RF Capital Management – Garrett Motion Inc. (NYSE:GTX)

The following segment was excerpted from this fund letter.

Garrett Motion (NYSE:GTX) – Industry trends remain compelling, and there continues to be strong revenue visibility. Turbocharger growth trends look strong due to tougher CO2 regulations and increased production of turbocharged cars by 2025. Win rates continue to be robust with ~50% of competitions won. For 2021E, the revenue breakdown is 91% awarded, 4% replacement, and 5% new business. For 2023E, the breakdown is 68% awarded, 15% replacement, and 17% new business. Organic growth continues to outperform global auto production. In the third quarter, GTX’s organic growth outperformed by five percentage points. In fact, GTX has outperformed global LV production every quarter since going public.

Current guidance for the year remains unchanged for the most part. Organic net sales growth remains -1% to +1% and the adjusted levered free cash flow conversion rate is still 50-55%. However, adjusted EBITDA has been lowered to $580-$600 million due to impacted margins by gas products sales exceeding diesel sales.

GTX also filed a complaint against Honeywell (NYSE:HON) on December 2nd. In the complaint, allegations include: 1) top Honeywell executives devised the spinoff to offload its asbestos liabilities, 2) HON did not negotiate the one-sided Indemnification Agreement with GTX, 3) the Indemnification Agreement violates NY law, 4) onerous and unlawful covenants in the Agreement affects GTX’s key corporate decisions for 30 years, and 5) HON breached the Agreement it wrote for itself.

In the complaint, GTX also alleges that the company did not have proper legal representation. HON retained the same lawyers for both HON and GTX. GTX also believes that the Indemnification Agreement illegally requires GTX to indemnify HON for punitive damages, which are meant to punish HON. Additionally, GTX thinks the Agreement hobbles the company’s ability to refinance debt and engage in corporate transactions such as an M&A deal. Since GTX also has no right to prepay Honeywell for the liabilities, HON is essentially in control for 30 years. Also, GTX alleges that HON failed to provide information regarding the asbestos liabilities despite repeated requests for more than a year.

Although Mr. Fan has a legal background, our firm is not in the business of predicting the outcomes of lawsuits. Instead, we incorporate the worst-case scenario when valuing the company. Thus, we view a successful lawsuit by GTX as a free option. Prior to investing in GTX, we assumed the company would pay $175 million every year until the expiration of the Agreement. If GTX is successful in the lawsuit, it would certainly help the markets reassess the company’s value in a positive light. If GTX is unsuccessful, however, it wouldn’t affect our investment thesis either. We established a full position size prior to the lawsuit, and we were fully aware of GTX’s debt load and asbestos liabilities.

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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