Then one day, Patriarch Henry Knueppel went down to Chicago to meet some investment bankers from Baird who were trying to offload Marathon Electric. Buying Marathon would double the size of Regal. The Baird salesmen explained how Henry could double the size of the company by leveraging it to the hilt.

Henry took a deep breath, closed his eyes to the obscene fees Baird charged, and dove right in. Fortunately for Henry, the industrial market boomed in the late 1990's and he was able to service the debt from the Marathon transaction.

Almost 15 years later, Henry and his buddies at Baird are still at it. Leverging up the company and buying cast offs from the industrial manufacturing world. Regal doubles the size of the company very few years via a big acquisition and continues to make small acquisitions inbetween.

It isn't quite a roll-up strategy and it isn't quite a conglomerate strategy - but it has made both Henry and Baird prosperous. Owners also did quite well over the years securing nearly double the S&P 500 gains.

While Henry has been using inexpensive debt to fund his buying spree, Owners might want to know how the operating companies fare. Managers who buy 20 companies a year (Regal's number of acquisitions in 2008) don't have much time to attend to the mundane tasks of operations.

At Regal the operating companies appear to muddle along - Operating Marging for the last 12 months were just under 10% at 9.34%. 9% operating margin is not good and is not bad in this sector. However, it is 1/2 of what operating margins were 15 years ago. Regal used to have some of the best margins in its space, now it has below average margins.

Now that the era of cheap money is over, what can we expect of Henry, Baird, and Regal-Beloit ?

Regal Beloit just raised $150 million via a secondary offering. This equity raise diluted existing shareholders about 10%. Interesting that Regal couldn't secure inexpensive debt financing and had to go the expensive equity raising route instead.

The financials tell us that with the $150 million secondary and some $80 milllion cash on hand - Henry is sitting on over $200 million cash and his cash flow can easily service his existing debt. Plus, he doesn't have any significant term debt due until way out in 2012. Regal's Owners can expect that the $200 million cash will be married to some $400 million of debt to make a big purchase.

Plenty of buy out shops are desperate to off load companies they bought a few years ago during the height of the cheap money craze. $600 million might buy a industrial enterprise with $1.8 Billion in revenue these days - effectively doubling the size of Regal once again. Perhaps Regal/Baird already has their eye on one....

Should owners invest alongside Henry in his latest adventure ?
Should owners expect another 15 years of double digit stock growth ?

Gudovac1941 can't predict the future, but he is able to make some basic conclusions based upon Henry Knueppel's actions (which speak louder than words, don't they ?).

Henry has such confidence in the future of Regal Beloit that he sold a little over 103,000 shares in the last 11 months. He sold 34,996 shares at $30.26. If Henry thinks Regal shares aren't worth $30.26, who are we to argue ?

Henry's 2008 stock options also indicate a certain attaitude towards Regal's future stock appreciation. In May 2008, The Board of Directors awarded Henry a few stock options at a $42.28 exercise price. This was the approximate value of the shares trading on the open market at the time. Granting stock options with a excerise price equal to the sale price at the date of award is common enough practice not to be questioned by auditors or regulators. However, it indicates a rather low bar for management to be 'in the money'.

Gudovvac1941 likes to see management options priced such that managers need to generate for stockholders a 15% annual return. If the market price per share was $40 at the time of award and the options have a 3 year life. The exercise price should be north of $60.

If Regal's Board had granted Henry options with an exercise price of $60, owners could have a high degree of confidence that management would be driven to increase the value of shares over time. Instead, Regal's Board priced the options such that even a paltry 3% annual increase in share price will make management's options very valuable.

At $30 share Regal Beloit's Enterprise Value would be about 1.1 times book value. Owner's would be paying approximately 4 times EBITDA. 4 times EBITDA is a reasonable price to pay for a 9% operating margin business growing through acquisitions for those who can bear a fair amount of risk.

Don't get Massacred !

Gudovac1941
Gudovac1941@gmail.com