Investment funds affiliated with Marcato Capital Management and Oskie Capital Management are significant stockholders of Lear Corporation (the “Company”), with holdings together representing beneficial ownership of approximately 5.6 percent of Lear’s outstanding common equity. We share the view expressed in the Company’s press release of February 7, 2013 that the Company is undervalued, and we see what we believe to be a serious discrepancy between Lear’s improved operating performance and business prospects and its current market valuation. It is our view that this discount is directly linked to a questionable capital allocation strategy by the Board. Specifically, we believe the Company’s current undervaluation reflects investors’ distaste for the Company’s practice of stockpiling an increasing net cash balance, along with concern that the Company may be willing to make costly acquisitions or invest in other low-return projects at a time when the repurchase of Lear’s undervalued stock would be far more accretive to the long-term equity value of the Company.
It is therefore no surprise to us that Lear’s stock is trading both at a significant discount to its peers, and well below its long-run historical multiple of 5.5X EBITDA.
It is our contention that the Company’s recent announcement – to accelerate the pace of its existing stock repurchase program and raise its dividend – is insufficient. Simply put, we view Lear as dramatically overcapitalized. With net cash of almost 1x EBITDA, we believe Lear is approximately 2x full turns of leverage below the average of a group of its peers – despite Lear’s lower capital intensity, better pension liability position, favorable tax advantages and higher free cash flow conversion. Further, Lear’s large cash balance has the effect, we believe, of increasing the Company’s equity value, thereby artificially inflating the Company’s P/E multiple and distorting the value of the core enterprise.
The Board’s choices regarding capital allocation appear parsimonious and are even more disappointing in light of the positive operational progress the management team has made during and since emerging from Chapter 11 reorganization. The Company is now more diversified by geographical end-market and customer mix, and with its strong competitive position in its core seating business and a lower fixed cost base, we believe the Company is well positioned to generate significantly improved margins for a given level of production.
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