U.S. Securities and Exchange Commission
Washington, DC 20549
Notice of Exempt Solicitation
1. Name of the Registrant:
Lear Corporation
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2. Name of person relying on exemption:
Pzena Investment Management, LLC
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3. Address of person relying on exemption:
120 West 45th Street, 20th Floor, New York, NY 10036
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4. Written materials. Attach written material required to be submitted pursuant
to Rule 14a-6(g)(1).
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Pzena Investment Management, LLC
120 West 45th Street, 20th Floor, New York, NY 10036
March 21, 2007
Institutional Shareholder Services
2099 Gaither Road
Rockville, MD 20850
Glass, Lewis & Company
One Sansome Street, Suite 3300
San Francisco, CA 94104
PROXY Governance Inc.
8000 Towers Crescent Drive, Suite 1500
Vienna, VA 22182
Greetings,
We are writing concerning the takeover offer by Carl Icahn's American Equity
Partners LP of Lear Corporation. We are major, long-time shareholders of Lear
and believe the $36 offering price is far below the fair value of the company.
We believe Lear is currently earning far less than it could in a normal business
environment and based on those earnings, we think the company is worth between
$55 and $60 a share. We plan to vote against the deal and have urged other
shareholders to do the same.
We believe the company's management and the potential buyer intend to capture
those potential gains for themselves, rather than allowing outside shareholders
to participate in the recovery. We see this as a disturbing trend, and
appreciate your willingness to protect the rights of public shareholders.
Knowing the pivotal role your organization can play in these situations, we want
to present you with our analysis of Lear's future earnings potential. We also
want to raise issues of conflict of interest between Lear's management and Mr.
Icahn. Finally, we'd like the opportunity to meet you in person to go through
our analysis.
Feel free to call with any questions.
Sincerely,
/s/ Richard S. Pzena and John Goetz
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Richard S. Pzena and John Goetz
Co-Chief Investment Officers
Pzena Investment Management
212-583-1295
LEAR ANALYSIS FROM PZENA INVESTMENT MANAGEMENT
BACKGROUND
Lear is a major auto parts company with about 80% of net sales coming from auto
seating and the remainder from electronics. The company divested its auto
interiors business (interior parts other than seats) last year to an entity
controlled by Wilbur Ross. The company supplies nearly all major auto makers but
is heavily dependent on the Big Three.
The company's long-term profitability comes from the seating business. Unlike
other businesses in the auto supply chain, seating has historically been a
profitable industry. Two major players--Lear and Johnson Controls--have 80%
market share, which is split evenly. The business does not require heavy capital
spending and seats, because of their bulkiness, cannot be shipped very far,
which further limits competition. Lear had $12 billion in revenue in this
business last year, and historically has seen mid single digit growth.
Lear is also a major player in the electronics business, with $3 billion in
revenue and margins in the upper single digits. The interiors business, which
Lear disposed of last year, had been losing money in recent years.
LEAR'S PROFITABILITY
Lear's earnings are well below their historical normal level. Earnings have
declined significantly due to several negative factors which have combined to
dampen results temporarily. These factors are:
1. dramatically lower demand for some highly profitable SUV models 2. rapidly
rising raw material prices 3. broad industry pricing pressure
In the seating business, operating margins excluding restructuring costs have
already rebounded to 5.6% in 2006 from 3.2% in 2005. We agree with management
(as presented at the Gabelli Automotive Aftermarket Symposium) that normal
margins are between 6% and 7%. Margins are likely to return to historical levels
as the product mix improves and raw material price increases are either passed
on and/or the price of raw materials begins to decline. Lear itself, as recently
as late last year, predicted a return to normal margins in 2008. In the
electronics business, operating margins remain depressed at 4.9% and we see
normal margins at 7%.
Several factors will enable Lear to return to normal margins. First are raw
material prices. Lear would obviously benefit if raw material prices fell. But
even if they don't, it will also be able to pass through a portion of those
price increases to customers. Its two main competitors expect to do that too.
Lear will also benefit from the end of a series of restructurings that cost $300
million over the past two years.
The company will get a boost from an estimated $1.2 billion in tax loss
carry-forwards, which we believe have a net present value in excess of $4 a
share. And, Lear's interest in the joint venture to which it sold its interiors
business has more than $4 per share in value.
By our analysis, Lear should grow revenue roughly 2% per year for the remainder
of the decade. Lear has had several different revenue growth estimates in the
past few months. Last July, Lear management told the company's board that there
would be almost no revenue growth for the next three years. Three months later,
Lear told investors at the Gabelli conference that it was targeting 5% annual
sales growth. Then, after the company began negotiating with Mr. Icahn,
management told the board it expected revenue to fall an average of 3% a year
over the next three years. While internal projections may have changed, a lower
growth rate would better justify the low deal price.
Nevertheless, our analysis points to roughly $16 billion in revenue over the
same time period. With that modest growth rate, Lear's earnings should
accelerate rapidly over the next few years. The company can earn more than $4 a
share in 2009, compared with a loss of $1.50 in 2006 and a profit of $2.04 a
share in 2007, as expected by the consensus of Wall Street analysts.
Lear itself appears to share our optimistic view of the future. In a
presentation to analysts in January, the company said its main priority was to
return the business to historic levels of operating margins and free cash flow.
The company said it expects to get $125 million in annual savings from its
recent restructuring. It also predicted that seating margins would improve to
the mid 5% level, electrictronics margins would rise to between 5.5% and 6% and
it would have solidly positive free cash flow. The company is guiding to between
$560 million and $600 million in core operating earnings for 2007.
THE DEAL
As demonstrated above, one does not need heroic assumptions to believe Lear's
earnings can reach $4 a share. At roughly the market multiple of 15 times
earnings, Lear would be worth $60. That's far above the $36 offer price, meaning
the acquirer would nearly double his money in just a couple of years. Some
historical perspective bolsters the argument that $60 a share is not an
unreasonable price for Lear's stock. It traded at $33, just below the current
offer price, as recently as November. And the shares were at $60 at the start of
2005. Mr. Icahn's offer was just a 3.8% above the previous day's closing price
for Lear.
There are other corporate governance issues involving the deal that are clearly
not in the interest of outside shareholders. One is the conflict of interest
between Lear's current management and the acquirer. Mr. Icahn has offered
management pay packages worth tens of millions of dollars and, not surprisingly,
management supports Mr. Icahn's bid. The top executives get: guaranteed
contracts and bonuses; their current stock and options holdings immediately vest
and are paid out, a portion of their retirement benefits are paid early and they
get options to buy a total of 1.6% of the company at a price equal to the deal
price. If Lear's valuation rises to the equivalent of $60 before the options
expire, this piece of their compensation alone would be worth more than $29
million for the three of them. Finally, the company would set aside up to 6% of
its shares as grants to employees, the total value of which would top $275
million at the equivalent of a $60 share price.
What is amazing to us is that Mr. Icahn has a long history of criticizing
corporate managers, arguing that the executives who run most American companies
are greedy and inept. At Lear, where the share price has been effectively flat
for a decade and where management spent more than more than $3 billion to build
an auto interiors business that it sold for a fraction of that amount, the
current executive team is excellent in his view. Indeed, the day Mr. Icahn's
offer was accepted by Lear's board, new employment contracts for Lear's top
three executives were filed with the SEC.
Clearly these contracts create a conflict of interest for management. We are
concerned that management is acting in their own interests instead of the
interests of shareholders. The proxy clearly states that the board approved the
deal in part because management was in favor of it.
What is more disturbing to us is that the board, faced with a clearly conflicted
management, refused our offer to present our analysis of the company's valuation
to them before they approved the deal. (We have included a copy of that letter.)
Indeed, the board appeared to be in a rush--the offer was made on a Monday and
approved that Friday. The day before the board vote, Lear shares closed 11%
above the offer price.
There is also evidence that the company considered the possibility of an offer
from Mr. Icahn last fall. In its proxy, the company says discussions with Mr.
Icahn didn't begin until January. Consider the chronology. Last October, Mr.
Icahn bought 8.7 million shares of Lear at a negotiated below-market price of
$23 a share. Mr. Icahn was already a shareholder in Lear, and at the time of the
transaction, we shared with him our analysis of Lear's future profitability.
Then last November when Lear sold bonds to term out its debt, it said it had "no
present intention to engage in a transaction involving change of control,
although it is possible that we would decide to do so in the future." But at the
same time, Mr. Icahn was included as a "permitted holder" within the change of
control language for some of those bonds. Under the change of control provisions
in those bonds, anyone not named as a "permitted holder" would have to buy back
the bonds at a premium if they were to buy the company. This makes an
acquisition even more expensive for anyone but Mr. Icahn. It was only two months
after the bonds were sold and the company said it had no present intention to
sell itself that Mr. Icahn began negotiating with management about buying the
company. The only thing that changed in the interim is that Lear disposed of its
money-losing interiors business.
The terms of the transaction make it difficult for another bidder to emerge.
While Lear did agree to a go-shop period, it is only 45 days long. In addition,
the company agreed to a breakup fee that could top $90 million, which is high
relative to other recent deals. That along with Mr. Icahn's privileged status in
relation to Lear's bonds and the low-cost stake he already has in the company
make it hard for someone to top his offer. The board has created a situation
where Mr. Icahn wins no matter what. Either he gets the company at a low price,
another buyer comes and he gets their higher price plus the breakup fee, or the
company remains independent and his stake in Lear appreciates as earnings return
to normal.
SUMMARY
We believe Mr. Icahn's offer for Lear follows a disturbing pattern of companies
siding with private equity buyers against public shareholders. This situation is
particularly egregious because of the windfall that management would receive in
such a deal and because of the clear potential for improvement in the company's
operations.
We agree with Mr. Icahn in one key area: Lear at its current price is
undervalued. In a recent prospectus for a debt offering for American Real Estate
Partners, the Icahn affiliate that is actually seeking to acquire Lear, Mr.
Icahn states: "We intend to continue to make investments in real estate and in
companies or their securities which are undervalued." Our response is why should
shareholders, or the company's board, agree to sell to a buyer who is
effectively saying he is getting the company on the cheap.
We are not alone in our view of the deal, there are currently seven outstanding
lawsuits seeking to block it. Other outside shareholders have sold or reduced
their stakes, because they don't want to be involved in a merger situation or
because they feel the offer, even if it is rejected, will make it harder for
them to realize their fair value of their investment.
For further information, please contact Richard Pzena at 212-583-1295 or
Lawrence Kohn at 212-583-0594.