market folly

At day two of the Value Investing Congress, Adam Weiss & James Crichton of hedge fund Scout Capital gave the case for a long of Williams (WMB) and Sensata Technologies (ST) in a presentation entitled "Two Investment Opportunities."

Be sure to check out all our notes from the Value Investing Congress.


Scout Capital

Adam Weiss: long Williams Co (WMB)

Three parts: pipelines, midstream producer of LNG, E&P. Feb new CEO breaking up the company. Stock $24, Base case $37, based on infrastructure business being revalued on break up, reserves is $9 per share for E&P, “hidden asset” worth $3/share. Upside case is total $47-50.

*Note: In the past we saw large hedge fund buying in WMB and analyzed it in a past issue of our Hedge Fund Wisdom newsletter.

Business quality: “good, not great”

Business model: inevitable product/service, benefits of scale, favorable competitive environment as pipelines take time to build, WMB is low cost provider.

Sustainable growth: 7-10% EBITDA CAGR over 5 years. Well-located pipelines, in most cases, coal to gas switching is required by law and Transco (WMB) has the only pipelines there.

Management: New CEO, break-up of company within months of taking over, strong performance record in the past – he ran the WMB midstream business prior to this and it had the highest growth of any division.

Street misunderstanding: spin/break-up of a conglomerate- different types of investors in the stock- E&P and infrastructure are at odds with each other. Sell-side and buy-side coverage issues. New CEO, new culture. Hidden asset- the off-gas processor in the Canadian gas sands. By breaking up the company, shifts focus from EBITDA to multiples to dividend power, yield and NAV.

Valuation: Sum of the parts: Base case $37, bull case $47-50

1. Infrastructure assets. Dividend of $1.14-1.37, 1.2x coverage, gets $25 stock based on 4.5% yield, similar to KMI or OKE comps. Upside case 4% yield is $30.

2. E&P business: $9.00 floor share, based on NAV comps- CHK, et al. $1.24 per proven mcf, 25% below peers.

3. Hidden asset. Canadian Midstream business, oil sands gas processor. Based on 4.5x EBITDA get $3.00 base case, upside based on dividends, 0.40 div, 4.5-5.0% yield, get $6-8 per share in bull case.

4. Balance sheet value/ cap structure optimization. Either M&A or buyback, get $2-3 per share.


Risks: MLP valuation risk, NGL stability (20% of EBITDA from commodity-sensitive margins), regulatory changes - taxation of MLPs are a headline risk.

Path to realization? Spin of business Q1-2012 is catalyst. Dividend raise. Discovery of hidden asset by Street. Excess capital usage.



James Crichton: long Sensata Technologies (ST)

Airbags, jet circuit breakers, HVAC systems. High value add solutions. Low cost, high value nature of products, with high switching costs. The current issue of our Hedge Fund Wisdom newsletter also analyzes ST.

How Scout determines their Circle of Competence: Know the right people? Not quarter-to-quarter news flow, deep industry knowledge. Product? Do we understand the drivers of demand? Mental models: are there any useful predictable models in place? His example, Sensata engineers work at customers’ facilities, so familiarity makes it easy for customers to buy from them. Impact of un-analyzables. Identify risks and things that you can’t know for sure.

Business Quality. Powerful moat, inevitable product- make machines safer and more efficient. High value, low cost value proposition- typical sensor costs $10, in a multi-thousand dollar engine. High switching costs once designed into products. In flat GDP, grows revenue from 4% to as high as 20% in a better economy. FCF grows 12-30%.

Management: grew revenue 6.5% CAGR despite auto industry contraction. Management owns 2.2%, $100M of stock, CEO owns $45M.

Misunderstanding by Street: levered equity stub in a relatively new public company without peers. Change of incentives makes levered equity stubs work. (This was a Bain LBO from TXN in 2006, and then IPO’d). Management is paid more by stock than cash. Scout is higher than Street on estimates. “Sponsor” still owns 51% of stock, is selling, and may become more liquid. (Can be some overhang in these situations though).

Risks: need auto sales to hold up, improve for stock to work. Scout is modeling no growth, but also no further drop. Also, bull case relies on further accretive acquisitions. Valuation multiple may not expand.


Q&A Session: Did KMI/EP deal change their numbers for WMB? Gets you 11-12x EBITDA for pipeline asset, does indeed add to bull case price target.


For more from this hedge fund, head to some of Scout's other new positions.

Don't miss the rest of the hedge fund manager presentations in our notes from the Value Investing Congress.