Fox Factory (NASDAQ:FOXF) made a sizeable acquisition which creates a perfect opportunity to update the investment thesis. In fact, the last article on the stock dates back to August of 2013 when the company made its public debut. The company has delivered impressive growth and margins expansion in recent years and has proven to be a savvy dealmaker.
The market has picked up on this great achievement, now awarding the stock quite a steep multiple, as the balance sheet now contains some debt as well following the latest deal. This makes me interested in the stock, just not at these levels, after a recent momentum move higher.
The Old Thesis
Fox Factory is a designer and manufacturer of high performance suspension products, used on mountain bikes, on- and off-road vehicles, motorcycles and snowmobiles. Customers of the company include pure player Polaris Industries (NYSE:PII) as well as a name like Ford (NYSE:F).
The company went public at $15 per share in August of 2013 as shares rose to nearly $19 on their first day of trading. At those levels, equity of the company was valued at nearly $700 million, equal to 2.8 times its annual sales just shy of a quarter of billion, while net earnings came in at $15 million, creating a very high earnings multiple attached to the business.
For that reason, I was quite cautious on the shares, and that initially was the right move. It took until August 2016 before shares broke through the $20 mark again, marking essentially two years of stagnation in terms of the share price. Ever since shares went on a huge momentum run which pushed shares up to $80 this summer, before falling back to $70 ahead of the latest deal announcement by the company.
Actual Progress?
In February of 2019, Fox Factory reported its 2018 results. The company reported a 30% increase in sales to $620 million, making that revenues were up a factor of 2.5 times compared to the situation at the time of the IPO. Much of this growth was driven by acquisitions and solid deal-making as well.
The company has become immensely profitable as it generated full year operating earnings of $94.5 million, equivalent to more than 15% of sales. The company reported high after-tax profits of $85 million, in part because of a tax rate just of merely 6%. Net earnings of $84 million worked down to earnings of $2.16 per share.
Despite deal-making, net debt totaled just $31 million, a fraction of the $125 million in adjusted EBITDA generated that year. Furthermore, the company issued an upbeat guidance with sales seen around $705 million for 2019 and adjusted earnings improving to $2.50 per share, despite a much higher anticipated tax rate. With shares trading at around $60 at the start of the year, valuation multiples came in at 24 times, a full valuation.
Momentum in the share price was observed as the company raised the midpoint of the 2019 revenue guidance to $725 million as soon as the release of the first quarter results, with earnings seen at $2.57 per share. In May, the company furthermore announced a very small acquisition, with the $14 million purchase of Ridetech. Second quarter sales prompted the company into raising the guidance to $735 million in sales and $2.60 per share in earnings, prompting shares to jump towards the $80 mark during the summer.
In October, the company raised the guidance again as it released the third quarter results. Sales were now seen at midpoint of $743 million with earnings seen around $2.66 per share.
Shares had fallen back to $60 again which is noteworthy as the company operates with a minor net debt load and valuation multiples have contracted to 22 times earnings. This is despite the strong track record and the fact that the company had raised its already strong guidance already three times throughout 2019.
With shares trading at $70 in early February, the company was awarded a $2.7 billion equity valuation and $2.8 billion enterprise valuation once a small net debt load has been included. This values the company at 3.8 times sales, yet the company has managed to deliver on significant margin expansion over the years, more than I imagined to be possible at the time of the public offering.
A Nice Bolt-On Deal
With management having a great track record, investors were excited as the company announced a sizeable bolt-on deal in February. The company is acquiring SCA Performance Holdings in a $328 million deal. With the deal set to close in the second quarter, the company anticipates a nine-month sales contribution of around $86 million. The EBITDA contribution for the period is estimated at $23 million, which should drive a $0.16 per share accretion to adjusted earnings.
That suggests about $115 million in annual sales and $30 million in EBITDA per annum. If that annualised number is correct, Fox has paid 2.8 times sales, a factor of 1 times less than its own valuation. That is quite encouraging as Fox reports an EBITDA margins of around 20%, yet SCA is even more profitable with margins in the mid-twenties based on that metric.
With Fox generating about $150 million in EBITDA and this deal adding $30 million, pro forma EBITDA will rise to $180 million. Given the deal consideration and an existing net debt load of $45 million by the end of the third quarter, pro forma net debt will come in around $375 million, for about a 2 times leverage ratio. Given the move, this provides a clear road map for earnings around $3 per share in 2020. In fact, shares jumped 10% in response to a deal adding about 15% to pro forma sales.
This means that valuation multiples at $75 have expanded to about 25 times earnings. Not only is this a bit higher than the recent past, leverage will jump as well, although deleveraging and anticipated synergies of $3 million per annum post 2020 provide room for continued earnings improvements. That is, if all goes well, of course.
What Now?
Based on the discussion in the paragraph above, it is clear that expectations have been on the rise, yet Fox has seen a fair bit of volatility in its share price, potentially creating nice opportunities to buy dips down the road.
The company has rapidly built out a great growth and M&A track record in recent years, and investors have recognised this, now awarding a premium valuation multiple to the shares at 25 times earnings. Not only does this mark a big premium to the market, but it also comes after leverage levels have jumped quite a bit following the latest deal.
Hence, chasing the current momentum might not be the best solution, yet I certainly believe that this is a very interesting stock and company to be placed on the watch list in case concerns about cyclicality, growth or leverage might provide buying opportunities down the road.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
