Investors in Sensata Technologies (NYSE:ST) were very much pleased with the company's acquisition of the Schrader Group.
While the deal looks nice on a standalone basis, the growth prospects and synergies to be realized only add to the appeal. Yet the high valuation of Sensata overall limits the risk-reward opportunity in my eyes at the moment.
Highlights Of The Deal
Sensata announced that it has reached an agreement to acquire the Schrader Group from Madison Dearborn Partners.
The company will pay a total enterprise value of $1.0 billion for the producer of tire pressure monitoring sensors, also known as TPMS.
The deal, which is suspect to usual closing conditions is expected to close in the fourth quarter of this year.
Strategic Rationale Behind The Deal
Schrader producers low TMPS as well as low-pressure sensing capabilities. The already large market is expected to have even better days in the future driven by more strict regulation across the globe.
Schrader, which is a US headquartered business, is pretty much a global business, employing some 2,500 workers across the globe including some 300 engineers.
The company has pioneered the TMPS, which is pretty much a standard safety feature in North America, being used by all the large OEMs. Tougher environmental rules regarding fuel economy and safety regulations are driving the expected growth of the business.
The 17 million North American vehicles being sold per annum need to have TMPS since 2008. European rules will go into effect later this year, adding another potential market of 20 million vehicles. The real potential for growth comes from China as the government is making progress to create a mandate enforcing 23 million cars per annum to be equipped with TMPS.
CEO Martha Sullivan likes the business, giving the company a dominant position in the global $2 billion low-pressure sensor market, which is showing rapid growth. The expertise in sensing, wireless communications and design is complementary to Sensata's own operations, creating real synergies through the organization's expertise and skill.
The $1 billion price tag looks okay given the reported profitability of the firm and anticipated growth.
The deal values Schrader at 1.8 times anticipated revenues of about $550 million expected to be realized this year. The deal furthermore values the company at 10 times anticipated EBITDA of $100 million foreseen for 2015. No earnings details regarding the current profitability of the business have been announced.
The deal should be accretive by $0.13-$0.16 per share to 2014's adjusted earnings. Accretion is anticipated to increase toward $0.18-$0.21 per share for next year.
Yet the real benefits will be seen after the integration of the company and the pay down of debt, adding another $0.50-$0.55 per share in anticipated earnings per share accretion. On top of that, the ramp-up of TPMS in China could add another $0.18-$0.22 per share in earnings. All in all, the total benefits of the deal could be very sizable in the future.
Even after not taking into account the potential for all these various sources of synergies, the valuation in terms of EBITDA and sales ratios look very appealing to Sensata's own valuation as seen in the valuation section of the article.
Strategy For Long-Term Growth
The deal fits within Sensata's aim to double revenues from $1.9 billion in 2012 to nearly $4 billion by 2017. The company aims to achieve this by making deals including the purchase of Wabash Technologies, DeltaTech Controls and now Schrader. Deals are being supplemented with a 7-10% targeted annual organic growth.
This deal is sizable, adding significantly to the revenue targets as the other two deals added about $200 million in revenues combined. Yet the deal tag and decision to finance the purchase with debt does result in an increase in leverage, thereby limiting the potential for large deals in the short run without diluting the shareholder base.
The current 2.7 times net debt/EBITDA ratio is expected to rise toward a multiple of 4 times following the closure of the deal. This could all move toward a 2-3 times ratio within a period of 18 months following closure of the deal.
At the end of July, Sensata released its second quarter results. The company ended the quarter with some $185 million in cash and equivalents while the total debt position totaled $1.7 billion, resulting in a $1.5 billion net debt position. Following the deal, this will increase toward $2.5 billion.
On a trailing basis, the company has posted sales of $2.1 billion on which it posted EBITDA of about $600 million and net earnings of $260 million.
With 173 million shares outstanding and shares trading at $49 per share, equity is valued at $8.5 billion. This values equity of the business at 4 times sales, roughly 14 times EBITDA and 32-33 times earnings. Including the impact of the acquisitions, sales could be much closer to $2.8 billion while I could envision EBITDA of $750 million and earnings of $300 million in the near future.
This would result in equity being valued at 3 times sales, 11-12 times EBITDA and an earnings multiple just below 30 times.
A Look At The Recent History
The company has a long history, starting operations early in the 20th century. Since 1959, the business was part of Texas Instruments (NYSE:TXI), which sold the business in 2006 to Bain Capital, which sold the company to the general public in an IPO in 2010.
Today, the company operates in long-term growth markets focusing on safety, a clean environment and energy efficiency solutions in a wide range of applications and industries. Investors buying into the IPO or just thereafter have seen solid returns. Shares traded in the $15-$20 region in 2010, but have steadily risen to fresh all time highs of $49 following the news of the latest deal.
Sensata has two big tailwinds allowing it to report rapid growth. This is solid organic growth as well as deal-making. These deals combined with organic growth should allow the company to post sales of $4 billion by 2017.
Given the focus on high margin businesses a billion in annual EBITDA might be very likely in such a scenario, easily supporting earnings of about $500 million. That being said, the company already has an $8.5 billion equity valuation while assuming $2.5 billion in debt.
These steep valuations combined with the lack of dividends make me a bit cautious at this point in time, although I like the underlying business very much. For the year, the company anticipated to post earnings of about $2.42 per share. Adding anticipated accretion of about $0.15 per share resulting from the deal, this can push this earnings guidance to $2.53 per share.
Unfortunately, this is the adjusted forecast, a non-GAAP accounting measure, with GAAP earnings historically coming in at roughly 65% of non-GAAP earnings. This values the company still at a 30 times GAAP earnings multiple for 2014, which is simply quite rich.
I'm willing to pay a 20-22 times multiple for the company based on next year's earnings, and at the most can squeeze out a potential entry point of $40 per share. This is after pushing the valuation by applying a higher multiple on a generous earnings forecast for next year.
As such, a substantial correction would have to occur before shares are appealing in my eyes. That being said, I applaud both management and shareholders with a greatly accretive deal, which already created nearly $500 million in shareholder value on Monday.
For me, the current valuation offers no appealing risk-reward opportunity at the moment.
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.