Shares of Pentair (PNR) are rallying after the diversified industrial manufacturing company is merging with Tyco's Flow Control business making it the largest player in its sector. Shares hit an all time high of $48.77 in the morning before falling back to $46 near the close, still up 15% on the day.
The deal is rather complicated. Pentair is buying Tyco's (TYC) Flow Control in a deal which values the division at $4.6 billion. Under the deal current shareholders of Pentair will hold 47.5% of the shares of the combined company and shareholders of Tyco will hold the remainder. The actual deal is called a "reverse Morris trust" in which Tyco (which is headquartered in Switzerland) will actually buy Pentair, with its headquarters in the US, in order to avoid US tax liabilities.
On completion of the deal Pentair will increase the product line of valves and control systems of Tyco and boost its presence in Asia, according to Pentair's CEO Hogan. Furthermore the companies expect annual synergies of around $250 million.
Shareholders of Pentair and Tyco are both enthusiastic about the deal. Pentair increased 15% thereby increasing its market value by $600 million. Shares of Tyco increased 4.3%, marking an increase in market value by $1 billion.
Tyco, which once was one of the largest industrial companies in the US has faced harsh times after the company engaged in accounting fraud and its former CEO Kozlowski stole $150 million from the company.
Its current management has revived the company by focusing on debt reduction as the company had over $20 billion in debt.
Management has decided to split up the conglomerate in an attempt to create shareholder value. Tyco will be split up in three separate companies being: Tyco Flow (which now is going to merge with Pentair), Tyco Fire & Security and ADT Home security.
Shares have rallied over the last year, which is a reflection of the general positive sentiment and shareholders enthusiasm about the split of the company, thereby ending the "conglomerate" discount.
The industrial company has long focused on pool filters for residential use. During the housing downturn the company saw the drawbacks of this focused strategy and decided to diversify into pumps and filters for water systems and beverage production.
Pentair expects the acquisition to increase 2013's earnings per share by some 40 cents. For 2015 the company now targets earnings per share above $5. Furthermore, Pentair will pay out an annual dividend of $0.88 and it could have $400 million available for share repurchase programs.
Pentair's business generated $3.4 billion in revenue for 2011, while Tyco's Flow business generated $3.6 billion for a total of $7 billion for the combined entity.
Pentair should be able to achieve net profit margins of around 5% during normal economic circumstances resulting in roughly $170 million in net profits. Tyco Flow reported operating profits of over $413 million in 2011 which would lead to a net profit of around $250 million assuming normal leverage and tax rates.
As such the combined entity is expected to earn about $420 million per annum which excludes $250 million in pre-tax synergies to be achieved, bringing the total net income of the integrated combined entity close to $600 million per annum by 2013-2015, or $6 per share. This compares to today's conservative earnings guidance of earnings per share of at least $5 by 2015.
At these levels the company is valued at mere 7-8 times 2015's annual earnings despite today's 15% jump in the share price.
The merger makes strategic sense and shareholders have understood this as they bid up the combined entities' market value by some $1.6 billion today.
Despite the huge spike in Pentair, shares are relatively attractively valued for the intermediate future given the limited execution risk of the deal.
An intelligent investor would use his time to make his own assumptions about the deal and most likely arrive at the conclusion that it is best to pick up some shares for the long run.