A123 Systems (AONE) filed for Chapter 11 protection on the 16th of October 2012. On the same day, it signed an agreement to sell all of its automotive assets to Johnson Controls (JCI) in a transaction valued at $125 million. According to the agreement, JCI was supposed to receive AONE's auto-assets including its automotive technology, two factories in Michigan and one in China. Also, had the agreement gone through, JCI would have become the owner of AONE's equity interest in its Joint Venture with SAIC. In conjunction with the transaction, JCI had to provide debtor-in-possession (DIP) financing of $72.5mn to AONE to support it through its Chapter 11 bankruptcy filing.
However, Wanxiang Group, one of China's biggest part manufacturers, announced to outbid JCI for A123's automotive-business assets. Wanxiang was interested in buying AONE's auto-assets, well before AONE went bankrupt. According to an article published in The Wall Street Journal, Wanxiang offered $450 million for AONE's auto-assets.
After Wanxiang's offer, AONE's management suspected that it would have to pay the break-up fee of $2.5 million to JCI, if the auto assets were not transferred to JCI. However, the court's decision came in favor of AONE and now AONE's assets will be sold through an auction on the 6th of the next month.
Given the level of interest that has developed in the battery-maker in the last month or so, the market expects the auction to last several days.
AONE's automotive business is exclusively focused on the prismatic lithium-ion batteries and has current production contracts with General Motors (GM), BMW, Daimler, Fisker and Smith Electric. Prior to its filing, A123 was on track to make an overall loss of around $170 million (50% of this came from the automotive section). The deal will position JCI to be the dominant surviving US-based, lithium-ion battery maker. Therefore, being a monopolist, JCI will be able to increase the prices to narrow those losses that AONE had made.
The acquisition is consistent with JCI's "three era" approach to the automobile batteries. The first era, which JCI already dominates, is about the traditional lead-acid batteries. JCI is seeking to grow the margins and the revenues through vertical integration and expansion in the emerging markets.
The second era is about the AGM batteries (still based on lead-acid chemistry). The Absorbed Glass Mat (AGM) battery type uses a start-stop technology in which the engine automatically turns off when the car is idling. JCI is also well-positioned in this segment. Barclays claims that it sees an inflection point for adoption over the next few years as part of the High Efficiency Powertrain.
The third era is about the lithium-ion batteries, which have witnessed a slower than expected adoption rate. Four years ago, JCI had higher hopes for the lithium-ion business. However, after the growth stalled, JCI put the business into a holding pattern (with part of the expenses funded by the Department of Energy), waiting for both the demand to inflect and the business to consolidate.
The purchase of A123's assets is consistent with JCI's holding pattern strategy. For JCI, the transaction is relatively small - only 1.9% of the assets of Power Solutions ($125 million out of $6.6 billion) and 1.4% of the revenue (A123's revenue was $84 million in 2011 versus Power Solutions' revenue of $5.9 billion). The transaction demonstrates that JCI intends to have a presence in the lithium-ion battery segment as it evolves. Further, the transaction also demonstrates JCI's patient approach to strategic growth of the business.
Valuations and Conclusion
The stock is trading at a forward multiple of 8x. JCI recently reported its fourth quarter earnings. The company topped the earnings estimates and met the revenue estimates. The company significantly improved profitability at its Building Efficiency, Power Solutions and North American Automotive Experience segments. However, a weak auto industry in Europe remains a headwind in the near future.
For JCI, as mentioned before, the overall transaction of acquiring AONE's acquisition is relatively small. However, this should not undermine its significance given the incremental profits and market share that JCI expects after this acquisition. For FY 2013, JCI forecasts earnings to remain flat or slightly higher on a Y-o-Y basis. However, I believe, the acquisition of AONE's segment will give a boost to its earnings. Therefore, after the acquisition, the market is expected to revise (favorably) the valuations at which JCI is currently trading. I recommend the stock as a buy.