PHINIA Spin-off Deep Dive
June 30, 2023
Summary
BorgWarner (BWA) will spin-off PHINIA (PHIN), its Fuel Systems and Aftermarket segments, by the end of the day on July 3, 2023. Regular way trading will begin on July 5, 2023. BWA will spin-off 100% of PHIN. Shareholders will receive 1 share of PHIN for every 5 shares of BWA.
In 2022, the SpinCo businesses generated $3.6BN in revenue (21% of total revenue) and have an adjusted operating profit of 14.5% (vs. 13.7% for RemainCo).
PHIN is trading in the when issued market at $31.50. At that price, the company has an enterprise value of $2.0BN and a market cap of $1.5BN.
Its valuation multiples are as follows: EV / 2023 sales: 0.6x, EV / 2023 EBITDA: 4.1x, P / 2023 FCF: 7.4x.
While this looks reasonable on an absolute basis, I don’t think it looks particularly attractive vs. other auto supply companies.
I think we could see some epic indiscriminate selling in PHINIA. I don’t know who really wants to own it, given it will have a $1.5BN market cap, significantly smaller than its parents market cap ($11.5BN). Further, PHINIA end markets are perceived to be in secular decline.
One caveat is that the stock will be added to the S&P 600 index effective July 6. Usually spin-off selling pressure is interrupted on the day before inclusion in the index. So I wouldn’t be surprised if PHIN was strong on the first day of regular way trading (July 5) especially in the afternoon.
After that, I would expect heavy selling pressure.
PHIN could be attractive at the right price, but it would have to fall below 5x FCF to get me interested.
Resources
PHINIA Investor Day Slide Deck
Phinia (PHIN) Capitalization
Additional Analysis
Rationale for the Spin-off
To put it simply, the rationale for the spin-off is to shed exposure to internal combustion engines and increase exposure to electric vehicles. Borgwarner is on track to meet or exceed its goal of 25% of revenue from EV by 2025. The intended separation will also address our previously stated goal of completing dispositions by 2025 of internal combustion assets generating approximately $3 billion to $4 billion in annual revenue.
Business Overview
The spin-off generates revenue from two business segments:
- Fuel Systems
- Aftermarket
Fuel Systems
The Fuel Systems division of the company creates and produces parts and systems that help gasoline and diesel engines work efficiently. They make things like pumps, injectors, control units, and complete fuel systems. These systems are designed to improve fuel economy and reduce emissions in both regular and hybrid vehicles. One of their technologies, called gasoline direct injection (GDi), allows for precise fuel delivery, which helps the engine burn fuel more effectively, resulting in lower emissions and better fuel efficiency. Their diesel fuel injection systems also improve emissions and engine performance without being too expensive. The company’s common rail fuel injection system is a key technology used in various types of vehicles, both for commercial and personal use, on and off the road.
Aftermarket
The Aftermarket division of the company sells products and services to two types of customers: independent aftermarket customers and original equipment service customers. They offer both new and remanufactured products. Their product lineup includes a variety of solutions in areas such as fuel injection, electronics and engine management, starters and alternators, maintenance, test equipment, and vehicle diagnostics. This division of the company has a reliable and steady source of revenue because many of these products need to be replaced regularly and it’s not something that customers can choose to ignore or postpone.
PHINIA generates sales globally:
PHINIA’s customer base is broken down as follows:
OES stands for original equipment supplier and IAM stands for independent aftermarket.
Big Picture Outlook
We could see decent growth over the next 2-3 years as global light vehicle production recovers:
But longer term, PHINIA is facing secular challenges from increased electric vehicle penetration:
Valuation
At its current price, PHINIA is trading at 4.1x 2023 EBITDA and 7.4x 2023.
This valuation seems relatively cheap on an absolute basis and on a relative basis (auto supplier companies below):
However, I think PHIN deserves to trade at a substantial discount to its peers given its disproportionately exposed to internal combustion engines.
I think the best comp is probably Garrett Motion which is also very exposed to internal combustion engines as it is focused on manufacturing turbochargers.
I think the most appropriate way to compare valuations of Garrett and PHINIA is based on a price to free cash flow multiple. At its current price, Garrett trades at 5.5x 2023 free cash flow guidance whereas PHINIA trades 7.4x. I believe they should trade at parity. Garrett may even deserve to trade at a premium given its high margin profile and lower capital intensity.
In conclusion, I’m not interested in PHIN in the $30 price range, but if it were to fall sharply, it could get interesting.
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