2023-06-13 17:54:06 ET
Summary
- Tire manufacturer Goodyear has recently come under pressure from activist Elliot Investment Management.
- Elliott has acquired a 10% stake and is pushing for divestiture of the retail store network and margin improvements in the remaining business.
- Management changes and subsequent business turnaround might be likely given Goodyear’s underperformance in recent years and the activist’s solid track record.
- Elliott suggests that after a potential divestiture and operational improvements, Goodyear might be worth $32/share - 140%+ above current share price levels.
This is an interesting recently announced activist campaign. Pressure from the activist has the potential to drive a business turnaround, including the sale of a segment and a significant margin improvement in the remaining business.
The Goodyear Tire & Rubber Company ( GT ) is a $3.7bn market cap ($13bn EV) company that is one of the largest tire manufacturers worldwide. Several weeks ago, activist investor Elliott Investment Management (owns 10%) sent a letter to GT, arguing that the company, despite its leading scale and market position, has significantly underperformed over the last decade as evidenced by the stock’s poor performance vs peers and the broader market. Elliott has pushed for two initiatives to help drive a share price re-rate:
- Monetization of the company-owned retail stores . Elliott argues that GT’s retail business (generates c. 7% of revenues) might be worth $8.33/share or 65% of the company's current market cap.
- Improvement of operating margins . The activist has noted that another $16.41/share price uplift might come from the expected operating margin improvements in the remaining tire manufacturing business. Elliott has suggested that GT might raise its adjusted operating margins by 385 basis points from the consensus 2023E operating margin 4.8%. The margin expansion is expected to be driven by SG&A savings (114 basis points) and a shift in the company’s marketing and branding strategies (271 basis points). Note that any incremental value from operating margin improvements would come on top of the tire manufacturing business’ currently estimated value of $7.14/share (i.e. without any margin expansion).
Elliott intends to nominate five directors to GT’s 12-director board. GT’s annual shareholder meeting already took place in April; however, I think the chances of a near-term settlement between the activist and the company are solid given the business’ underperformance in recent years as well as Elliott’s activism track record.
While GT’s share price has jumped 10% since the activist released its letter, there seems to be substantial upside remaining here if the activist can achieve its goals. The current upside to activist’s share price target of $32/share is over 140%. Meanwhile, the downside might be partially protected as the value of GT’s as-is tire manufacturing and retail businesses exceeds GT’s current market cap. This means that at the current share price levels, investors are seemingly paying little for the potentially significant margin improvement optionality.
My further write-up is structured as follows:
- An overview of GT’s business and the company’s historical operational performance, highlighting its underperformance under the current management team relative to peers.
- A review of the activist’s suggestions - a sale of the retail segment and the margin improvement in the remaining business. The section includes my thoughts on why these initiatives might be likely to come to fruition.
- A review of the activist’s valuation of the company.
- A glance at Elliott’s activism track record. This is important given that the investment thesis substantially relies on the activist’s ability to drive a business turnaround.
- A discussion of key risks.
Goodyear Tire & Rubber Company
GT generates the majority of its revenues from manufacturing and sale of tires, with a revenue share of 84-94% depending on the region. Around half of tire units are sold in the Americas while the rest comes from EMEA and Asia Pacific. 78% of the tire units sold are replacement tires vs 22% as original equipment (OE). The company’s tire brands include Kelly, Mastercraft, Roadmaster, Debica, Sava and Fulda. The main production inputs and synthetic and natural rubber. Other important raw materials include carbon black, steel cord, fabrics and petrochemical-based commodities. GT operates 57 manufacturing facilities globally. The company’s primary competitors are Bridgestone and Michelin. Aside from tire manufacturing facilities, GT operates a network of c. 1025 retail locations. Company-owned stores sell tires as well as provide automotive services, including oil change, brake servicing, wheel alignment and others.
Company Filings
GT has been led by its current CEO/Chairman since 2010. Most of GT’s current board - six directors out of 12 - have been serving since at least 2015. Two more directors have been on the board since 2019. The company’s performance under the current management team has largely been stagnant/deteriorating. From 2016 to 2019, GT’s topline was flat, before a COVID-induced decline in 2020. GT’s revenues subsequently grew by 42% and 19% in 2021 and 2022 driven by an increase in tire unit due to post-COVID pent-up demand for road travel as well as inflationary pressures. Importantly, however, GT’s segment-level operating margins have been on a nearly continuous decline since 2016, leading to industry-low adjusted operating margins as well as increasing margin gap versus the two primary competitors Bridgestone and Michelin (see below).
Elliott Investment Management Presentation
The activist Elliott has highlighted that this has been driven by several aspects:
- Suboptimal SG&A spend . While gross margins of the three largest tire manufacturers - GT, Michelin and Bridgestone - have been under pressure since FY16-FY22, the two peers have managed to reduce their SG&A expenses significantly more as opposed to GT. During FY16-FY22, GT’s SG&A as a percentage of sales fell 128 basis points vs 369 bps for Michelin and 242 bps for Bridgestone.
- Suboptimal go-to-market strategy . Since 2018, GT’s management has shifted its sales model from selling primarily through local distributors to a company-owned wholesale distribution network TireHub. Given TireHub’s lack of scale and sales force as well as limited selection of tire brands, the move eventually led to GT’s decreasing market share. To preserve its market position, GT offered lowered prices to its channel partners which has caused the gap between the prices paid by end consumers and those received by GT (i.e. tire manufacturer) to widen during FY16-FY22 eventually leading to lower margins. This compares to peers Michelin, Pirelli and Continental whose sell-in average sale prices outpaced the sell-out average sale prices increases.
- Ineffective brand strategy . Elliot has highlighted that GT has had minimal brand differentiation among its tire offerings, with a relatively high number of low-volume SKUs. This compares to Bridgestone and Michelin which have boasted a higher price differentiation across its products - see below:
Elliott Investment Management Presentation
The Activist’s Plan Is Likely To Be Successful
The activist’s has outlined several avenues through which operating margins might be improved:
- SG&A Reduction . The activist has argued that the company’s SG&A reduction efforts might uplift the company’s operating margins by 114 basis points. Such an increase would be in line with GT’s underperformance in terms of SG&A margin reduction vs close peer Bridgestone from FY16 through FY22. Elliott has highlighted several potential avenues for SG&A cost savings, including elimination of extraneous business lines (such as merchandising websites), reductions in back office functions and a review of the management’s incentives.
- Review of Go-To-Market Strategy . The most substantial part of the margin improvement plan is expected to come from a review of the company’s distribution strategy (201 basis points). Elliott has noted that the company should formulate a renewed strategy that would push sales to distributors. The activist also intends to launch a strategic review for TireHub, with options including a new relationship with a large national distributor or a combination of TireHub with a strategic distribution partner.
- Brand and SKU Strategy . Margin improvement of 70 basis points is expected to come from a redesign of GT’s branding strategy. Elliott’s plans include a review of the company’s portfolio and a reduction in the long-tail of low-volume SKUs. The activist expects to implement a so-called “good-better-best” pricing strategy which is expected to drive incremental sales.
I think there is a decent chance of the Elliott plan successfully achieving its set out goals of divesting the retail business and raising the remainCo’s operating margins should the activist take control of the company. Several aspects indicate that the activist’s margin objectives are largely, if not fully, achievable:
- GT has the scale required to achieve significant cost synergies, leading to operating margins closer to its smaller peers. As of 2021, Goodyear was the third largest tire manufacturer globally with an 8% market share. In North America, Goodyear is the market leader with a 21% share in the replacement tire sub-segment (compared to 14-15% for Michelin and Bridgestone) and boasts the largest light vehicle tire manufacturing capacity. For reference, significantly smaller competitors Toyo and Hankook ($3.8bn and $6.7bn in 2022 revenues vs $20.8bn for GT) have displayed 2022 adjusted operating margins of 8.9% and 8.4% vs 5.1% for GT.
Michelin Investor Presentation
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Elliott has highlighted that GT is likely to increase its margins given broader tire manufacturing industry tailwinds, including a shift to electric vehicles as well as the trend toward larger cars. GT is set to benefit from increasing EV adoption as the company continues to win EV fitments at a higher rate than on traditional ICE vehicles. Meanwhile, the trend towards larger vehicles (and hence higher-margin larger tires) is expected to disproportionally benefit GT given that 44% of the company’s replacement tire sales come from ? 18-inch tires vs the US industry average of 40%. Finally, GT has displayed higher attach rates with OEMs such as GM, Stellantis, Honda and Ford which have since 2016 grown their average selling prices at a higher clip vs other OEMs where GT’s attach rate has been smaller, including BMW, VW, Toyota and Nissan.
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Pushback from the activist comes after GT’s cost saving measures announced in January ’23, including a 5% workforce reduction. M anagement has noted that the rationalization is expected to deliver $15m in quarterly cost savings from Q2’23 vs $125m in Q1’23 segment-level operating income. Meanwhile, on the revenue side, management expects to fully realize $250m in sales synergies from the Cooper acquisition (completed in June’21) by mid-2023 vs $100m run-rate synergies achieved as of Q3’22 - from Q3’22 conference call :
And then finally, we'll get -- by middle of next year, we'll get to our full Cooper synergies. So in the third quarter, we got about $25 million of benefit from Cooper synergies. And so that is obviously a run rate of about $100 million a year. We're looking to get ourselves up to that $250 million level on an annualized basis by middle of next year. So that's something that also would help create some optimism around what we could get. So first half of next year, we still got some of the same challenges. But by the middle of next year, I think, there are a number of things here, volume, cost and Cooper that could all be a fairly constructive setup.
As for the divestiture of the retail segment, the activist has stated that the retail segment operates in a highly consolidated market and would likely attract significant acquisition interest from strategic and financial players. It's worth noting that segment peer Monro ( MNRO ) has recently stated that they have been interested in potential M&A activity in the space - from Monro’s Q4’FY23 conference call :
As part of our growth strategy, we continue to carefully review value-enhancing acquisitions while maintaining our disciplined approach in evaluating multiples. We have significant capacity to be an opportunistic acquirer of businesses, which fit into our overall strategic plan.
Given that potential acquirers would be able to drive significant cost savings/economies of scale (coming from purchasing, advertising and training, among others), any consolidation interest in GT’s retail stores would not be surprising. Another important aspect is that the automotive aftermarket service industry is defensive as evidenced by its positive same-store-sales growth during the GFC. This would bode well in light of the potential macroeconomic downturn.
Valuation
Below is an overview of the valuation performed by Elliott.
Elliott Investment Management Presentation
Retail Stores ($2411m or $8.33/share) . While GT does not breakdown the topline/EBITDA of its retail store segment, the activist has estimated the segment’s 2023E revenue and EBITDA at $1.5bn at $195m respectively (translating to 13% margins). To value the segment, the activist has used a 12.9x EV/2023E EBITDA multiple - in line with the average of public peers Valvoline ( VVV ), Mister Car Wash ( MCW ), Boyd Group Services ( BYD:CA ), Driven Brands ( DRVN ) and MNRO. Worth noting that VVV, MCW and DRVN have boasted adjusted EBITDA margins of 28%, 32% and 25% respectively in FY22. Having said that, the margins of BYD:CA - a peer trading at 13x 2023E EBITDA - stood at 11% in FY22. The average multiple of three recent industry transactions, including Icahn Enterprises acquisition of Pep Boys (completed in 2016), LWG’s purchase of Midas Automotive Experts (2013) and BayPine’s acquisition of Mavis Tire (2021), stood at 14.6x. Worth noting that Goodyear’s retail stores have ranked #3 and #1 in the US full service maintenance & repair and tire replacement satisfaction studies as of 2023, suggesting the segment might be reasonably valued at the midpoint of public peer averages and/or precedent transactions.
Tire Manufacturing Business Less Net Debt ($2067m or $7.14/share). Elliott values GT’s core tire manufacturing business at 6.2x pro forma 2023E consensus EBITDA - in line with where GT was trading as of early May’23. GT’s similar-size but higher-margin peers Bridgestone and Michelin are currently trading at 5.1x and 4.6x 2023E EBITDA. The peers have boasted significantly adjusted operating higher margins in CY2022 at 11.7% and 11.9% respectively vs 5.1% for GT. Smaller peers Toyo (8.9% margins) and Hankook (8.4%) are currently valued at 4.5x and 2.9x 2023E EBITDA. Considering that all four peers are listed outside of the US (Bridgestone and Toyo in Japan, Hankook in South Korea and Michelin in France), I think GT might warrant a 6.2x multiple despite lower operating margins.
Margin Improvements at Tire Manufacturing Business ($4748m or $16.41/share) . The activist estimates $227m, $400m and $139m in EBITDA savings coming from SG&A, go-to-market and brand strategy initiatives, capitalizing them at a 6.2x multiple.
Elliott Investment Management
I think Elliott’s solid activism track record suggests it might potentially be able to achieve the set out operational changes at GT. Elliott Investment Management is a multi-strategy investment firm with c. $55bn in assets under management and is led by the billionaire Paul Singer. Some of the activist’s successful campaigns are listed below:
- In 2019, Elliott disclosed a sizable stake in eBay and called for strategic changes, including the potential sale or separation of certain business units, such as StubHub and Classifieds. Shortly after the activist’s pressure, eBay launched a strategic review for these divisions. StubHub was sold in Feb’20 while the Classifieds business was disposed of in 2021.
- In 2020, the activist disclosed a stake in Marathon Petroleum and pushed the company to split its convenience store, midstream and independent merchant refiner businesses. Eventually, Marathon Petroleum divested its convenience store business in 2021.
- In 2020, Elliott launched an activist campaign at SoftBank, pushing the company to initiate governance changes and share buybacks. Eventually, SoftBank announced a large $41bn asset monetization plan, including the sale of a number of assets, as well as appointed several new independent directors to its board.
Elliott disclosed its stake in GT in mid-May, suggesting that the position was likely acquired in the $10-$12/share range - slightly below current share price levels.
Risks
- GT is a highly levered entity, with a net debt of $7.9bn as of March ’23 vs $1.3bn in 2022 segment-level operating income. Having said that, the company has relatively distant debt maturities, with $0.8bn and $1.7bn in funded debt to mature in 2025 and 2026 respectively. Importantly, a potential divestiture of the retail store network (valued at $2.4bn in a sale scenario by Elliott) would allow for repayment of a sizable portion of GT’s net debt.
- Another risk here is potential macroeconomic headwinds impacting the company’s operating performance, including falling automotive sales and rising material costs. Management has noted that H1’23 is expected to be slower driven by softer industry volumes and the ongoing effects of inflation. However, the company expects operational performance improvement in H2’23 as raw material costs moderate. During the Q1’23 earnings release, GT has guided for $100m higher raw material costs in FY23 (vs FY22) compared to a $200m increase anticipated previously. Another aspect here is that the business has generally been resilient through macroeconomic downturns (except for COVID) as evidenced by flat revenue growth in 2008 and a rather modest sales decline in 2009 (-16%) followed by 16-21% revenue growth in 2010 and 2011.
Goodyear Q1'23 Investor Letter
Conclusion
GT currently presents an interesting investment setup with a potential near-term catalyst. Given the presence of a reputable activist and the current management’s spotty track record so far, there seems to be a decent chance of the activist successfully pushing for governance and operational changes. Importantly, the downside seems to be largely protected by the value of GT’s current tire manufacturing and retail businesses. At current share price levels, investors are seemingly paying relatively little for the exposure to the potentially significant upside coming from the operational improvements.
For further details see:
Goodyear Tire & Rubber Company: Activist Pressure Might Catalyze A Turnaround