Spruce Point Capital Releases A Strong Sell Research Opinion On Aerojet Rocketdyne Holdings, Inc. (NYSE: AJRD)
NEW YORK, April 9, 2019 /PRNewswire/ -- Report entitled "Ready, Aim, Blow-Up" outlines how AJRD faces 40-60% intermediate downside risk to approximately $13 to $20 per share due to significant fundamental challenges in both Space and Defense, wider appreciation for the role that aggressive accounting has played in obfuscating the slowdown, and the market's failure to appropriately value the company's true growth prospects and large unaccounted-for liabilities.
- Shifts In The Competitive Landscape And Program Specific Funding Present Fundamental Challenges: AJRD's Space business has been largely dependent on ULA for some time. AJRD's loss to Blue Origin for support of ULA's Vulcan rocket late last year is indicative of the challenges that the company faces from disruptive competitors like SpaceX and Blue Origin and the challenges of being a cost-plus contract provider. AJRD's Space business is now largely linked to SLS, a program best known for missing deadlines and its dependence on regional political support. However, both the current administration and NASA recently placed the project on watch as they consider "all options" in meeting the targeted launch schedule.
On the Defense side of the business, AJRD has historically enjoyed a duopoly with Orbital ATK for missile propulsion. However, last year Northrop acquired Orbital ATK to vertically integrate its manufacturing. The FTC would later reach an antitrust settlement with Northrop in hopes of promoting competition amongst primes for missile systems, but AJRD has claimed in a public comment letter that the settlement effectively removed any incentive for other primes to seek bids from Aerojet Rocketdyne. The actual implications of the settlement on AJRD's SRM business remain to be seen, but we do know with certainty that the segment will face significant headwinds due to declining budgets for the key THAAD and Standard Missile programs through 2020.
The above challenges apparently aren't lost on AJRD's management team, which saw the departure of three experienced SVPs between December 2017 and December 2018. AJRD's response to these challenges has been to talk up cost savings initiatives and dangle the prospect of strategic acquisitions. In Spruce Point's opinion, AJRD's sole recent acquisition of 3DMT was de minimis in scale and an acknowledgement of its need to enhance its manufacturing capabilities.
- Aggressive Accounting Has Inflated Recent Performance And Obfuscated Growing Financial Strain: Based on Spruce Point's adjustments, we believe that headline EPS, EBITDA and cash flow appear aggressive and overstated. Numerous subjective "one-time" adjustments have inflated metrics such as YoY EBITDAP margin growth and operating cash flow growth to high teen levels when they are low single digits per our adjustments. We have also observed an explosion of unbilled receivables, which we believe to be a sign of weakening earnings. Concerningly, AJRD recently stopped disclosing the definition of this item. We also believe that inventory and working capital are showing strain, but this analysis is difficult to conduct given that AJRD hasn't restated 2017 results for new accounting standards. Our accounting concerns are heightened by the fact that the CFO's bio may have been misrepresented and by the presence of long-standing current/recent board members who in the past have been associated with accounting frauds and companies with weak controls.
- Valuation Disconnected From Growth Prospects And Unaccounted For Debt: At face value, Aerojet's revenue and earnings growth are comparable with industry peers and suggest that the company is valued fairly or at a discount to peers. However, Spruce Point believes that, once realistic assumptions are applied to the company's future growth, and adjustments are made for aggressive accounting, the company appears overvalued. AJRD's valuation becomes materially more detached from reality once we account for approximately $900 million in "real" liabilities that aren't being accounted for by analysts. Just four smaller brokers with varied ratings see ~20% upside, but we find evidence that several fundamental investors have been selling to passive investors over time. We see 40-60% intermediate downside in AJRD shares on disappointing revenue growth and a multiple re-rating, and even more potential future downside when all liabilities are taken into account.
Spruce Point Capital has a short position in Aerojet Rocketdyne Holdings, Inc (AJRD) and stands to benefit if its share price falls.
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
About Spruce Point Capital
Spruce Point Capital Management, LLC, is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities.
