Compass Diversified Stock: Upgrade to buy; 30% increase (NYSE: CODI)
Down about 17% since mid-December, we are moving Compass Diversified (NYSE: CODI), a private equity investment vehicle, from neutral to bullish.
Based on a sum-of-the-parts methodology and taking into account several positive company announcements over the past three months, we have raised our price target from $32 to $35 per share.
Trading at ~$27, we view CODI as an attractive opportunity with an upside of around 30%, plus a well-hedged dividend yield of 3.7%.
We initiated a small position on Friday afternoon and expect to increase our exposure to these levels.
Based in Westport, Connecticut, CODI is a holding company that owns controlling interests in ten mid-market companies based in North America.
Historically, the investment team has focused on identifying targets in the consumer and industrial market segments. However, over the past 3 years, the consumer space has become a bigger priority.
CODI’s strategy is to acquire, develop and eventually dispose of companies that:
- maintain leading positions in attractive market niches;
- generate stable cash flows;
- dealing with limited technology and/or competitive obsolescence; and
- employ strong management teams.
CODI’s current portfolio includes entities engaged in the following business lines:
Branded consumer subsidiaries
- The development and marketing of specially designed technical clothing and equipment for a wide range of global customers (5.11);
- The design and manufacture of a unique lacing system, which is integrated into specialty footwear products (BOA technology);
- The development and marketing of portable baby carriers, strollers and related products (Ergobaby);
- The designer, manufacturer and distributor of high-end jewelry (Lugano Diamonds & Jewelry);
- The innovation and manufacture of baseball/softball equipment and associated apparel (Marucci Sports); and
- The design, manufacture and marketing of airguns, archery products, optics and related accessories (outside speed).
Niche industrial subsidiaries
- The manufacture of fast, small series and rigid printed circuit boards for production (Advanced Circuits);
- The design and production of custom molded protective foam solutions and OE components (AltorSolutions);
- Manufacturing engineered magnetic solutions for a wide range of specialist applications and end markets (Arnold Magnetic Technologies); and
- The manufacture and marketing of portable food warming systems, creative indoor and outdoor lighting and air freshener solutions for the restaurant industry and consumer markets (Sterno).
CODI uses the cash flows generated by its subsidiaries, as well as the proceeds associated with divestitures, to invest in organic/inorganic growth initiatives and to make cash distributions to shareholders.
CODI shares tend to be very popular with retail investors as they offer unique access to private equity investments, as well as an attractive dividend yield. Exposure to private equity is considered by many to be highly desirable due to the expectation of long-term value creation, as well as limited correlation with public equity markets.
As for the dividend, at Friday’s close of $27.27, CODI offers a reliable yield of 3.7%.
With regard to evaluation, our approach remains consistent. We use a sum-of-the-parts (SOTP) method to calculate the fair value of CODI.
For each operating subsidiary, our analysis forecasts a 2022E Adjusted EBITDA target and applies an appropriate corporate EBITDA multiple based on comparable public peers and prior M&A transactions.
We then deduct net debt and management fees to arrive at an equity valuation.
Our analysis takes into account the recent add-on acquisitions of Altor Solutions and Marucci Sports, as well as the previously announced divestment of Advanced Circuits (expected to close in 1Q22).
The consideration for the Advanced Circuit deal included a combination of cash and equity, as noted in the mid-October press release:
Under the terms of the agreement, CODI and the other selling shareholders will receive consideration in the amount of $310 million, consisting of $240 million in cash and $70 million in common stock of Tempo upon the closing of the transaction, excluding certain working capital and other adjustments. In addition, CODI and the other selling shareholders could receive an additional $30 million of Tempo common stock within five years, subject to Tempo stock price performance. »
Our SOTP analysis allocated the cash proceeds to debt repayment and marks Tempo Automation’s equity at $70 million. To be on the safe side, we place no value on the potential to receive the additional $30 million in equity from Tempo Automation.
As noted above, our estimate of fair value goes from $32 to $35 per share. At Friday’s close of $27.27, the revised price target offers an attractive total return of around 30% equity appreciation plus a dividend yield of 3.7%.
There are several scenarios that could improve our $35 price target over the next 6-12 months.
- CODI maintains a substantial dry powder, allowing it to pursue additional acquisitions. The company aims to acquire 1-2 new platforms per year, as well as 2-3 strategic additions to the existing portfolio. Management’s core competency is accretive M&A, providing a likely scenario over the next 12 months.
- CODI has a long history of disposing of holdings at attractive valuations. A rig sale at a value above our subsidiary estimate would increase the value. A potential divestiture concerns clothing supplier 5.11. In early November, 5.11 filed a registration statement with the SEC for a proposed IPO.
- Operational performance above forecasts. We estimate that the portfolio should generate adjusted EBITDA of $349.3 million in 2022. However, we recognize that we may be underestimating the growth potential of several holdings. For example, Lugano Diamonds, CODI’s new platform, has the potential to top our $30.5m at $35-38m.
- Given the reclassification of the company into a joint-stock company, the action can now be included in the indices. There is a good shot that CODI will be added to the Russell 2000 and 3000 in late spring.
CODI is a well-managed holding company with controlling interests in ten mid-market companies in the industrial and consumer segments.
The portfolio has performed well in 2021 and management has been aggressive, executing a number of strategic initiatives to maximize shareholder value.
We increased our fair value of CODI from $32 to $35. Given the stock’s poor performance over the past month, we see an attractive risk-reward opportunity and have started to build a position.