LONDON Britain will need to raise taxes and cut spending later this year to stabilise the public finances after last week’s shock vote to leave the European Union, Chancellor George Osborne said on Tuesday.
Osborne said Britain would be poorer due to the public’s decision to leave the EU, which he had campaigned against, and that the country now needed to deal with the economic consequences, as well as to tackle new social divisions.
Sterling plunged against the dollar to its lowest since 1985 after the vote, and two ratings agencies downgraded Britain’s sovereign credit rating late on Monday.
“We need a plan as a country to get ourselves out of this, whilst respecting the verdict of the British people. wholesale jerseys That means financial stability, ending economic uncertainty and providing unity in our society,” Osborne said in a BBC radio interview.
British police say there has been a spike in racist incidents since the June 23 vote.
Hours earlier Osborne had ruled out standing to succeed Prime Minister David Cameron, who said on Friday he would make way for a new leader of the Conservative Party after coming out on the losing side of a referendum he had called.
Osborne refused to be drawn on whether he had advised Cameron against the referendum, and said he himself was the wrong person to unify the Conservative Party, though another supporter of EU membership possibly could.
“I am not backing any candidate at the moment. I was full throttled in arguing for remaining in the EU and because half my party wanted to leave the EU I don’t think I can be the person who can bring the party back together at this moment.”
Osborne said the leadership contest would allow the party to decide how close Britain should stay to the EU.
“The candidate who is able now to articulate, in my view, the clearest, crispest version of what relationship we are seeking, which in my view involves the best possible terms of trade for services and goods, is the candidate I think who can lead the country,” Osborne said.
Before the referendum Osborne said Britain would need an emergency budget to impose extra austerity if the country voted to leave the EU, but on Monday he said this would have to wait until Conservative party members elected a new leader.
On Tuesday, when asked if new budget measures would involve tax rises and spending cuts, Osborne said “Yes, absolutely.”
“We are adjusting to life outside the EU and it will not be as economically rosy as life inside the EU,” he said.
Ugly Duckling Morphing Into A Lovely Swan
SummaryAt first sight, Knowles appears to be a capital intensive, commoditized, low return business who deserves its 10x FCF multiple.
Upon further digging however, it appears that the ugly duckling is in the process of morphing into a lovely swan.
The Company golden goose has been heavily disguised by its undifferentiated, capital sucking speaker and receiver franchise. On February 11, management announced that it is jettisoning the business.
Adjusting for the elimination of the speaker and receiver business, the Company remaining business appear to possess several durable competitive advantages, as well as numerous levers for growth. By definition, such businesses do not possess any discernable advantage over their peers, and tend to persistently invest in a low return business (either due to inertia or otherwise), a prospect that is destined for measly shareholder returns at best. However, there are a select few companies that appear to fit the above profile, but in actuality, do not. In my view, Knowles (NYSE:KN) (“Knowles” or the “Company”) is the rare example.
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Reasons for the opportunity: divestiture, zero bulge bracket coverage, and apparently unprofitable business with high leverage.
The thesis for Knowles is one of the simpler theses that I have detailed on SeekingAlpha. In a nutshell, my argument revolves around the hypothesis that the Company has a gem of a business which is being obfuscated by a crappy, commoditized business. Said gem is protected by competitive advantages which ensures its high margins are able to be sustained for the foreseeable future.
Upon the sale of the commoditized business, the premium business would be reflected in subsequent company filings and should result in a sharp re rating of shares. Apart from the improved optics that the sale would yield, it would also result in a removal of what I believe to be a significant overhang on the stock the Company’s substantial debt (at least apparently). Moreover, there also seems to be some opportunity for growth in KN’s high margin franchises, which would supplement free cash flow growth.
Based on an undemanding 6.5% FCFE yield, shares should see 50% upside from current levels. As management at Dover begun assessing their portfolio, they decided to spin off Knowles to their shareholders in early 2014. Upon the spin off, bulge brackets such as Merrill, Barclays, Citi, et. al stopped covering the spin off, instead focusing on the parent. Now, the Company covered solely by small, independent boutiques.
The sale of the speaker and receiver business
Any way you slice it, this is a bad business to begin with. Speakers and receivers have limited barriers to entry there is little IP around the product, and even then, consumers cannot really differentiate across different manufacturers. Thus, even if your product is truly differentiated, consumers would likely be oblivious to said differentiation, thus making the act of differentiation a non starter.
Unsurprisingly, the financial results of the business has been disastrous. In 2015, it generated $235m in revenues and $272m in pre tax losses (or $128m, adjusting for the $144m non cash impairment charge regardless, the point still stands). Clearly, this is not the place to be. Management has finally waved the white flag, announcing its plan to sell the business line on February 11, 2016 after years of trying to improve its operations. With the information that management has provided, we can roughly estimate the FCF generating ability of continuing operations (numbers are all sourced from the 2015 10 K):
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Running the numbers, one would arrive at $102m in free cash flow to equity. At approximately $1b in equity value at current prices, the equity currently trades at an undemanding 10x levered free cash flow. Importantly, viewed in this lens, the Company’s debt load of approximately $430m is very manageable. Note that these numbers could possibly be conservative given:
they exclude any organic growth the Company could generate (I make the case for this in a later section), does not account for lowered capital expenditures once the sale of the speaker and receiver business has been completed management has suggested the S business is highly capital intensive and there is opportunity for a reduction in overall capex once it is sold. Additionally, it is likely that the Company would sell this business at a loss to its historical cost, while should increase its NOL base, further sheltering the business from taxes going forward. The question then turns to how much could the commoditized business go for. Not much. That business had $441m in assets as of the year end 2015, which the majority of assets comprising of goodwill about $329m which would fetch zero in a sale. The remainder assets are largely current assets of $91m and PP of $20m.
Management has not to the best of my knowledge quantified these assets into further detail, but I am assuming it would largely consist of receivables and inventory which tend to be money good. The fact that allowances for bad debt have been historically at 0.9% suggests that such as assumption is reasonable.
An argument can be made for assigning a discount to inventory, given commoditized tech products tend to fall in price rather quickly. Using a 50/50 split for the receivables and inventory for the business as a whole, and assigning a 50% discount to inventory implies scrap value of $68m for current assets.
As for PP it is difficult to make the case for a premium to book value given the Company owns very little land ($11m in 2015) which is usually an asset that can be sold at a substantial premium to historical cost due to land inflation. http://www.cheapjerseys6vm5.top As a result, I am assigning a simple 50% discount to the value of PP for the speaker and receiver business, arriving at $10m in value.
Current liabilities are $52m, and as a result the proceeds from the sale (assumed no taxes incurred as it would be sold as a loss numerous impairments have already been charged on this business) of the commoditized business should be ample to cover its liabilities.
While there is a possibility a buyer might assign greater value to the business based on some sort of strategic consolidation rationale, there is little point in speculating on this given that the Company has not announced who is it selling the business unit to.
Regardless, if the Company managed to negotiate a far greater price, it would only add to the upside (though with the handicap that if the unit was sold at such a high price than the Company recorded a gain on sale, it would need to pay taxes on the proceeds). In any case, the most likely scenario appears to be the Company would be able to rid itself of a commoditized business without much, if any, negative effect on its balance sheet.
Introducing the golden goose
With $162m in pre tax earnings (adding back capex and interest expense from free cash flow to equity) on $849m of revenue implies 20% pre tax margins, numbers that are suggestive of a reasonably profitable business. The question is whether these numbers are sustainable going forward. In my view, they are.
Sans the commoditized speaker and receiver line, the Company is left with the mobile consumer electronics (“MCE”) business producing only critical acoustic components such as ultrasonic sensors, voice processors, and integrated audio sub systems, which are a long way from receivers and speakers. KN’s specialty components (“SC”) business unit sells specialized electronic components which are typically high performance solutions to a wide variety of markets.