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Shares of Allegheny Technologies (ATI) spiked upwards on Monday after the specialty metals producer announced the divestiture of its tungsten materials business.

As Allegheny fetches a great price for the unit, the deal reduces leverage of the firm by quite a degree, while resulting in only very modest revenue and earnings dilution. The deal has bolstered the financial position of the firm and has bought Allegheny time to improve the core operations of the firm.

The Deal

Allegheny Technologies announced that it has reached an agreement to sell its tungsten materials business to Kennametal (KMT) in a $605 million deal.

ATI's Tungsten Materials business employs 1,175 employees and produces tungsten powder, tungsten heavy alloys, carbite materials and cutting tools.

Allegheny will focus on the core strategic business, which is the technical, commercial and operational synergies between the High Performance Metals and Flat-Rolled Products. The company reckons that the business is better off being owned by Kennametal which can result in a stronger business.

For the fiscal year of 2012, the business generated revenues of $338.6 million, operating earnings of $37.2 million, and EBITDA of $45.3 million. This values operations at 1.8 times annual revenues, 16 times operating earnings and 13.3 times EBITDA.

The deal is subject to normal closing conditions including regulatory approval, and is expected to close in the fourth quarter of 2013.

Valuation

Allegheny ended its second quarter with $74.1 million in cash and equivalents. The company operates with $1.47 billion in total debt, for a net debt position of $1.4 billion.

Revenues for the first six months of 2013 came in at $2.31 billion, down 14.6% on the year before. Net earnings fell by 87% to $14.4 million.

Factoring in gains of 10%, with shares exchanging hands at $31 per share, the market values Allegheny at $3.4 billion. This values the equity in the firm at 0.7 times annual revenues and 21-22 times last year's earnings.

Allegheny currently pays a quarterly dividend of $0.18 per share, for an annual dividend yield of 2.3%.

Some Historical Perspective

Long-term holders in Allegheny have seen much volatility. Shares rose from merely $6 in 2003 to highs of $120 in 2007. A leveraged balance sheet combined with lackluster demand for titanium alloys and related products have sent shares tumbling.

Shares have fallen to lows of $20 in 2009 to recover to $70 in 2011. Shares fell again to lows of $25 in the summer, currently exchanging hands around $31 per share.

Between the calendar year of 2009 and 2012, Allegheny has increased its annual revenues by a cumulative 65% to $5.03 billion. Net income rose to $158.4 million last year, after peaking in 2011.

Investment Thesis

Investors in Allegheny reacted with great enthusiasm towards the deal.

Essentially, Allegheny is selling an underperforming asset which generates roughly 7% of annual revenues for some $605 million, which represents 12% of the total enterprise value of Allegheny. With the proceeds of the sale, the firm can almost cut its net debt position in half.

Allegheny receives a cool 1.8 times annual revenues for the business compared to its own enterprise valuation at roughly 1.0 times annual revenues. The modest profit contribution of the activities are offset as Allegheny can use the proceeds to pay off some of its debt on which it currently pays some 4% annual interest rates.

Investors are applauding the move which reduces leverage of the firm and the overhang of the $1.5 billion debt position amidst poor earnings in the core of the company. Some investors were fearful of further dilution of the shareholder base.

All in all, a solid deal for Allegheny and its shareholders. The company receives a price tag which is equivalent to 12% of its enterprise value and roughly 17% of its equity value, for a business which generates 7% of firmwide revenues. The price tag is even better given the disappointing profitability of the unit. As proceeds will be used to reduce "expensive" debt, the earnings dilution will be extremely limited. Yet the deal reduces the uncertainty caused by the debt overhang and poor earnings in the "core."

While the deal creates some short term sunshine, further stock gains have to be fueled by improved operating performance. At least the deal has brought Allegheny some time in still uncertain times.

Source: Allegheny Technologies: Solid Sale Price Of Tungsten Reduces Leverage, Buys Time