Why Aerojet Rocketdyne's Revenues Are Set To Decline And It Is 5x More Levered Than It Appears: 40% - 60% Downside Risk

Report Entitled: "Ready, Aim, Blow-Up"

Spruce Point Capital Management is pleased to issue a "Strong Sell" opinion on Aerojet Rocketdyne Holdings, Inc (NYSE: AJRD). The full contents of the report are available on our website . We also encourage readers to follow us on Twitter @sprucepointcap.

In our opinion, Aerojet – formerly Gencorp (NYSE: GY) – is facing fundamental pressures, masked by complicated and aggressive accounting, which gives investors a potentially misleading impression of stability and growth. While holding no conference calls or giving financial guidance, and having only four analysts cover the stock, we believe the market is fundamentally ignoring ~$900M of liabilities associated with the business, making the Company 5x more levered than it appears and its valuation “cheap”. Furthermore, analysts blindly pencil in 4% revenue growth in the next two years, despite hundreds of millions of dollars in revenue programs that are disappearing. We see 40% - 60% downside ($13 to $20 per share) once investors piece the puzzle together.

Key Report Highlights

Shifts In The Competitive Landscape And Program Specific Funding Present Fundamental Challenges:

AJRD’s Space business has been largely dependent on ULA for some time. AJRD’s loss to Blue Origin for support of ULA’s Vulcan rocket late last year is indicative of the challenges that the company faces from disruptive competitors like SpaceX and Blue Origin and the challenges of being a cost plus contract provider. AJRD’s Space business is now largely linked to SLS, a program best known for missing deadlines and its dependence on regional political support. However, both the current administration and NASA have recently placed the project on watch as they consider "all options" in meeting the targeted launch schedule.

On the Defense side of the business, AJRD has historically enjoyed a duopoly with Orbital ATK for missile propulsion. However, last year Northrop acquired Orbital ATK to vertically integrate its manufacturing. The FTC would later reach an antitrust settlement with Northrpp in hopes of promoting competition amongst primes for missile systems, but AJRD has claimed in a public comment letter that the settlement effectively removed any incentive for the other primes to seek bids from Aerojet Rocketdyne. The actual implications of the settlement on AJRD’s SRM business remain to be seen, but we do know with certainty that segment will face significant headwinds due to declining budgets for the key THAAD and Standard Missile programs through 2020.

The above challenges apparently aren’t lost on AJRD’s management team, which saw the departure of three experienced SVPs between December 2017 and December 2018. AJRD’s response to these challenges has been to talk up cost savings initiatives and dangle the prospect of strategic acquisitions. In Spruce Point’s opinion AJRD’s sole recent acquisition of 3DMT was de minimis in scale and an acknowledgement of its need to enhance its manufacturing capabilities.

Aggressive Accounting Has Inflated Recent Performance And Obfuscated Growing Financial Strain:

Based on Spruce Point’s adjustments, we believe that headline EPS, EBITDA and cash flow appear aggressive and overstated. Numerous subjective “one-time” adjustments have inflated metrics such as YoY EBITDAP margin growth and operating cash flow growth to high teen levels when they are low single digits per our adjustments. We have also observed an explosion of unbilled receivables, which we believe to be a sign of weakening earnings. Concerningly, AJRD recently stopped disclosing the definition of this item. We also believe that inventory and working capital are showing strain, but this analysis is difficult to conduct given that ARJD hasn’t restated 2017 results for new accounting standards. Our accounting concerns are heightened by the fact that the CFO’s bio may have been misrepresented, and by the presence of long-standing current/recent board members who in the past have been associated with accounting frauds and companies with weak controls.

Valuation Disconnected From Growth Prospects And Unaccounted For Debt:

At face value, Aerojet’s revenue and earnings growth are comparable with industry peers ( LMT , GD , NOC , LLL ), and some analysts suggest that the company is at a discount to low-quality SMID cap peers we have previously profiled ( AVAV , KTOS , MRCY ). However, Spruce Point believes that once realistic assumptions are applied to the company’s future growth, and adjustments are made for aggressive accounting, the company appears overvalued. AJRD’s valuation becomes materially more detached from reality once we account for approximately $900 million in “real” fixed-cost liabilities that aren’t being accounted for by analysts. Just four smaller brokers with a mix of varied ratings see ~20% upside, but we find evidence that several fundamental investors have been selling to passive investors over time. We see 40%-60% intermediate downside in AJRD shares on disappointing revenue growth and a multiple re-rating, and even more potential future downside when all liabilities are taken into account.

Disclaimer

This research presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation Aerojet Rocketdyne Holdings, Inc (“AJRD”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.

This research presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US Dollars, unless specified otherwise.

To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of AJRD or other insiders of AJRD that has not been publicly disclosed by AJRD. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. You should assume all statements made are our opinions, unless sourced as facts where practical.

This report’s estimated fundamental value only represents a best efforts estimate of the potential fundamental valuation of a specific security, and is not expressed as, or implied as, assessments of the quality of a security, a summary of past performance, or an actionable investment strategy for an investor. This is not an offer to sell or a solicitation of an offer to Buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is not registered as an investment advisor, broker/dealer, or accounting firm.