Investors in Aecom Technology (NYSE:ACM) react cautiously optimistic to the news that the company will acquire its larger competitor URS (NYSE:URS). The deal will create the second largest US engineering and construction company behind Fluor (NYSE:FLR), as the combination anticipates to reap the benefits from significant synergies estimates.
I and investors in Aecom act a bit more reserved given the challenges to complete a successful integration and the build up in leverage.
The Deal Highlights
Aecom Technology announced that it has reached a definitive agreement to acquire URS. The announced deal values URS at $56.31 per share, or roughly $4 billion and will be financed in a combination with cash and debt.
Including the debt held by URS, which will be assumed by Aecom, the total price tag of the deal increases towards $6 billion.
Scale seems to be the major driver behind this deal, giving Aecom greater global reach and grater capabilities to deliver services to its clients. The strong expertise of URS in construction, oil & gas, power and government services adds to Aecom's integrated business model.
The new company will be a fully integrated infrastructure provider which employs 95,000 workers in 150 countries. On a pro-forma basis, the business posted sales of $19 billion and adjusted EBITDA of $1.3 billion.
CEO Michael Burke sees the expanded capabilities and scale as a very important reason for the deal in a global market, allowing the combination to service new clients and existing clients in a better way.
While the company will increase its operations in an absolute basis in APAC and the EMEA, the relative share of these operations will decline given the relative smaller activities of URS in those geographical areas.
As such the deal is very consistent with the strategy of Aecom to focus on higher growth energy markets and the increased demand from clients for integrated services.
Aecom pays $56.31 per share of URS, a 19% premium over the average closing price over the past 30 trading days. Investors in URS stand to receive $33 per share in cash and 0.734 shares in Aecom for every share they are currently holding.
Investors in URS can actually elect their preference for shares or cash, as long as the total mix of the deal takes place for 59% in cash. This makes that shareholders in URS will hold a combined 35% stake in the new business.
URS generated sales of $11.0 billion for 2013 on which it posted EBITDA of $847 million and reported net earnings of $247 million. The total deal tag of $6 billion values URS at 0.55 times sales, and 7.1 times EBITDA for 2013. Equity is valued around 16 times 2013s earnings. What should be noted is that URS has witnessed significant pressure on revenues and earnings lately, not reflected yet entirely in 2013 results.
The company anticipates that the deal will be accretive to cash earnings per share by 25% in 2015. This of course excludes one-time acquisition related costs. On top of this are anticipated cost synergies of $250 million per annum, anticipated to be fully realized by 2016. Including some of those synergies, Aecom expects that the EBITDA multiple paid will be slightly less than 7 times expected EBITDA for URS by 2015.
Valuation And Pro-Forma Business
To finance the deal, Aecom has received a financing commitment from Bank of America (NYSE:BAC). Following the deal, Aecom will operate with roughly a 150 million shares outstanding. At the same time, it will add $4.4 billion in debt through the assumption of $2 billion in debt from URS, and the financing of $2.4 billion to pay for the deal. This was after the company operates with a very modest net debt position itself, resulting in an expected $5.2 billion net debt position following the deal.
Aecom itself posted trailing revenues of $8.0 billion in 2013 on which it reported EBITDA of $489 million and net earnings of $244 million. The combination will post revenues of $19 billion, EBITDA of $1.3 billion and net earnings of close to $500 million. Note that Aecom will incur roughly $100 million in additional financing costs given the incremental $2.4 billion debt assumed to finance the deal.
However add to that incremental cost synergies of $250 million per annum and pro-forma after tax earnings could improve towards $600 million per annum.
Note that Aecom posted earnings per share of about $2.35 last year. The company guides for 25% accretion by 2015, which would push earnings towards $3 per share. With a 150 million shares outstanding following the deal, this results in earnings per share of around $3.
Adding in the after-tax benefits of full synergies and a deleveraging of the balance sheet and earnings per share of $4 by 2016 should be attainable.
The deal was necessary to some extent. Both Aecom and URS were struggling to report revenue growth in an industry in which scale offers the opportunity for both cost savings as well as improved sales offerings.
For investors in URS this deal is not a complete surprise as the share price jumped up already on Friday on rumors about a potential deal, and investment fund Jana Partners has pressured the company to create more value for investors.
Given the strong financial position, it is not surprising to see Aecom acquiring URS, despite generating roughly a quarter less in total sales. The deal will however add to the leverage position, with leverage expected to increase towards 4.4 times anticipated EBITDA, while the company targets a leverage ratio of 2.0 by 2017.
At the moment of writing, shares trade about a dollar higher suggesting an incremental value increase of some $150 million in Aecom's shares on the back of the deal. This looks rather modest to anticipated synergies of $250 million per annum and guidance for strong accretion in earnings per share.
I can understand why investors are reserved. The net debt position of the combination is sizable following the deal while there are of course large integration challenges as well in such a large deal. Just think about the huge workforce, integration of back office systems and the complications of huge construction projects.
I remain cautious. This has to do with the poor long term track record of both companies and the poor track record in creating shareholder value of the general construction industry at large. I see the rationale behind the deal, but note that there are risks related to integration and leverage as well.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.