Kemet Corp. (KEM): Perfectly Tuned To Break Investors' Hearts

by Sonya Colberg, Senior Editor - 6/21/2016 12:42:32 PM

If Kemet Corp. (KEM) were a country crooner, it would be singing "There's A Tear In My Beer" as its heartthrob walks out the door.

Indeed, informed investors couldn't be blamed for walking away as downside risks mount up for this South Carolina manufacturer of capacitors - battery-like gizmos that store electric energy.

Kemet entities have been slapped with investigations or inquiries into alleged anti-competitive actions by: *The United States; *China; *Europe; *Brazil; *South Korea; *Taiwan; *Singapore; *Japan.

Yet the stock turned upward as Kemet reported a quarterly earnings miss and $183 million revenue down 5% year over year; as well as settlement of one of these investigations.

This misunderstanding-fueled rally grows more ludicrous when we consider three factors.

*First, filings show lawsuits, verdicts and investigations - for March 2015-March 2016 alone - cost Kemet about 6.1 billion yen or $58 million. 

*Second, price-fixing probes are not over yet. The company and subsidiaries are defendants in multiple ongoing global investigations into price fixing and bid rigging conspiracies by capacitor manufacturers.

*Third, Kemet may be on the hook to pay ~$400 million to acquire the "one who done him wrong."

While investors may find other viewpoints here, consider TheStreetSweeper's details on why Kemet stock is now perfectly tuned to fall back toward sanity.

*1. Calling Dr. Phil: Troubled Relationship Begins

Kemet paid $50 million three years ago for a 34% stake in Nec Tokin - the partner it intends to buy in its entirety.

But Nec Tokin has now pled guilty to criminal price fixing. The US Department of Justice determined that from April 2002 to December 2013, Kemet's partner had been "conspiring ... to fix prices" for capacitors in America.

FBI Special Agent David J. Johnson stated: “For over a decade and through various financial crises, NEC Tokin has exploited American consumers and fixed the price of capacitors..."

Investigators said Kemet's partner had set prices using code names and misleading justifications "to cover up their collusive conduct."

On Jan. 21, 2016, Nec Tokin became the first capacitor company to plead guilty in the ongoing probe. It was sentenced to pay a $13.8 million criminal fine.

Also, Taiwan slapped fines on Nec Tokin and other Japanese companies involved in an alleged price-fixing cartel, while EU, South Korea, Brazil and Singapore continue investigating such allegations. Also, Japan recently issued Nec Tokin a cease and desist order.

Despite the market's misunderstanding, Kemet is clearly not out of the antitrust woods yet. Kemet continues to defend itself and its entities (pages 20-21) in ongoing litigation in both the US and Canada - where 11 class action lawsuits are pending.

Meanwhile, how much has Nec Tokin gotten to Kemet thus far? .... Read on ...

*2. Antitrust OOPS: When "Good" Investments Turn Bad

Kemet had to take a $16.4 million net loss (link page 31) as it forked out its share of $51.6 million in lawsuit costs and antitrust fines against Nec Tokin.

Add in related expenses for its fy 2016 and we see Kemet has paid plenty...

Altogether, Kemet has poured about $42.7 million down the drain.

Thank you very much Nec Tokin.

Yet Kemet claims it wants Nec Tokin. Really? At what price?

*3. On The Hook: ~$400 Million

Incredibly, Kemet may be on the hook to pay another ~$400 million to acquire the rest of Nec Tokin.

That's right.

Through a put option, NEC "may require" Kemet "to purchase all outstanding capital stock of Nec Tokin."

The filing says the price will be whichever is greater ... six times Nec Tokin's EBITDA or its debt ( ~$232m in 2014).

Six times EBITDA (earnings before interest, taxes, depreciation, amortization) of 82.6 billion yen is about $474 million. 

Unless something changes, the estimated price tag is not too far off half-a-billion dollars... For a company still under investigation by multiple governments for alleged anti-competitive activities.

(Sources: Company SEC filings)

Yet cash and equivalents are just about $65 million.

So even a conservative Nec Tokin cost estimate of $350 million is five times the cash in Kemet's pockets.

The $493 million estimated cost is a whopping seven times greater than available cash.

But there's more financial pressure .... what about Kemet's debt? Sorry you asked ...

*4. Tennessee Ernie Ford and Kemet Agree: "Another Day Older and Deeper In Debt"

Strikingly, 85% of Kemet's total value or enterprise value is debt.

That's right. To its credit, the company does have a debt repurchase plan. Regardless, the company has dug itself into about $390 million worth of debt while the enterprise valuation of the entire company is $460 million

The debt picture is so ugly, Egan-Jones and Moody's have rated Kemet bonds "junk" status:

(Source: Bloomberg)

Debt is eating away at Kemet as debt interest is 10.5%. Indeed, the company's interest expense reached ~$40 million .... a stunning 5.5% of sales.

And the debt will mature in May 2018.

Yet remember that Kemet has only $65 million cash.

(Source: Bloomberg)

Such cruddy bond ratings could make it difficult or impossible for Kemet to borrow money, especially at better than draconian terms.

The pressures on Kemet are also showing up in its sales trends ...

*5. Sales: Dropping

Kemet sales seem to be caught in a painful downward trend that has continued rather consistently for years.

(Source: Company SEC filings here, here;)

Our chart below shows that compared with 2011, current sales are down significantly.

(Source: Company SEC filings, pg 27, FY 11 net sales $986.5, FY16 net sales $734.8m)

Downward momentum has been picking up. So Kemet may have difficulties turning things around.

*6. Executives Humming: "We're In The Money"

While the company struggles, its leaders are humming happy tunes.

(Source: Company SEC filing)

The top three executives alone make more than $4.6 million.

In contrast, Kemet's cranking out only a 5% operating margin, 22.8% gross margin and otherwise offering pitiful returns to investors:

(Source: Wall Street Journal)

*7. Insiders: Stock Selling Frenzy

Kemet executives and directors have been selling company stock like mad. Just since April, insiders have unloaded more than 105,000 shares.

For the sake of brevity, the chart below shows insider sales only since May 17, when the CEO sold 9,509 shares for ~$2.55 per share ....a price that is about 14% below today's stock price.

(Source: insidertrading.org)

Click on the link to get a better handle on the scope of insider selling. All that selling suggests that those who know the company best may feel the stock price has approached its peak price.

*Conclusion: "Here Comes Goodbye"

Kemet's stuck in a low margin, declining sales, fiercely competitive biz where older products face price erosion. Meanwhile, more tears may fall in Kemet's beer as governments across the world continue their scrutiny over the industry amid price-fixing allegations.

Yet Kemet wants to increase its stake in snake-bitten - still incredibly risky - Nec Tokin to 100%.

The company may be wanting to kiss and makeup with investors. But we think stockholders are too smart to fall for another old cowboy song ... and this stock is now pitch-perfect for a 40% drop back to earth.

* Important Disclosure: The owners of TheStreetSweeper hold a short position in KEM and stand to profit on any future declines in the stock price.

* Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to [email protected].

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