The latest addition to my Special Situations portfolio will take advantage of the reorganization going on at Visteon (NYSE: VC ) . Visteon has sold stakes in a few assets, cleaning up its balance sheet and making it easier for analysts to evaluate, and it's now highly exposed to the rapidly growing economies of Asia.
In addition to fundamental improvements, the company has committed to a huge buyback over the next two years that should drive its stock price higher, too. So my Special Situations portfolio is buying warrants on the company, which magnify the gains on the stock as it climbs. Here are the details that make the warrants a compelling purchase.
The special situation
Visteon has been busy recently cleaning up its shop. In December, it announced it had closed a deal to sell its 50% stake in Yanfeng Visteon Automotive Trim Systems and other interior-related joint ventures. That along with distributable profits from 2012 and 2013 will bring Visteon cash of over $1.2 billion.
Those divestitures leave Visteon with two core divisions: climate and electronics. And those divisions are highly geared to the growth economies of Asia. The Halla Visteon climate unit makes about 60% of its sales from Asia, while the electronics unit makes almost 40% there. The climate unit has achieved sales growth of 7% and is the world's No. 2 player, while electronics has notched 12% revenue growth and is the No. 3 player in driver information and controls. So, the reorganization not only cleans up its portfolio, but it also gets Visteon into higher-growth segments of the market. Visteon now does less than 10% of its business in the slow-growth U.S.
So, what's it going to do with that new cash? Exactly what it should be doing, by my calculations. Return it to shareholders via stock buybacks. Last year, the company announced a $1 billion buyback authorization through December 2015. That amounts to 25% of the stock at today's prices, and it should act as an excellent tailwind for the stock and create value for shareholders. Currently, the company's enterprise value is just 4.5 times estimated 2014 EBITDA of $620 million (midpoint). That's much too low for a company with a clean balance sheet and the growth prospects that Visteon has.
The interesting bit here is that Visteon has warrants. So, instead of buying the common stock, my portfolio will buy the warrants (ticker: VSTOW), long-dated securities that function a lot like call options. Warrants and long-dated calls are an excellent place to look for value, since it's often difficult to accurately price them. The Visteon warrants expire in October 2015 and have a strike price of $58.80. They trade for around $25.50, against a common-stock price of $82. That means we're paying about $2.30 in time value. With a significant buyback announced and a cheap valuation, the warrants should offer good returns if the stock moves higher.
One of the biggest risks here is a potential slowdown in Asia. The markets are worried, but they're always worried about something. So Visteon's high exposure to Asia cuts both ways, here.
Another concern is the relative power that car manufacturers have over suppliers such as Visteon. Carmakers have a habit of squeezing their parts suppliers, especially when times get tougher, and the industry is littered with stories of failed suppliers. That includes Visteon itself, a 2000 spin-off of Ford that declared bankruptcy in 2009. For example, Visteon relies heavily on Hyundai and Kia, and if they stumble, it could make things difficult for Visteon. This bears watching.
In addition, investing in warrants and options carries its own risks, especially the timing element. Not only does the thesis have to be right, but so does the timing. These warrants have 21 months until expiration, so that's a lot of time for the market to move up or down -- or both. It's a lot of time yet for the thesis to play out.