Fuel Systems Solutions, Inc. (FSYS)

[Democritus_of_Abdera]

Re: share price plunge following 2013Q3 CC...

There have been suggestions that the 18% drop in FSYS share price on the day of Q3 earnings release was an over-reaction (e.g. #msg-93921816)

Even though I have a substantial position in FSYS and am a believer in its long-term value, the drop in price from from $17/share to $14/share on Nov 7 was justified in my opinion. It was justified because the CC supported the view that FSYS should not be considered a growth stock.

Based upon the CC I don't think that FSYS can viewed as a growth stock because as soon as its DOEM growth starts to show sustained acceleration, one can expect the OEMs to in-source the production of CNG/LPG engines and abandon their collaboration with FSYS. This belief is based upon the following examples highlighted in the Q3 CC:

1) Honda Thailand (a long time FSYS collaborator) has decided to terminate the collaboration so as to in-source their CNG vehicles.

2) Pugeot in Europe (a long time FSYS collaborator) has decided to terminate the collaboration so as to in-source their gaseous vehicles.

3) Volkswagon of Shanghai has decided to terminate their collaboration with FSYS so as to produce their gaseous vehicles in-house... actually, this is not a surprise, I assumed that the Chinese would copy FSYS technology as soon as it was in their best interest, that seems to be their modus operandi.

4) An unnamed collaborator in Japan has withdrawn from their collaboration so as to produce their heavy duty vehicles with an in-house diesel-based technology...

5) In-sourcing has also happened with respect to Kia's Picanto model and Hyundai i10 model.

As a value stock, I believe that an FSYS shareholder should assign a current fair value of less than $15/share... That is, current revenue is about $400M/yr with 25% margin. Subtracting 7% R&D and 13% SG&A from the margin leaves 5% for the shareholder (about $20M/yr before CAPX, investments, etc.) There are 20M shares, so the profit will range up to about $1/share, which at a P/E of 15 would translate into a stock price of $15.... The value investor should discount this price because there is no dividend, and because this theoretical $1/share profit has not yet been attained .... not even close in recent quarters.

As a long-term believer in FSYS, I must acknowledge that I am still in denial... On an emotional basis, I believe that there remains substantial growth opportunities. In particular, I hope that

1) FSYS direct injection technology might include patents not easily circumvented by the OEMs.

2) The GM Cruze program or Ford F250 programs might escalate (but this will be shadowed by the possibility of OEM capture).

3) The OEM movement into CNG/LPG/Bi-fuel vehicle production might accelerate the implementation of service station availability. This in turn would accelerate adoption of after-market conversions, a forte of FSYS.

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Selected quotes from the 2013Q3 CC:

Timothy Standke (Chief Technology Officer, IMPCO) in prepared remarks:
In Thailand, Honda’s volumes declined due to the end of the city CNG program. Our OEM business has unfortunately been replaced by DET which is a subsidiary company of Honda. We do not foresee regaining any OEM business in Thailand at least for 2014.

In the U.S. market, we also developed a bi-fuel CNG system for the model year 2014 Chevrolet Cruze 1.4 liter sedan. This aftermarket solution represented the first EPA certification for a model year 2014 bi-fuel passenger sedan.... The IMPCO automotive powered Chevy Cruze is an excellent option for fleet vehicles and provides both fleet and customers an option when considering gaseous fuel transportation.

For the commercial vehicle segment, our lead heavy-duty customer in Japan continued to focus on a new truck development program, which resulted in lower volumes.

Pietro Bersani, CFO in prepared remarks:
Our Automotive OEM programs with Honda Thailand and Volkswagen China are coming to an end almost simultaneously between the end of 2013 and beginning of 2014 and are not being renewed. The reasons vary by OEM, but include the preference for suppliers belonging to the same carmaker as is the situation with Honda or deeply connect with it as is the case with Bosch for Volkswagen. Economic pressures that encourage in-sourcing have often been the reason for some of our DOEM customers to decide to integrate their conversion to vehicles in their plant, as was the case with Kia’s Picanto model and Hyundai i10 model.... and as these model programs have proven popular with customers, they are being brought under the direct responsibility of the OEM’s corporate headquarters.

Pietro Bersani in Q&A:
We also have an important European DOEM programs that will be coming to an end, which actually just finished, that will be impacting Italy....

...The worst case scenario of the program terminations that are affecting 2013 is the revenue risk of approximately $35 million.

...Some of them in connection with certain best seller vehicles slash platforms made this in-source decision in order to optimize their operation of course, and also in connection with a response to the economic pressures. I will give you some example. When we talk about Hyundai, that means that one of the best seller, which is the i10 will be progressively reduced in terms of volumes and that’s just because Hyundai made a decision to directly provide it with CNG offering directly means that in their manufacturing facilities in Turkey and in South Korea.... <Mriano Costamagna FSYS CEO interjects:> The car maker at the end are interested to go in-house just when there is high volume. We continue to produce in our facilities the low volume and for many years.

...I think that you should first consider the investments about our direct injection technology, which is very important, it’s a masterpiece and also from a potential opportunity – commercial opportunities, why, because, of course, more and more OEM are implementing direct injection platforms. So the capability by Fuel Systems group to meet with the direct injection system, which come into these new vehicles, new platform is key in order to continue to make progress.

<Matthew Blair asked> And can you say what OEMs you lost in Italy?... Pietro's response: The OEM we are talking about is a PSA, which is the Peugeot group.