The deal that saved Oshkosh
Wisconsin company banks on military contracts to defend itself against the recession.
By Scott Eden, TheStreet.com
When Defense Secretary William Gates paid a visit last week to the corporate headquarters of the commercial and military truck maker Oshkosh, in Wisconsin, he lauded the company's new bomb-busting all-terrain fighting vehicle, which the Pentagon has fast-tracked into service as the war in Afghanistan intensifies.
To an audience of Oshkosh workers, Gates intoned, "With every vehicle you complete, you are saving American lives."
What the secretary didn't mention was that the truck -- and the multibillion-dollar Army contract to produce them -- might have saved Oshkosh's life as well.
"It's amazing how rapidly their fortunes have changed," says Loren Thompson, the chief operating officer of the Lexington Institute, a libertarian-leaning think tank specializing in analysis of what used to be called the military-industrial complex. "They've gone from the edge of Chapter 11 to Valhalla."
Oshkosh won the contract in June and will, when it's all said and done, probably take home from the Pentagon somewhere north of $3.2 billion in revenue.
Already, the company has received orders for 6,219 of the trucks, known as M-ATVs (short for Military All Terrain Vehicle), and will be delivering them to the Army through April of next of year at a clip of about 1,000 trucks per month.
There's a chance, too, that the military will order more if, for instance, the Obama administration chooses to escalate the war in Afghanistan by adding to troop levels there.
All of this has thrown the relatively little-known defense contractor -- whose home base sits on the shores of Lake Winnebago, 50 miles southwest of Green Bay -- into the spotlight. Prior to this summer, you could be forgiven for momentarily thinking that Oshkosh was a manufacturer of children's overalls -- or, given the company's location -- an RV maker.
Another way of thinking about Oshkosh prior to this summer: a maker of cherry pickers and cement mixers so tied to the collapsing construction business, and so levered up after a spree of boom-time acquisitions, that its market cap was dwarfed by its mountainous debt load.
Oshkosh started life in 1917 as the Wisconsin Duplex Auto Company. One of the pioneers behind the development of four-wheel drive, its trucks were designed to deal with the rough, unpaved roads that then dominated most of the country at dawn of the automobile age. (It's also credited with bringing the first cement truck to market.)
Always popular as cargo haulers for construction companies, Oshkosh's trucks first went into combat during World War II (along with the entire auto and truck industry, of course), though the company didn't start producing heavy supply trucks for the military on a regular basis until the early 1980s.
Oshkosh never lost sight of its civilian business, however, adding to its product lines in the commercial segment through a series of acquisitions beginning in the 1990s. It was a buying binge that culminated, in 2006, in the $2.3 billion purchase of a company called JLG Industries, the cherry-picker and aerial-lift manufacturer.
This being 2006, Oshkosh made the deal at nearly the absolute top of the market, and took on a massive amount of then-cheap credit to do so. Basically, the company overpaid.
"The timing turned out to be just horrendously bad," says Kent Mortensen, an analyst at the Thrivent Financial for Lutherans, a group of funds with $63 billion under management, and with offices in Appleton, Wis., a 20-minute drive from Oshkosh. His fund owns some 660,000 shares of Oshkosh, making it a top 25 holder.
"We weren't fond of that acquisition," he says of JLG. "I guess we understood it, but we felt it was a little late."
Oshkosh did not respond to several requests for executive comment.
At the end of 2006, just before the JLG deal, the company had about $90 million in debt. A year later, it had $3.3 billion, with a debt-to-cap ratio of 75%.
Then, disaster struck: When the financial meltdown and the recession hit, the bottom dropped out of the JLG business (as well as cement mixers and, increasingly, fire trucks, with municipal governments reeling from the recession as well), sending Oshkosh into a serious funk.
"The business was decimated," Mortensen says. The JLG unit has lost money for four straight quarters, posting a staggering $1.1 billion loss in fiscal 2009, which ends in September.
At the depths of the bear market, investors were pricing Oshkosh's stock, like that of many other firms, as if the company were going out of business. Almost exactly a year ago, the shares fell as low as $3.85. Oshkosh had to renegotiate loan covenants.
"Certain people talked about the potential for a bankruptcy filing," says Charles Brady, an analyst covering diversified industrials at BMO Capital Markets.
It was several months later that Thrivent, which owned a small number of Oshkosh shares, decided to add substantially to its stake in the company, whose shares were still mired at little over $5. It was, for Thrivent, a "binary" bet, says Mortensen.
"The stock would either work out handsomely for us or go to zero. We had to take a leap of faith." He adds, "They still had a leading brand and good end markets, and we felt they'd be able to pull through the downturn."
As it happens, Oshkosh's defense arm had been messing up badly as well. In October 2008, the defense department spurned its jointly developed project with Northrop Grumman that would have produced a successor to the Humvee and brought in many billions of dollars. (Estimates were as high as $20 billion over a decade.)
The Oshkosh-Northrop truck was considered a frontrunner in the competition, so the rejection came as another blow to the company just when it needed a lift.
On the very night of the rejection, Oshkosh design executives started work on the M-ATV. The Pentagon wanted a different version of its MRAP (short for Mine Resistant, Ambush Protected) vehicle, then being built by several contractors and designed specifically to withstand the kinds of homemade bombs used by insurgents in Iraq.
The new version of the MRAP, however, would be going to Afghanistan, where the rugged, mountainous terrain demanded its own set of requirements. Oshkosh's truck, for example, uses a heavy-duty suspension system and chassis from a bigger off-road vehicle it already makes for the Marines.
In the end, its design won out over a slew of heavy hitters, including Navistar, the U.K. giant BAE Systems, Force Protection and General Dynamics.
"They were favored to win the [Humvee successor] contract. When they didn't, that surprised people," says BMO Capital's Brady. "But they've taken lessons from that. Clearly they did a good job figuring out what mistakes they made and correcting them."
On the day the award was made public, Oshkosh shares, then trading at below $15, shot higher by nearly 30%. (Thrivent also added to its stake after the M-ATV announcement.) They've since more than doubled in value.
Indeed, in lifting the company's stock price, it's not a stretch to say that the Pentagon deal may have saved Oshkosh. For one thing, it allowed the company to issue nearly 15 million shares at $25 a pop, raising $375 million, which it used to pay down debt.
The cash flow from the M-ATVs has also helped, of course (since the JLG acquisition, Oshkosh has trimmed its debt load by about $1 billion). The truck has a fairly high operating margin: according to company executives, it's slightly narrower than the defense segment average of 15.5%, which, says Brady, is "pretty good for an original equipment contract." The JLG unit, by comparison, was drawing 15% margins only at the peak of its profitability in summer 2008.
Oshkosh's M-ATV deal is set to end in April next year, though it's highly likely the Pentagon will order at least another 400 trucks, bringing the total to more than 7,000. And then, of course, there's the possibility that the Obama administration will escalate the Afghan war.
Says Brady, "Who knows what's going to happen at this point. But if the troop levels go up," the Pentagon could well re-up its M-ATV contract in a major way."
It hasn't been all good news for Oshkosh lately, however. In August, the company won a contract to build a type of combat supply truck called the FMTV (short for Family of Medium Tactical Vehicles), beating out the incumbent, BAE Systems, by offering a cheaper price. Though neither Oshkosh nor the Defense Department put a value on the deal, it could have been worth more than $3 billion, according to analysts’ estimates.
But in September, BAE (as well as Navistar, which was also bidding for the business) filed a protest with the Government Accountability Office, and the Army put out a stop-work order on Oshkosh. The gist of BAE's complaint: it thinks the Pentagon, which judged both bids to be equal when it comes to everything except price, did nothing to assess the risks it believes are inherent in Oshkosh taking over manufacture of the trucks. A ruling is scheduled to come down by the middle of December.
According to the defense analyst Thompson of the Lexington Institute, Oshkosh underbid the previous BAE contract by 30%. (BAE underbid its own earlier FMTV deal by 21%, Thompson says.) Thompson believes the GAO will rule in BAE's favor. "It struck me that the Army made no attempt to determine whether the Oshkosh bid was realistic." In other words, whether the company could build and deliver the trucks at all at the promised price.
"I want to stress that Oshkosh is a very capable company," Thompson says. "Maybe more so than BAE. But that doesn't really speak to whether the [bidding] process was conducted appropriately."
For its part, Oshkosh has gone ahead with ramping up production of the FMTV as if nothing has gone wrong, procuring parts on its own dime. Indeed, because the bid was so low, they pretty much have no other choice.
Thrivent's Mortensen, for one, isn't worried. He calls BAE's protest "a long shot," noting that Oshkosh knows well what's it is or isn't capable of doing, and at what price, given its long history of making trucks for the military -- even if it's never produced this type before.
But what if Oshkosh loses the FMTV contract? How much would it hurt? The question raises a series of issues.
For one thing, the long-term investment thesis behind owning Oshkosh appears to be that the company's business with the Pentagon has bought it time. Now, it can simply wait for its commercial units (lifts, cement mixers) to recover alongside the broader economy. "Then, you'll have a nice handoff from the military to the commercial business," Mortensen says. By that point, too, the defense orders will begin to fade away, since by definition Pentagon contracts are limited.
The conventional wisdom holds that sometime in 2011 is the earliest point at which Oshkosh's commercial segments would recover. But because JLG is losing so much money, it would simply need to break even, says Mortensen, to provide Oshkosh's bottom-line growth with a significant tailwind. "They could show some nice earnings leverage in 2011 and beyond," he says.
Should the FMTV deal fall apart, though, the real impact on Oshkosh wouldn't be felt until 2011, because that's when the contract would truly kick in. (The FMTV program is a longer-range program than the fast-tracked, emergency M-ATV order.)
If no FMTV dollars flow to the shores of Lake Winnebago, however, Oshkosh had better hope for as V-shaped a recovery as is possible. As Mortensen says, failure to keep the FMTV contract "would require commercial to pick up the slack a little sooner."
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Bill Stiritz owns more than 5% of the company, and has experienced an estimated $145 million in paper losses on his investment.
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