March 2, 2010 -- In November 2006, private equity firm CCMP Capital purchased Wisconsin-based Generac Power Systems, a manufacturer of standby power generators in both the residential and business markets. CCMP contributed $689 million of its own cash with the rest in debt.
A little over three years later, it's taken Generac public, selling 18.75 million shares at $13 each for net proceeds of $224.1 million. Most of the funds from its IPO will go to reducing its debt. More importantly, the IPO values the entire business at $852.5 million, less than half what CCMP paid in late 2006. Does this make Generac shares a bargain?
Why Pay So Much
Generac's revenues in 2006 were $680 million. CCMP paid almost three times sales for the business. Clearly, this was too much, as Generac was forced to take a $503.2 million goodwill impairment charge and $80.3 million trade name impairment charge in 2008, barely two years after making the acquisition. Assuming there are no additional impairments to follow, you could make the argument the business is worth $1.4 billion. But then why sell shares at a 39% discount?Too Much Debt
Like many private equity deals, CCMP loaded the company with debt, seriously hurting the quality of its balance sheet. Before the acquisition, Generac was virtually debt free and making good money. In fact, the company made 14 consecutive quarterly profitability bonus payouts to its employees leading up to the buyout, and was averaging 20% revenue growth for close to 20 years.
What changed? For starters, the founder, Robert Kern, was no longer involved. Add $1.28 billion in long-term debt and $125.4 million in annual interest expense and you've got a recipe for disaster. In 2006, the company's operating earnings were $169.5 million on $680 million in sales for an operating margin of 24.9%. In the latest nine months ended September 30, 2009, it was 15.9%. Add in the interest expense and there goes the profits.
An Exit Strategy
Generac is a dominant North American market share in standby generators. Its competition include Briggs and Stratton, Caterpillar, Cummins and Honda. These are all big companies and formidable opponents. Fundamentally, there's nothing wrong with Generac's business. Unfortunately, it has a majority owner (CCMP) with an equity position that's upside-down and looking for a way out.
Generac's total indebtedness after the IPO will be approximately $887.1 million, equivalent to its market capitalization, giving it an enterprise value of $1.85 billion. Sadly, there appears to have been few takers at this price, forcing CCMP to take it public in the hopes of quickly selling its 40 million shares above $17 and break even in the process.
The Bottom Line
If you bought shares in the Generac IPO, you might be holding them awhile. Robert Kern made a brilliant move selling his business in 2006. The same can't be said for the buyers.
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