FOOL ON THE HILL
An Investment OpinionBy
ThermoRecovery? Warren Gump (TMF Gump)
August 24, 1999
The past couple of years have been miserable for shareholders of Thermo Electron <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TMO)") else Response.Write("(NYSE: TMO)") end if %>, a conglomeration of wholly owned and majority-owned subsidiaries that makes scientific, medical, and industrial instruments. After rising from single digits in 1990 to $45 in 1997, the company's stock price rapidly disintegrated to its current price of $16 (it went as low as $12 1/2 in April). A complicated organizational structure, management missteps, and a horrible worldwide economic environment led to the downfall. The company has begun addressing some of the internal problems and has a recovering worldwide marketplace. Could it now be time for a ThermoRecovery?
Saying that Thermo Electron is complicated is the understatement of the day. I've been watching the company for over two years and still can't say that I understand everything under the its hood. As of last August, the company had 23 publicly traded subsidiary companies, including Thermo Instrument (AMEX: THI), ThermoSpectra <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: THS)") else Response.Write("(AMEX: THS)") end if %>, and ThermoTrex <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: TKN)") else Response.Write("(AMEX: TKN)") end if %>. These companies were carved out to the public after they developed the product and financial wherewithal to be independently traded.
Such carve-outs provided several advantages when they were completed. During the period when most of them occurred, investors were attracted to and provided high valuations to small capitalization growth stocks. Another advantage of the spinouts was that they provided a cash infusion to help fund the continued growth, along with making it much easier to issue stock options and motivate management.
The carveouts also directly helped out Thermo Electron. It was able to record a gain on the sale of stock in its subsidiary. While analysts usually consider such gains "one-time" events, Thermo was such a prolific seller of subsidiary stock that analysts began incorporating these gains into their earnings estimates. That strategy worked while shares in subsidiaries were regularly and profitably being sold.
After slowing down in 1997 and 1998, the carveouts have now come to an abrupt halt due to a market that become uninterested in smaller capitalization stocks (particularly those where only a small portion of shares are publicly traded). In 1996, Thermo Electron recorded gains on the sale of subsidiary stock of $127 million, equal to 34% of pretax, pre-minority interest income. Those numbers fell to $80 million (16%) in 1997, $52 million (13%) in 1998, and will likely be zero in 1999. If you were banking on those gains continuing at Thermo in 1996, you were obviously paying for a bunch of earnings that didn't materialize.
"Market dynamics" and "lack of interest in small caps" don't fully explain the problems embedded with the Thermo family of companies. Their stocks have also been suffering from the weight of lower operating earnings (a figure that excludes subsidiary-sale gains). At the parent company level, operating income excluding restructuring charges fell last year to $375 million from $407 million. Some subsidiaries did better than this, but many of the smaller ones did much worse. If you are interested in getting specific information, Thermo's website links to a vast amount of subsidiary information.
The operating problems at Thermo subsidiaries can be tied to many factors, but a major reason for the slowdown is weak sales to the semiconductor industry and general weakness in Asian markets. The slowdown in semiconductor capital spending, a major market for Thermo's measurement and detection systems companies, was well documented last year. On the international front, about 33% of Thermo's sales are made directly overseas, but an additional 16% of sales occur in the U.S. for export. The weakness experienced in some of these other economies significantly hampered results for the Thermo family.
Not all problems at Thermo Electron are related to overall economic conditions -- quite a few are company-specific. Trex Medical <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: TXM)") else Response.Write("(AMEX: TXM)") end if %> lost a major customer that was acquired by another company. Thermolase <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: TLZ)") else Response.Write("(AMEX: TLZ)") end if %> has suffered from terrible performance at its day spas. Thermo Ecotek <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: TCK)") else Response.Write("(AMEX: TCK)") end if %>, which is involved with clean power resources, has been burdened with the expiration of power contracts that has lowered revenues and profits. A few other subsidiaries are also facing self-induced challenges.
To address the problems being experienced by Thermo Electron and subsidiaries, Richard Syron, the former head of the American Stock exchange, was recruited as the company's new president and CEO. He is trying to increase the focus of the Thermo family, improve cash flow, and ensure that the company pursues growth opportunities.
As part of a massive restructuring program, which has thus far totaled charges of more than $440 million, the company has written down unproductive assets and is streamlining operations. One objective of the plan is to sell 20 individual business units with more than $350 million in revenue, but virtually no contribution to the bottom line. The most important announcement thus far announced is a definitive agreement to sell Thermolase's money-losing spas. Additional deals should be completed over the next year.
Structurally, Thermo Electron is trying to rein in confusion and reduce the number of tiny public subsidiaries. The company announced a plan last August that would reduce their number to 15 from 23. Since then, the plan has been modified and expanded, with the ultimate goal of having only 11 public subsidiaries. These consolidations will be completed through asset swaps, stock swaps, and cash buyouts. A list of the proposed transactions, some of which won't be completed until the second quarter of 2000, can be found here.
It's going to take time for Thermo Electron to benefit from its restructuring and simplification efforts. As those start to kick in over the next year, though, it looks like some of the macroeconomic environments affecting the company are starting to improve. International economies seem to be recovering from the problems of the past two years and the semiconductor equipment business is starting to accelerate.
During the second quarter, internal bookings (which exclude the benefit of acquisitions) increased by 3% -- a small amount, but a positive sign. In addition, backlog, orders waiting to be produced and shipped, jumped up 9% excluding acquisitions. Another positive indicator is that research and development spending has increasing, as the company accelerates new product development.
I've found that an investing "sweet spot" is when a damaged company you want to own is starting to show concrete signs that its problems are being successfully addressed. Such a company's stock price can start to surge as investors realize that the company has hit bottom and is poised for improvement. We'll find out over the next few quarters if Thermo Electron is at such an inflection point, but the signs I see indicate that it is.