Investors in Lear (NYSE:LEA) like the announcement of the company's much-rumored acquisition of Eagle Ottowa sending shares to levels approaching the $100 mark.
While the deal in itself is quite nice, it is rather small compared to Lear's existing operations. As such, the deal is not being large enough to move the needle in a significant way. As such I remain very cautious amidst the multi-year momentum and cyclicality of the business despite an appealing headline valuation.
Lear announced after rumors have been going around in the past few weeks that it has acquired Eagle Ottowa in a $850 million deal.
Eagle Ottowa is an automotive leather supplier, being around for over 150 years as it was held in private hands over the past 50 years. Lear stresses the superior quality, strong management team, innovation and low costs of the acquired business.
If all goes per plan, the deal could close as soon as the first quarter of 2015.
With the deal, Lear will expand its position in the market for luxury and performance automotive seating. Eagle Ottowa currently employs some 6,500 workers across 19 facilities which are located in 12 different countries.
CEO Matt Simoncini likes the deal and in particular Eagle Ottowa's leather design and development capabilities. Furthermore the combined company will have greater technical expertise while increasing the level of craftsmanship.
The company supplies to tier-one original equipment manufacturers including the likes of BMW, Daimler, Fiat, Ford (NYSE:F), GM, Honda (NYSE:HMC), and Toyota (NYSE:TM) among many others. Some 50% of its sales are generated in North America, nearly 30% in Asia and the remainder 20% in Europe.
Besides combining operations and the sharing of best practices, Lear anticipates to generate sales synergies on top of cost synergies as well, boosting the appeal of the deal.
The $850 million reported deal tag will be paid all in cash, while Lear might finance the deal through a combination of both cash and debt.
The deal values the company at 0.9 times sales which are anticipated to increase to $925 million this year. It should be noted that Eagle Ottowa has grown rapidly in recent years, posting sales just below the half a billion mark as recent as 2011.
The deal values the company at 6 times anticipated EBITDA forecasted for next year, which implies that EBITDA is seen at around $140 million in 2015. On top of that, Lear anticipates to generate $20 million in operating synergies per annum within two years following closure of the deal. Potential accretion is seen thereafter resulting from potential sales synergies.
All in all, the direct accretion without factoring in any synergies at all is anticipated to add about 5% in annual earnings per share.
Back in April, Lear posted its first quarter results reporting an overall sales growth of 10%. The company ended the quarter with $919 million in cash and equivalents while having some $1.09 billion in net debt outstanding. This results in a net debt position of just about a $100 million, a leverage position expected to increase towards a billion following the announced deal.
At the time the company forecasted sales of $17.2-$17.7 billion and core operating earnings of $935 to $985 million. Adjusted earnings of $152 million as reported for the first quarter compared to $243 million in reported core operating earnings. Based on this ratio, adjusted earnings are seen around $600 million this year.
With 83 million shares outstanding which are currently trading at $98 per share, equity in the business is valued at around $8.1 billion. This values operating assets at about 0.5 times sales and roughly 13-14 times annual earnings.
A Problematic Track Record
Lear has a long term problematic track record. Sales peaked at $18 billion in 2006 but have fallen to levels as low as $10 billion in 2009 amidst the automotive crisis, forcing the company to file for bankruptcy. This was as the net debt position was just about $2 billion at that time, yet operating losses made the company and its leverage profile just not viable at that time.
Ever since emerging from bankruptcy shares have recovered, recovering from about $35 in 2012 to $100 per share at the moment. This is as sales improved significantly again, approaching their pre-crisis highs. The business has furthermore significantly improved its operating profitability in the meantime.
While the leverage position of a billion following the deal is not very high, and is far below the $2 billion which put the company into bankruptcy during the crisis, increasing leverage is something to keep notice of.
The 5% accretion on earnings of about $7 per share could add some $0.35 per share in earnings, or close to $30 million in real dollar terms after taking into account the financing costs.
In that light and given the anticipated EV/EBITDA multiple discount, the anticipated accretion and improved growth profile, the business looks quite appealing at first sight. That being said, the acquisition adds just about 5% in firmwide revenues, by far not enough to move the needle in a significant way. This is despite the higher margins being reported by Eagle Ottowa.
While the 13-14 times earnings multiple looks attractive with the wider market trading closer to 17-18 times earnings, the discount is probably warranted given the cyclicality of the US automotive industry and the current good times within the industry. This, the troubled past and the great momentum in recent years, makes me a bit cautious despite liking the overall deal.
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