Heavy civil contractor, Sterling Construction (STRL), is ripe for takeover based on its relatively low valuation in the stock market. The company is significantly undervalued relative to Granite Construction, which is the nearest comparable publicly traded company. In fact it would make sense for Granite Construction to acquire Sterling Construction in an all stock deal using its richly valued stock to buy Sterling’s undervalued stock.
The following table shows comparable valuation for the two companies based on consensus earnings estimates.
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Sterling Construction is a pure-play heavy civil construction company that specializes in the building and reconstruction of transportation and water infrastructure primarily in Texas, Utah, and Nevada; and to a lesser extent in Arizona and California. Transportation infrastructure projects include highways, toll roads, city streets, bridges, and light rail. Water infrastructure projects include large diameter water systems, sanitary sewers, and flood control systems.
About 90% of Granite Construction’s revenue is generated from heavy civil contracting with most of the balance coming from the production and sale of construction materials like aggregates, asphalt, and concrete. However, Granite Construction is much larger than Sterling Construction with estimated 2011 revenue of almost $2 billion compared with estimated revenue of a little over $500 million for Sterling Construction in 2011. Also, the geographic scope of where Granite Construction conducts its heavy civil contacting is broader than where Sterling Construction does business. In terms of overlap, Granite Construction performs heavy civil contracting in all of the places that Sterling Construction does business.
A fair value in a takeover of Sterling Construction might be $15.00 per share. Based on my modeling this stock price would imply an acquisition value of approximately $209 million, which would be $247 million for the stock along with the assumption of cash that exceeds debt by $38 million. This takeover valuation represents an acquisition value to EBITDA multiple of 6.3 and a P/E ratio of 22.1 based on estimated earnings for 2011. The EBITDA multiple and P/E ratio are 5.6 and 17.9 respectively based on estimated earnings for 2012.
I believe a $15.00 per share takeover price should be attractive to Sterling Construction shareholders. It is a 37% premium to the current stock price, and in an all stock deal, Sterling Construction shareholders could benefit going forward from their ownership stake in Granite Construction.
A takeover at this price should also be attractive to Granite Construction, since it represents a reasonable price to pay to increase the scale of its business and future profitability at what may be near a cyclical low point in heavy civil contracting. Also, Granite Construction should be able to realize significant synergies based on cost reductions where there is geographic overlap between the two companies and based on the elimination of Sterling Construction’s public and independent company costs.
I do not know whether or not management of Sterling Construction is amenable to a sale of their company. However, the company’s relatively low valuation in the stock market makes it a tempting target. With that said I do know that Granite Construction is interested in looking at acquisition opportunities in 2012. In Granite Construction’s most recent quarterly conference call in November, Jim Roberts, the company’s CEO, confirmed this fact without naming any specific possible targets.