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Shares of MSC Industrial Direct (MSM) rose more than 2.5% during Friday's trading session. The distributor of industrial tools and MRO supplies announced the acquisition of the distribution activities of Barnes Group (B) before the market open.

The Deal

MSC Industrial announced that it has greed to acquire the North American distribution activities of Barnes Group. The unit provides fasteners and other high margin consumable products and services combined with an industry-leading field sales force and vendor managed inventory solution.

MSC will pay $550 million for the activities which are headquartered in Cleveland. The business serves more than 31,000 customers with approximately 1,400 associates.

CEO Erik Gershwind commented on the deal, "I look forward to welcoming BDNA into the MSC family. BDNA is a high quality business with a first rate team, a compelling product offering,strong customer value proposition and a broad geographic footprint including Canada. This acquisition furthers our strategy to build adjacent product expertise and deepens our connection to customers with in-plant solutions, thereby improving customer retention."

The activities generated roughly $300 million in sales for the year of 2012, valuing the company at approximately 1.8 times annual revenues. The deal has certain other benefits to MSC Industrial. The deal structure results in future tax benefits with a net present value exceeding $100 million, as well as cost synergies of $15 to $20 million per annum by 2015.

The company will incur unspecified transaction and integration costs in 2014 and 2015. The company does expect to take a $0.02 charge related to non-recurring transaction costs in the current second quarter. MSC expects earnings per share accretion of $0.15-$0.20 for 2014, and $0.30-$0.40 for 2015.

MSC anticipates to close the deal in the third quarter of this year. The deal is subject to common closing conditions including regulatory approval.

Valuation

MSC Industrial ended the first quarter of its fiscal 2013 with $233.5 million in cash and equivalents. The company operates with merely $3.3 million in short and long term maturities of capital lease obligations for a net cash position of $230 million. The company expects to finance the deal with existing cash at hand, a new credit facility and a term loan structure.

For the full year of 2012, MSC generated revenues of $2.36 billion on which it net earned $259.0 million. The company just released its first quarter results which shows modest revenue and earnings growth.

The market currently values MSC Industrial around $5.4 billion. This values operating assets around $5.2 billion. As such, the operating assets are valued at approximately 2.2 times annual revenues and 20 times annual earnings.

MSC Industrial currently pays a quarterly dividend of $0.30 per share,for an annual dividend yield of 1.4%.

Some Historical Perspective

Shares of MSC Industrial are trading roughly unchanged over the past year. Shares traded around the $85 mark during spring of 2012, before falling to the low sixties in summer. Shares did recover from those levels in the remainder of 2012, currently exchanging hands at $85 per share.

Long term holders have seen much better returns. Shares traded as low as $15 in 2003 and have gradually gained ground, trading around all time highs at the moment. Shares have risen as the company has successfully grown its business. In 2009, MSC generated annual revenues of $1.5 billion. This has grown to almost $2.4 billion in 2012. Earnings more than doubled over the same time period from $125 million to $259 million.

Investment Thesis

It seems that MSC has made an excellent deal, and shareholders react positively. The distribution activities will grow annual revenues by approximately 12%, from $2.4 billion to $2.7 billion.

The price tag seems very reasonable. MSC will pay roughly $550 million, or 1.8 times annual revenues for the acquired distribution activities. This compares to a valuation multiple of 2.2 times for MSC itself.

Excluded in this calculation are the net present value of tax benefits, estimated around $100 million, and $15 to $20 million in annual cost savings. Consequently, MSC expects an earnings accretion of $0.30-$0.40 per share, or $20 to $25 million per annum.

CEO Erik Gershwind commented on the importance of the deal in achieving MSC's ambitions: "We are very excited to have the BDNA associates join the MSC team, nearly doubling our existing sales force and helping us to take this logical next step in our revenue roadmap. This transaction, along with our expected long-term organic growth, will help us to achieve our goal of $4 billion in revenues by 2016."

Overall the deal is a net positive for shareholders in MSC Industrial. The deal multiples are very fair, while the leverage position remains very low. The company remains on its strategic track to generate annual revenues of $4 billion by 2016, on which the firm should be able to report annual profits of roughly $500 million.

The long term prospects for MSC remain good, no wonder shares are trading at all-time highs. Current valuation multiples, at 20 times 2012's annual earnings are a bit steep, but expected to drop to around 10 times annual earnings by 2016. As such, MSC has rightfully gained the respect of the investment community, and consequently higher valuation multiples.

Don't expect speculator returns in the short term, but the medium to long term prospects remain good. I would be a buyer on dips when the general market shows a correction. Note that dips for such high-quality names are often small and short lived.

Source: MSC Industrial - Shareholders Applaud The Addition Of Distribution Activities Of Barnes Group