Shares of IHS jumped up in Monday's trading session following the announcement that it will acquire R.L. Polk & Co.
Investors react favorably to the highly strategic acquisition which IHS made at a favorable price, even when one excludes the sizable synergy estimates. Despite the excellent deal, shares of IHS offer not enough appeal to my taste on the back of premium valuation multiples.
IHS announced that it has signed a definitive agreement under which it will acquire R.L. Polk, a leader in providing automotive information and analytics solutions.
IHS will pay $1.4 billion for the company of which 10 percent will be financed with new equity. The remainder will be financed with cash on hand, revolving facilities or new bank loans.
Combined, IHS is better positioned to provide its services to the automotive industry, establishing its position as a vital strategic partner for the worldwide automotive industry.
CEO Scott Key commented on the rationale behind the deal, "The acquisition of R.L. Polk brings extensive and complementary information and analytical solutions that would establish IHS as a vital strategic partner of the global automotive value chain."
R.L. Pork is generating annual revenues of around $400 million, while growing at a rate in the mid to high single digits. Attractive is highly recurring nature of its revenue streams and high renewal rates of around 90%. Adjusted EBITDA margins for the company are in their mid-twenties, creating solid free cash flows.
As such the deal values IHS at around 3.5 times annual revenues and roughly 14 times adjusted EBITDA.
The deal will be significantly accretive to 2014's earnings per share and the transaction is subject to customary closing conditions
IHS ended its first quarter of its fiscal 2013 with $318.7 million in cash and equivalents. The company operates with $1.05 billion in short and long term debt, for a net debt position of just above $700 million. Following the closure of the deal, the net debt position is expected to approach the $2 billion mark.
IHS has guided for full year revenues of $1.66-$1.73 billion, driven by a 5-7% increase in organic sales. Adjusted EBITDA are expected to come in between $540 and $582 million, with adjusted earnings per share expected to come in between $4.23 and $4.43 per share.
The market currently values IHS at around $7.1 billion. This values the company at around 4.2 times annual revenues and roughly 25 times adjusted earnings. GAAP earnings are expected to come in a bit lower.
IHS does currently not pay a dividend.
Some Historical Perspective
The growth strategy of IHS is largely dependent on strategic acquisitions, which has created a lot of value for shareholders in recent times. Shares rose from levels around $20 in 2006 to highs of $70 in 2008. After correcting to their low thirties during the crisis shares have steadily risen to highs of $120 in 2012. Shares are currently exchanging hands at $110 per share.
Between 2009 and 2012, IHS has grown its annual revenues by a cumulative 60% to $1.53 billion. Net earnings have risen some 25% in the meantime to $158 million over the past year.
The acquisition of R.L. Polk marks the latest in a string of over 50 acquisitions in recent years. The most interesting asset of Polk is its Carfax service, which compiles vehicle history reports and made up roughly 60% of Polk's annual revenues.
The deal multiples seem rather favorable. IHS is able to buy Polk's business at 3.5 times annual revenues which is roughly a 15% discount from its own valuation at 4.2 times annual revenues.
Note that adjusted earnings reported by IHS come in around 33% of total revenues, compared to a level in the mid-twenties for Polk. IHS is confident that it can boost margins to similar levels in the near future. Interesting as well is that IHS will only dilute its shareholder base by 2% by financing the majority of the deal with debt. Solid operating cash flows should bring its debt levels to more acceptable levels shortly.
While executed at a fair price, the deal is of a highly strategic nature. IHS hopes to replicate Carfax's business model in other countries and take advantage of the expanding used car markets around the world. Besides the revenue and strategic synergies the financial details are sound as well.
Within six quarters, IHS could generate free cash flows exceeding $500 million per annum, or little over three times the price tag of the deal. The fixed cost base of Carfax allows IHS to achieve significant operating leverage and achieve mid-thirties operating margins going forwards. A roughly 10% improvement in margins implies annual synergies of around $40 million, justifying the price tag to a great extent.
Despite the excellent deal, shares are still valued at premium valuation multiples. Following the deal, IHS is valued at little over 3.5 times annual revenues and roughly 35 times GAAP earnings. While the deal itself is excellent and will most likely create a lot of value, the stand-alone valuation of IHS was too high to begin with to initiate a long position.