RealMoney Silver - TTMI Sitting Pretty After Offering

TTMI Sitting Pretty After Offering
By Bill Trent
RealMoney.com Contributor
5/19/2008 10:55 AM EDT

TTM Technologies (TTMI) manufactures printed circuit boards for the high-end commercial and aerospace/defense markets. The company focuses on a "quick-turn" model that can provide custom-fabricated PCBs to customers within as little as 24 hours. This strategy allows TTM to charge a premium for quick-turn services (which account for 15% of total revenue) and insulates TTM from the extreme cyclicality faced by most electronics manufacturing services (EMS) providers. In the last 10 years, the company reported just one year of net losses (2002).

TTM's largest original equipment manufacturer customers in 2007 were Cisco (CSCO) , Honeywell (HON) , Juniper Networks (JNPR) , Northrop Grumman (NOC) and Raytheon (RTN) ; these OEMs accounted for a combined 24% of total sales. More than half of total sales were to EMS providers including my favorite, Celestica (CLS) , as well as Flextronics (FLEX) , Jabil (JBL) and Plexus (PLXS) . The diversity of customers and end markets should shield the company from short-term market share fluctuations among customers.

Wheeling and Dealing

TTM recently closed on an offering of convertible senior notes. While the headline was that the company raised $155 million paying 3.25%, the company also entered into "convertible note hedge transactions and warrant transactions, which are intended to reduce the potential dilution to TTM's common stockholders upon any conversion of the notes."

In essence, according to its related 8-K filing, TTM turned one transaction into three.

It received $155 million for issuing bonds convertible into 9.7 million shares at $15.96 and paying 3.25%.
It paid $33.9 million to buy 9.7 million call options with a $15.96 strike price.
It received $23.2 million for issuing warrants exercisable into 9.7 million shares at $18.15.

I'm generally not a fan of these complicated financial transactions, which I think often benefit the bankers and privileged customers more than the company and its shareholders. However, in TTM's case I think it may have gotten the better end of the transaction.

The first two transactions net into a straight coupon bond, at which the $5 million in annual interest expense represents a 4.2% yield on the $121.1 million in net proceeds. This bond was used to retire a credit facility with a weighted average interest rate of 6.83%, according to the 8-K. A lower interest rate for a longer maturity counts as a good deal in my book.

The third transaction results in the entire issue equating to a convertible note paying 3.5% and convertible at $18.15. Why the company didn't use one transaction rather than three to effect that offering remains a mystery to me, but what's done is done. Meanwhile, the company has increased its financial flexibility at a critical time and will be better able to pursue its acquisition strategy.

For What It's Worth

A strong first-quarter earnings report marked the third consecutive quarter with a positive earnings surprise of at least 10%. As a result, analysts raised their forecasts for this year and next. The current estimates call for the company to earn $1.07 a share in 2008 and $1.24 in 2009. At 13 times this year's earnings and 11.2 times next year's, the valuation seems reasonable.

TTM generated $74 million in cash flow from operating activities, though a portion of that was from working capital improvements that are likely not sustainable. I estimate the sustainable operating cash flow to be more like $60 million to $65 million. With $14 million in capital expenditures, sustainable free cash flow was likely in the $50-million range, representing a generous 8.4% free cash flow yield on the current market capitalization.

Given TTM's financial position and growth expectations, I think the free cash flow yield could contract to 6%, which would still represent a 100% premium over the current five-year Treasury yield. At that valuation, and assuming free cash flow grows in line with the expected 16% growth in earnings, the shares could rise more than 60% to around $22.50 over the next year or two.

While such a gain would trigger some dilution from the convertible note offering, I doubt shareholders would lose much sleep over it.