Spruce Point Capital Releases, A Dimming and Grim Outlook, a Strong Sell Research Opinion on Gentex Corporation (Nasdaq: GNTX)
NEW YORK, July 13, 2017 /PRNewswire/ -- Spruce Point conducted an extensive fundamental and forensic accounting review, encompassing several Freedom of Information Requests (FOIAs), a product tear-down (reverse engineering) test, and conversations with former employees. We believe that Gentex Corp. (Nasdaq: GNTX) faces 40%-80% downside risk as a result of potential financial misstatement and a litany of fundamental challenges.
Our forensic review raised multiple red flags pertaining to Gentex's financial statements:
- We've uncovered multiple instances where the Company has made contradictory statements across government entities, public financial statements and internal communications. Additionally, through FOIAs and forensic accounting analysis we have strong conviction that aggressive Capex and Inventory inflation may be used to inflate margins to forestall underlying weakness. These red flags are cause for heightened concern given conversations that we've held with individuals previously involved with the Company and the extremely poor governance, financial controls and audit oversight currently in place. Once interested third parties (SEC, Michigan Environmental Agency, Gentex creditors, etc.) evaluate our claims there is potential for Gentex to be in violation of its credit agreement.
In addition to concerns about Gentex's financials, we believe that investors will also have to look beyond myriad fundamental challenges on the horizon:
- Contribution and profitability from key modules are in decline: Our field research indicates that SmartBeam (10% of sales) is already in decline as cost of traditional driver assist packages continue to come down in price and OEMs look to avoid redundancies. HomeLink now faces competition for the first time from a comparable Magna product and various phone apps with additional functionality.
- We are likely in the early innings of a meaningful SAAR decline and de-contenting cycle: The past cycle of surging auto sales, high levels of affordability and the gradual digitalization of the auto user experience (UX) presented the ideal backdrop for Gentex. We believe the current dynamics of the used car market have set the stage for a dramatic reversal in auto sales and affordability. We believe that reduced affordability will lead to de-contenting, magnifying the challenge of the downturn for Gentex.
- The Full Display Mirror (FDM) is a problem, not the answer: Gentex's moat historically has been the auto-dimming feature of its mirrors. The fact that the FDM functions primarily as a display, rather than a mirror, makes the auto dimming feature almost irrelevant. This exposes Gentex to a much wider range of competitors, including display suppliers attempting to make mirrors and traditional mirror companies that have strategically partnered with display companies. We believe that Ficosa (Panasonic) is offering their own version of the FDM at a 50% haircut to the Gentex FDM price. Gentex's inability to rely on an auto dimming premium and reliance on Kyocera as a display supplier will limit margin and their ability to compete on price.
- The long-term viability of the mirror is difficult to envision: The convergence of the connected car and assisted driving are rapidly reshaping the technology UX experience of the automobile, particularly vehicle navigation. We believe that the future of vehicle navigation is cameras, sensors and displays, not mirrors. Over the past several years' multiple world class technology companies (e.g., Samsung, Panasonic, Intel, Google) have entered the space via strategic investment and acquisition of existing automobile navigation suppliers. All of these players are focusing their efforts on the UX and to date almost all of them are focused on Heads Up Display (HUD) or the center console. Gentex appears to be on an island, having not forged any strategic partnerships of meaning to date and linking their future to the likely ill-timed near-term solution of the FDM.
Wall Street analysts see just 12% upside in Gentex, a terrible risk/reward:
- Analysts assume that its margins are industry leading and fairly presented, its competitive position is defensible, management is trustworthy and honest, and its valuation should reflect a premium to auto supply peers. Analysts expect Gentex to achieve nearly 8% revenue and 10% earnings growth this year, despite creeping signs of peak auto sales.
- We believe this market consensus view is entirely flawed, and does not incorporate our incontrovertible evidence of irregularities, and product teardown results illustrating limited proprietary content. We estimate Gentex's gross margins are likely closer to 20-30% vs 40% reported, and its revenue growth expectations will disappoint. On a discounted 9x -12x multiple to account for the pending auto cycle correction and extreme potential for financial malfeasance, we see approximately $4.00 – $12.00 per share, or 40% – 80% near-term downside risk. Longer-term industry displacement of mirrors could render Gentex worthless.
- If you don't believe us, we suggest reading Bofa/ML's June report which places an $11 price target on Gentex: "In our view, the solid growth that Gentex once enjoyed is likely to be challenged by increasing competition and potential substitute products. At the very least, the existence of a potential replacement product will likely drive meaningful pricing pressure for Gentex."
The research report can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
Spruce Point Capital has a short position in Gentex Corporation and stands to benefit if its share price falls.
About Spruce Point Capital
Spruce Point Capital Management, LLC, is a forensic research activist investment manager that focuses on short-selling, value and special situation investment opportunities.
Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.
SOURCE Spruce Point Capital Management, LLC
