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Shares of Reliance Steel & Aluminum (RS) have been off to a great start of 2013. Shares of the metal service center have already returned 16% so far this year on the back of the acquisition of Metals USA Holdings (MUSA).

The Deal

Reliance Steel announced that it has agreed to acquire Metals USA Holdings, a leading metals service center provider of a wide range of products in heavy carbon steel, flat-rolled steel, non-ferrous metals and building products markets.

The company operates 48 service centers for a total of 5.9 million square feet of industrial space. As a result of the deal, Reliance Steel will operate 268 centers.

Reliance has offered $20.65 per share in cash for each share of Metals USA for an equity value of $767 million. Including the assumption of debt, the total enterprise value comes in at $1.2 billion.

Metals USA generated annual revenues of $1.98 billion for 2012 on which it earned $52.7 million. The transaction values the company at 0.39 times annual revenues and 14-15 times annual earnings.

Reliance expects to realize some synergies by means of lower financing costs, better metals sourcing, the redundancy of public company costs and the sharing of best practices.

The deal is subject to shareholder approval of Metals USA and a 30-day "go-shop" period during which Metals USA can solicit alternative transaction approvals. Furthermore, normal closing conditions including regulatory approval apply.

Valuation

Reliance Steel ended its third quarter of 2012 with $120.6 million in cash and short term investments and $1.37 billion in total short and long term debt. As a result of the acquisition of Metals USA, the net debt position of $1.25 billion will roughly double. The company already indicated that financing will be done within its current $1.5 billion existing credit facility, the re-financing of existing debt and/or the issuance of new debt.

For the first nine months of 2012, Metals USA generated $6.6 billion in revenues on which the company earned $323 million. As such the company is on track to report annual revenues of around $8.5 billion on which the firm could earn $400 million. Reliance is expected to report its full year results on the 21th of February.

The market currently values Reliance at $5.4 billion, which values the firm at roughly 0.65 times annual revenues and 13-14 times annual earnings.

Reliance Steel currently pays a quarterly dividend of $0.25 per share, for an annual dividend yield of 1.4%.

Some Historical Perspective

Shares of Reliance have traded in a $45-$55 trading range for most of 2012. Shares hit the $60 mark at the end of the year and quickly advanced to $72 at the moment on the back of the deal. Shares are trading near all time highs, set in 2008.

Between 2008 and 2012, Reliance consolidated annual revenues around $8.5 billion with exception of 2009 and 2010 when the slump in the world economy depressed revenues and earnings. Despite the slump, the company has been consistently profitable although earnings fell from $482.8 million in 2008 to an expected $400 million over the past year.

Investment Thesis

Shareholders of Reliance Steel are very optimistic about the sizable deal which will boost annual revenues by almost a quarter. Reliance Steel will pay a lower revenue multiple for Metals USA at 0.39 times annual revenues compared to an own valuation of 0.65 times.

The deal with Metals USA values the company at 14-15 times earnings similar to its own valuation of 13-14 times earnings. As such, Reliance buys the company at similar earnings multiples, while it reaps all the synergies. Metals USA reports net margins of just 2.7%, compared to 4.7% at Reliance itself.

Given that Reliance Steel is financing the deal with low yielding debt, the leverage of the company will increase but remain within acceptable ranges. As such, shareholders should expect significant earnings accretion, although this has not been specified by the firm.

The deal is sound and the price seems fair. No surprise that shareholders applaud the sizable addition. The valuation seems fair despite the fact that shares trade at all time highs. Positive as well are the large degree of flexible costs. In 2009, when revenues dropped 40% compared to the year before, the company was still profitable.

I like the long term appeal of Reliance's shares, but I do not see short term triggers after the recent tick-up in the shares.

Source: Reliance Steel - Acquisition Of Metals USA Is Excellent