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I am of a firm belief that companies generally destroy shareholder value when they acquire other companies. Synergies, that the most acquiring company expect out of the combined entity often fail to materialize, or are not enough to offset the premium paid for the acquisition.
Given that Audiovox was a great investment candidate in terms of valuation before it acquired Klipsch, we need to now evaluate if the Klipsch acquisition was a smart move on the part of the management.
Evaluating the Klipsch Purchase
As an investor, one can go about any number of ways to figure out whether the combined company still offers a good value. One way is to consolidate the finances of the two businesses as if the purchase occured a year ago (or if one is so inclined, going back a few years) and than look at the consolidated Balance Sheet and Profit/Loss statements and run the normal valuation models.
In this case, I will simply take Klipsch as a separate business and evaluate its intrinsic value as of the date of acquisition. This will help us determine if Audiovox paid a fair price for the business.
Terms of the Klipsch Acquisition
Let me summarize briefly the purchase price and how it is funded. We will keep this in back of our minds as we evaluate Klipsch.
Total Price Paid: $167.6 M
- Borrowed: $89.1 M (Using a newly entered credit facility with Wells Fargo, to the tune of $175 M)
- Own Cash: 167.6 – 89.1 = $78.5 M
With $167.6 M as the actual price paid, let’s now determine the intrinsic value of Klipsch. Audiovox issued an 8-KA statement outlining the financials of Klipsch for fiscal year ending June 30 2008, 2009 and 2010 as well as unaudited financials for 8 months ended Feb 28, 2011 and 2010 for comparison purposes. (All Audiovox filings can be accessed here)
We will start with the Balance Sheet as of Feb 28, 2011, which has been reproduced here.
Total Current Assets $ 73,535,438
PROPERTY, PLANT AND EQUIPMENT
Gross PPE $ 24,781,671
Less: Accumulated depreciation $ 18,934,896
Total Property, Plant and Equipment, net
Total Other Assets $ 15,535,150
TOTAL ASSETS $ 94,917,363
Total Current Liabilities $ 33,595,454
DEFERRED INCOME TAX $ 1,000,994
Total Liabilities $ 44,532,959
Total $ 50,465,241
Less: Receivable from stockholders $ (80,837)
Total Stockholders’ Equity $ 50,384,404
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 94,917,363
Even if all the assets correctly reflect the current market value it is hard to justify a $167.6 M price tag on $50.4 M worth of equity in the Klipsch business. One could question if the PPE is fairly valued but in this case after depreciation it is small enough to not make much of a difference. Goodwill and Intangibles may in fact be overstating the actual value in the market. To be really conservative, I will consider about 25% of the Goodwill and Intangibles as impaired (or about $3M) and value the company at about $47 M as an ongoing concern.
(As an aside, I get really concerned when a company borrows $89 M, and adds another $79 M of its own cash, to buy assets (net of liabilities) worth only about $50 M. Perhaps the combined business has a balance sheet that can justify this level of borrowing based on Audiovox’s strong balance sheet, but there are covenants that come with the debt that reduce a company’s flexibility in its operations. We will take a look at this in an upcoming post)
However, an asset based valuation model is the most conservative model and generally assumes that the business has no value ascribed to its earnings power (It is not the same as liquidation value – in that case we will zero out Goodwill and intangibles as they have very little value in a fire sale). Klipsch is a leading premium brand in the industry and it must be able to use the value of its brand and perhaps the resulting pricing power to generate above average returns.
We will look at Klipsch earnings power in Part 3 of the analysis to see if it offers any clue as to why Audiovox paid so much.