Ingersoll-Rand acquires the centrifugal compression business from competitor Cameron.
Investors like the deal given the sizable synergy estimates, resulting in solid anticipated accretion to earnings.
The premium valuation, leveraged position and cyclical results creates no appeal in my eyes.
Investors in Ingersoll-Rand (NYSE:IR) were pleased with the company's intention to acquire the centrifugal compression business from Cameron International (NYSE:CAM), in a deal which adds just 3-4% in annual revenues.
Investors send shares to fresh highs given the deal and the expected earnings accretion resulting from the acquisition. Despite the enthusiasm relating to the deal I don't like shares that much amidst a premium valuation, a substantial degree of leverage and cyclical past results.
Acquiring Cameron's Centrifugal Compression Business
Ingersoll-Rand announced that his has entered into an agreement to buy the Centrifugal Compression assets from Cameron in a $850 million deal.
The deal is expected to close by the end of this year, being subject to normal closing conditions including regulatory approval.
A Look At The Business
The centrifugal business provides equipment as well as aftermarket parts and services for industrial applications, air separations and gas transmission, among others. In essence, the business operates in a niche, generating high margins in the process.
The acquired company employs about 850 workers across 12 global locations including a manufacturing facility in the U.S. as well as in China. Among its most prominent brand offerings is "Turbo-Air" as well as "MSG".
CEO Michael Lamach likes the business given the complementary products, manufacturing and engineering strengths. The business which is based in Houston furthermore has great diversification across the globe, generating roughly a third of its revenues in the Americas, the EMEA region and Asia-Pacific & Middle East.
The unit will become a part of Ingersoll's Compressed Air Systems and Service business unit, with the products being used in industrial and manufacturing applications.
The $850 million price tag values the acquired activities at 2.1 times annual revenues. The reported deal value implies a valuation at roughly 10.5 times EBITDA, implying that EBITDA is seen around $81 million on a stand-alone basis.
The deal multiple is anticipated to come down to 6.5 times EBITDA after incorporating the anticipated synergies resulting from the deal. This implies that pre-tax synergies could come in as high as $50 million per annum, quite a bit in relationship to the reported deal tag and the revenue base of the business.
As such the deal could add as much as $0.08 to $0.10 in earnings per share by 2015, with accretion thereafter anticipated to increase to $0.15-$0.20 per share.
At the end of the second quarter, Ingersoll-Rand held about $930 million in cash and equivalents while its total debt position of $3.6 billion results in a net debt position of about $2.7 billion. This will increase towards $3.5 billion following the deal.
On a trailing basis, Ingersoll has posted sales of about $11.6 billion with the reported deal tag adding a relatively modest amount to reported revenues. With 274 million diluted shares outstanding, and the company guiding for earnings of $3.13-$3.21 per share, the company anticipated earnings of about $870 million. Note that this does not include the contribution of the latest acquisition.
With shares trading around $62 per share, equity in the business is being valued at $17 billion. This values operations at about 1.4 times annual sales and 19-20 times annual earnings.
A History Of Modest Growth And Cyclicality
The industrial business has seen its ups and downs in recent years, yet the company and its predecessors have been in business for a very long time. Back in 2009 the company moved its headquarters to Ireland before tax inversions came into fashion in order to cut the corporate tax bill of U.S. companies.
While lower taxes are helpful to shareholders, they prefer to see steady operational achievements. Over the past decade, the company has only increased its sales by about a quarter, after sales peaked at nearly $15 billion in 2011. It should be noted that the spin-off of Allegion PLC (NYSE:ALLE) as executed last year resulted in "lost" revenues of about $2 billion per year. The company has been profitable with exception of the crisis in 2008, posting net earnings between $300 million per annum and a billion ever since.
In the light of the slow pace of reported revenue growth, investors should consider that the company has reduced its outstanding share base by some 20-25% over this time period, adding to reported growth on a per share basis.
In a presentation at Sanford Bernstein's Strategic Decision Conference, the company reiterated its plans to accelerate revenue growth, demonstrate operational excellence while balancing capital allocation.
The company aims to benefit from challenges including climate change, food and water scarcity, urbanization and energy consumption through a focus on innovation. While its markets in terms of function remain highly diversified, the company still relies on North America for abut two-thirds of its revenues which is actually a benefit at this moment given the solid pace of economic growth.
Takeaway For (Potential) Investors
Investors in Ingersoll have seen volatile but overall quite nice returns over the past decade. Shares fell from levels around $50 in the years before the financial crisis until they fell to levels of just $10-$15 during the crisis.
Ever since shares have risen to current levels in the low sixties. While this has not provided great returns to investors who have invested before the crisis, it is important to realize that this performance has been understated. Last year investors in Ingersoll received 0.333 shares of Allegion PLC after which it was spun-off last year, now representing a value of $17-$18 per share.
On top of that investors have seen modest dividends, currently yielding 1.6% per annum, with the company increasing the pace of share repurchases in recent times. It should be noted that debt is increasing and is quite high at the moment. While I am not necessarily very worried about the leverage position, it does limit the capacity of the balance sheet to do future deals without creating dilution of the shareholder base.
I don't fancy paying a 20 times earnings multiple, a modest premium compared to the general market multiple. The increase in leverage and the lack of impressive historical growth don't warrant a premium valuation in my eyes.