Viewpoint -- TRW Has Hidden Value But Big Debt

Dec. 21, 2004
Home-grown technologies are fertile ground for new business and investments.

David Cote, president, chief operating officer, and soon-to-be CEO of TRW Inc., is worried about his company's performance in light of the expected downturn in the North American auto industry, and he is excited about the company's "technology bank," but TRW's massive debt is standing in the way of fast growth in the near future. Cleveland-based TRW derives one-third of its revenues from its Aerospace and Information Systems businesses, and Cote admits that those operations will not replace or fully offset expected declines in its automotive operations. However, Cote says that the Aerospace and Information Systems businesses have the potential to fuel a "tremendous future" for TRW. TRW's technology bank focuses on products it develops for the Dept. of Defense, NASA, and other governmental and quasi-governmental agencies, and includes high-speed semiconductors, satellite systems, solid state lasers, information-systems technologies and e-commerce applications, and high-performance electronics and sensors. Cote, who will succeed Joseph Gorman, TRW's chairman and CEO, on Feb. 1, sees TRW's home-grown technologies as fertile ground for new business and investments in the future. Cote points to sensors and wireless communication devices that can be used in connection with TRW's joint development venture with Michelin. That joint venture was launched in the third quarter, and is aimed at developing equipment to constantly monitor tire pressure on cars and let drivers know when their tires need air. Cote notes the development of a semiconductor chip -- known as the indium phosphide chip -- that TRW claims is four times faster than any other computer chip available today. Cote also points out that TRW Information Systems built the online record search and reporting database, Edgar, used by the U.S. Securities and Exchange Commission to track and report and deliver copies of corporate financial data. In each of these areas, Cote sees the latent talent and resources that are not being used to their fullest, and he has the task of unlocking their value and delivering it to TRW's shareholders. Brett Hoselton, an analyst with McDonald Investments Inc., points out that TRW needs to fully develop a strategy to get the most value out of its technology operations. Hoselton points out the company has three options open to it to define and develop the technology it is sitting on. TRW can commercialize the technologies itself, it can license the technologies, or it can establish new equity arrangements. The new equity arrangements Hoselton spoke of include tracking stocks, spinoffs or split offs, or selling the technology assets. However, in Hoselton's view, TRW and its shareholders would be best served by in-house commercialization of the technologies. In this do-it-yourself view, Hoselton says TRW could benefit directly from significant increases in revenues and earnings, and could give investors solid growth for the long term. However, Hoselton also notes that TRW has to carefully choose the technologies it will develop and the markets it enters with them. Whatever course the company chooses, Cote will have to deal gingerly with the company's debt, a huge legacy problem that Gorman is leaving behind him. TRW racked up $6.9 billion in debt to build its automotive sector, and the company currently has a 71.5% debt-to-capital ratio. Cote says the company's massive debt would be a concern for the future, but not an insurmountable problem. However, Hoselton notes that the huge debt limits TRW's ability to fund growth, especially in the technology sectors that have the greatest potential for growth, while forcing the sale of assets that it "makes more sense to keep or handle differently." The debt also restricts TRW's ability to make further acquisitions and "virtually eliminates" the possibility that the company splits or spins off its technology operations. Hoselton says by generating $300 million in free cash flow a year, its current rate, TRW would reduce its debt-to-capital ratio to 50% in six years. Cote's challenge will be to squeeze the company hard to cut that time, and to push TRW beyond the analyst's expectations. Bruce Vernyi writes for BridgeNews.

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