Based in Indianapolis, Indiana, Allison Transmission Holdings (proposed ALSN) scheduled a $500 million IPO with a market capitalization of $4.2 billion at a price range mid-point of $23 for Thursday, March 15, 2012.
SUMMARY
ALSN builds automatic transmissions for commercial-duty vehicles. It was bought from General Motors in August 2007 by the private equity firms of Carlyle and Onex.
It appears to us that ALSN will become an almost instant institutional favorite. We sat through the entire 45 minute road show presentation and found all of it interesting, which is highly unusual for us.
We like ALSN because is has a dominant market share, advanced technology with much more technology in process, branding even to the end user (through OEMs), is tightly focused on automatic transmissions and is positioned for significant growth in China and India.
Also, ALSN’s fully automated transmissions are premium priced, which is very good for gross profit margins.
Dividend policy
Even though ALSN is highly leveraged in terms of price-to-tangible book value, it expects to start paying dividends in the June quarter, at the rate of $.06 per share, an annual payout rate of 1% at the price range mid-point of $23.
We anticipate dividend increases over time.
CONCLUSION
We believe ALSN is a buy on the IPO. However, because the market appears ‘toppy’ right now, the actual IPO price may slide a little under the proposed range, and because ALSN is ‘just a private equity re-cycled industrial company’ it most likely will not ‘pop’. Nevertheless, it appears to be a good longer term hold.
VALUATION NOTES
ALSN has $1 billion of present value tax savings, based on how the leveraged buyout was structured in August, 2007, by Carlyle and Onex private equity funds.
- Adjusted earnings were $305 million in adjusted earnings for 2011, as presented in ALSN's road show by the CFO. Also page 14
- ALSN has reduced debt by $1.1 billion since it leveraged buyout in 2007.
- Capital expenditures are only 4.5% of sales. Operating working capital is less than 10% of sales.
- Delphi IPO’d November 16, 2011 at $22, price range bottom, dropped to $19.22 and now trades up 50%+ around $31.64 chart
ALSN sells transmissions globally for use in medium- and heavy-duty on-highway commercial vehicles (with limited exposure to the Class 8 manual transmission tractor market), off-highway vehicles and equipment and military vehicles.
Allison's customers include 250 OEMs of garbage trucks and city transit buses, military transports, and dump trucks.
ALSN also makes electric drives for buses and shuttles (and is the world's #1 heavy-duty hybrid producer). ALSN also remanufactures transmissions for aftermarket customers.
EFFECTS OF GOVERNMENT MANDATES
Governments are mandating restrictions on emissions that lead to vehicle system changes. New emission standards increase overall vehicle cost relating to pollutant-reducing systems. The emission standards and resultant compliance costs create uncertainty among vehicle owners about the quality, fuel efficiency and maintenance needs of the new engines.
In anticipation of an emission regulation change, commercial vehicle buyers may “pre-buy” vehicles with prior-year emissions compliant engines in the year preceding the regulation change. The act of pre-buying causes irregularity in transmission purchase patterns and creates forecasting challenges. In North America, a reduction in permitted emissions came into effect in January 2007, which resulted in a significant vehicle pre-buy in 2006.
Another tightening of emission standards took place in January 2010, which resulted in a significantly smaller vehicle pre-buy in 2009. More emissions regulation is expected in 2013. Generally, the degree of pre-buy in any end market directly correlates with the weight class of the commercial vehicle because the heavier the vehicle, the greater the cost to a buyer of complying with these new emission standards.
Outside North America, engine emission level compliance varies by the levels established by European Union regulations. As countries change from one emission level to the next, OEMs must change their powertrain configurations and validate the resulting combinations.
OEMs have cadenced their vehicle releases and product upgrades to incorporate emissions compliant improvements as they evolve and are regionally deployed. Supply agreements with key OEMs enhance ALSN’s position with those OEMs as they adjust their products to comply with new regulations.
GENERAL MOTORS
General Motors’ (GM) actions may materially affect ALSN’s business and results of operations.
Although ALSN is an independent company as a result of the Acquisition Transaction, General Motors’ future actions may still have a material impact on business and results of operations. Pursuant to the Cure Agreement resulting from General Motors’ emergence from bankruptcy in 2009, General Motors has assumed certain agreements from its predecessor, including the Asset Purchase Agreement, intellectual property and software license agreements, lease agreements, engineering services agreements, an employee matters agreement and a hybrid co-branding agreement. General Motors’ failure to comply with any portion of these agreements for any reason, including the indemnities therein, could inhibit ALSN from operating and expanding its business in the future.
Additionally, General Motors has received a non-exclusive, royalty-free, worldwide license to use the “Allison Transmission” name and certain related trademarks on General Motors’ line of A1000 transmission for use primarily in Class 2 and 3 pick up trucks. If General Motors, or any of its subsidiaries or affiliated entities, or any third party uses the trade name “Allison Transmission” in ways that adversely affect such trade name or trademark, ALSN’s reputation could suffer damage, which in turn could have a material adverse effect on ALSN’s business, results of operations and financial condition.
In connection with the Acquisition Transaction, ALSN entered into a mutual non-compete agreement with General Motors that restricts General Motors from competing with ALSN in non-military vehicles in North America with gross vehicle weights above 5900 kilograms (typically Class 4 and higher) with some limited exceptions for certain General Motors light-duty pickup truck and van platforms.
It also restricts General Motors from competing with ALSN in military vehicles globally and in non-military vehicles outside North America that exceed 3500 kilograms (generally Class 3 to Class 4 and higher) with some limited exceptions. The non-compete periods extend until 2017 globally, except in Europe, where they expire in 2012.
While ALSN does not expect the expiration of this non-compete agreement in Europe to have an impact on its business, ALSN doesn’t know if General Motors will not compete with ALSN in these markets in the future.
Similarly, ALSN is restricted from competing with General Motors in weight classes below the above mentioned thresholds for similar periods of time. Upon expiration of the non-competition periods, both Allison and General Motors will be permitted to compete with each other, but such expiration will generally not affect Allison’s rights under the Patent and Technology License Agreement to use on an exclusive basis within its respective weight classes (subject to previously mentioned exceptions) the intellectual property that is licensed to Allison on an exclusive basis.
INTELLECTUAL PROPERTY
In connection with the Acquisition Transaction, General Motors granted ALSN an irrevocable, perpetual, royalty-free, worldwide license under a large number of U.S. and foreign patents and patent applications, as well as certain unpatented technology and know-how, to design, develop, manufacture, use and sell fully-automatic transmissions and H 40/50 EP hybrid-propulsion transit bus systems for use in certain vocational vehicles, military vehicles and off-road products, which we refer to as Patent and Technology License Agreement.
With respect to the bulk of the intellectual property licensed to us under such license agreement, such license is exclusive with respect to the design, development, manufacture, use and sale of fully-automatic transmissions and H 40/50 EP hybrid-propulsion transit bus systems in vocational vehicles above certain weight rating thresholds, certain military vehicles and certain off-road products and non-exclusive with respect to certain other products that are within the scope of the licensed patents or to which the licensed technology can be applied.
ALSN considers the patents and technology licensed under such license agreement, as a whole, to be critical to preserving its competitive position in the market. However, General Motors continues to own such patents and technology, and pursuant to the terms of such license agreement, General Motors has the right, in the first instance, to control the maintenance, enforcement and defense of such patents and the prosecution of the licensed patent applications.
The Patent and Technology License Agreement permits ALSN to utilize the bulk of the intellectual property rights on an exclusive basis in non-military vehicles with gross vehicle weights above 5900 kilograms (typically Class 4 and higher) with some limited exceptions for General Motors light-duty pickup truck and van platforms.
It also permits ALSN to utilize the bulk of the intellectual property rights on an exclusive basis in military vehicles that exceed 4250 kilograms (generally Class 3 to Class 4 and higher). General Motors continues to have the right under such patents and technology to utilize the licensed intellectual property for use in vehicles below the above mentioned rating thresholds as well as some light-duty van and pickup truck platforms.
COMPETITION OVERVIEW
ALSN faces competition from numerous manufacturers of manual transmissions, AMTs (automatic manual transmissions) and fully-automatic transmissions for commercial vehicles.
Some of ALSN’s customers are OEMs that manufacture transmissions for their own products. Despite their transmission manufacturing abilities, ALSM’s existing OEM customers have chosen to purchase certain transmissions from ALSN due to the quality, reliability and strong brand of its transmissions and in order to limit fixed costs, minimize production risks and maintain company focus on commercial vehicle design, production and marketing.
COMPETITIVE POSITIONING
ALSN sells substantially all of its transmissions in the North American on-highway market to OEMs, including Blue Bird, Daimler, Hino, Navistar (NAV), PACCAR (PACCAR), Spartan Motors (SPAR), Volvo and many others. These OEMs, in turn, install ALSN’s transmissions in vehicles in which ALSN transmissions are either the exclusive transmission available or specifically requested by end users who are choosing between a manual transmission, an AMT or a fully-automatic transmission. OEM customers representing approximately 90% of ALSN’s 2011 North American on-highway unit volume participate in long-term supply agreements with us.
Generally, these supply agreements offer the OEM customer defined levels of mutual commitment with respect to growing Allison’s presence in the OEMs’ products and promotional efforts, pricing and sharing of commodity cost risk. The typical length of ALSN’s customer agreements is five years.
ALSN often competes in this market against independent manufacturers of manual transmissions and AMTs, and, to a lesser extent, against OEMs in certain weight classes that use their own internally manufactured transmissions in certain vehicles. For example, Ford Motor (F) offers its own fully-automatic transmission in its Class 4-5 vehicles in North America, though ALSN supplies Ford with ALSN’s fully-automatic transmissions for their Class 6-7 trucks.
TRUCKS
Truck classifications
Class 4-5 Trucks
The largest Class 4-5 truck OEM is Ford, which offers its own transmission in these vehicles. Until 2009, Ford and General Motors were the largest OEMs in this end market with a combined market share of 88% in 2008, but General Motors exited the medium-duty truck market after emerging from bankruptcy.
Since Ford uses its own fully-automatic transmission in this vehicle class, General Motors’ departure from this market resulted in a decline in ALSN’s sales of fully-automatic transmissions for use in the Class 4-5 truck market, which ALSN had served almost exclusively through General Motors.
To partially offset the loss of General Motors’ presence in this market, ALSN is the exclusive transmission supplier to the new Navistar Class 4-5 TerraStar truck specifically targeted at this end market. ALSN also intends to pursue business with other OEMs, should they choose to participate in this end market.
Class 6-7 Trucks
Class 6-7 trucks are generally used in urban applications, including larger distribution, commercial lease and rental, ambulance, rescue and fire trucks. While demand drivers for the Class 6-7 truck end market are generally similar to those of the Class 4-5 truck end market, economic and pre-buy volatility are higher in these classes. The largest OEMs in this end market are Navistar, Daimler, Ford, Hino and PACCAR.
ALSN’s overall penetration of the Class 6-7 truck transmission end market was 68% in 2011, and ALSN supplies virtually all of the fully-automatic transmissions sold in this end market. In this market, ALSN competes primarily with manual transmissions and AMTs manufactured by Eaton (ETN).
Class 8 Straight Trucks
The most common vocations that utilize straight trucks are refuse, construction, fire and emergency. Primary drivers of Class 8 straight truck demand are general economic conditions and federal, state and municipal spending, which affect the purchases of many fire and emergency trucks, refuse vehicles and construction vehicles, and the purchases of other private refuse fleet operators.
The largest Class 8 straight truck OEMs are Navistar, Daimler, PACCAR and Volvo. In 2011, ALSN’s overall penetration of the Class 8 straight truck transmission end market was 54%, and ALSN supplies virtually all of the fully-automatic transmissions sold in this end market. In this market, ALSN competes primarily with manual transmissions and AMTs manufactured by Eaton.
Buses
School buses have historically comprised 75% of the North American bus market by volume. While school buses vary in weight and engine size, the majority of ALSN’s transmissions are used in Class 6-7 buses.
The primary demand driver for school bus purchases is municipal spending, specifically school district budgets and the capital expenditure plans of private fleet operators. School bus demand is also affected by the number of school-age children, which is driven by birth rates and immigration. The demand in this end market has generally been stable, although it does experience declines during economic downturns as municipalities defer purchases.
The largest school bus OEMs are Navistar, Daimler and Blue Bird. ALSN supplies transmissions for virtually all of the school buses produced in North America and currently faces little competition from other suppliers to this end market. The bus market also encompasses non-hybrid transit and conventional coach and shuttle buses. ALSN has the leading market share in the non-hybrid transit bus market, where ALSN primarily competes against Voith GmbH, or Voith and ZF Friedrichshafen AG, or ZF.
Motorhomes
ALSN sells transmissions for use primarily in larger motorhomes (Type A). Substantially all of the Type A motorhomes used fully-automatic transmissions in this market in 2011.
The motorhome market was severely impacted by the recent economic downturn with volumes declining approximately 60% from 2007 to 2011.
ALSN expects motorhome demand will benefit from improving economic conditions, increased availability of credit and favorable demographic trends such as the aging of “baby boomers.” ALSN typically sells to chassis manufacturers, such as Navistar and Daimler, that supply body manufacturers, such as Thor Industries, Winnebago Industries, Inc. and Fleetwood RV, Inc.
ALSN had a 42% share of the fully-automatic transmissions used in Type A diesel and gasoline powered motorhomes and substantially all of the share of the fully-automatic transmissions sold in Type A diesel powered motorhomes. In this market, ALSN competes primarily with Ford, who uses its own internally-produced transmission in the lighter-duty motorhomes.
Hybrid Transit Buses
The global interest in conserving fuel and reducing greenhouse gas emissions is driving demand for more fuel efficient commercial vehicles.
As of December 31, 2011, ALSN had delivered over 5,000 H 40/50 EP hybrid-propulsion transit bus systems globally to 230 cities in 13 countries, making ALSN the world’s largest supplier of the hybrid-propulsion transit bus systems.
In North America, ALSN sold nearly 80% of all units for the hybrid transit bus market in 2011. Customers in this end market are typically city, state and federal governmental entities, which utilize government funds to subsidize a portion of the purchase price for the transit buses containing ALSN’s hybrid-propulsion system. In this market, ALSN competes primarily with BAE.
Off-Highway
ALSN has provided products used in vehicles and equipment that serve energy, mining and construction applications for over 50 years.
Off-highway energy applications include well-stimulation equipment, pumping equipment, and well-servicing rigs, which often use a fully-automatic transmission to propel the vehicle and drive auxiliary equipment.
ALSN maintains a leadership position in this end market, with nearly all producers of well stimulation and well servicing equipment utilizing heavy-duty off-highway transmissions.
Customers include Halliburton Company, BJ Services Company, Weatherford International Ltd., National Oilwell Varco, Inc., and Key Energy Services, Inc. For example, new methods of drilling and extracting oil and natural gas from shale formations, such as hydraulic fracturing, have driven demand for oil and natural gas equipment, which utilize highly engineered heavy-duty fully-automatic transmissions.
Competition in both the well stimulation and well servicing markets comes primarily from Caterpillar Inc., or Caterpillar and Twin Disc, Incorporated.
ALSN also provides heavy-duty transmissions used in mining trucks and other specialty vehicles. Mining applications include trucks used to haul various commodities and other products, including rigid dump trucks, underground trucks and long-haul tractor trailer trucks with load capacities between 40 to 110 tons.
Major competitors in this end market are Caterpillar (CAT) and Komatsu, Ltd., or Komatsu, both of which are vertically integrated and manufacture fully-automatic transmissions for their own vehicles. Specialty vehicles using our heavy-duty transmissions include airport rescue and firefighting vehicles and heavy-equipment transporters.
DEALERS
ALSN works with a network of approximately 1,500 independent distributors and dealers that provide post-sale service and parts and support equipment. ALSN depends on the pull-through demand generated by end users for its products.
DIVIDEND POLICY
Even though ALSN is highly leveraged in terms of price-to-tangible book value, it expects to start paying dividends in the June quarter, at the rate of $.06 per share, an annual payout rate of 1% at the price range mid-point of $23.
USE OF PROCEEDS
The selling stockholders in this offering are affiliates of Carlyle and affiliates of Onex, and will receive 100% of the IPO proceeds
In addition, there is a scheduled $211 million pre-IPO payment that reflects
(i) $211.0 million cash paid (including $11.0 million of premium) in connection with the redemption of $200.0 million in aggregate principal amount of the 11.0% Senior Notes,
(ii) $16.0 million of fees to terminate ALSN’s services agreement with its Sponsors and
(iii) an additional $0.9 million of estimated fees and expenses expected to be incurred in connection with this offering.