Eaton Corporation (ETN) the diversified power management company entered into a definitive agreement to acquire Cooper Industries Plc (CBE). The transaction will increase the capacity and geographical breath of the combined entity focused on power and electrical markets.
The Deal
Eaton Corporation and Cooper Industries Plc have entered into a definitive agreement under which Eaton will acquire Cooper. The new entity will be incorporated in Ireland in order to achieve significant tax savings. Eaton's current CEO Cutler will become the new chief executive officer of the combined company.
Shareholders in Cooper will receive $39.15 in cash and 0.77479 shares in Eaton for each Cooper share they currently own. Based on the closing prices of the 18th of May, shareholders in Cooper will receive $72 per share, a premium of 29% compared to the day before. The $72 offer values Cooper Industries at around $11.8 billion. Under the proposed transaction Eaton's shareholders will own approximately 73% of the combined entity with Cooper's the remainder. The acquisition, to be funded with a combination of debt and equity, is expected to close in the second half of 2012.
Combined entity
On a pro-forma basis the combined entity generated revenues of roughly $21.4 billion in 2011. Eaton, the much larger company reported $16 billion in revenue vs. $5.4 billion for Cooper Industries. Pro-forma net income came in at $2.2 billion as Eaton reported net income of $1.35 billion for 2011 and Cooper $828 million.
The combined entity operated with some $1.8 billion in cash and $4.9 billion in debt for a net debt position of $3.1 billion. The $39.15 cash distribution portion of the offer will add another $6.2 billion in debt raising the net debt position of the combined entity to roughly $9.3 billion.
Taxation
The combined entity will reside in Ireland which has a 12.5% corporate tax rate. Ireland's tax rate represents a significant saving compared to the official 35% corporate tax rate in the US and Cooper Inudstries was already incorporated in the country. Despite an official 35% tax rate, Eaton paid an effective tax rate around the 20% mark in the US as the company has found many loopholes. Analysts were always worried about the low effective tax rate especially given the public sentiment towards corporate loopholes, which called for a simplification of the tax code. The combined entity could save up to $160 million on taxes per year by being incorporated in Ireland.
Valuation
Besides tax synergies the firms expect to generate up to $260 million in cost savings per annum in four years time. Furthermore the firms anticipate $200 million in sales synergies through 2015.
Pro forma the combined entity could generate $21 billion in sales for 2011 with net income of $2.2 billion. Factoring in the tax and cost synergies net income would rise to roughly $2.6 billion. The assumption of $6.2 billion in additional debt to be paid to Cooper's shareholders will reduce net income to roughly $2.4 billion assuming an effective interest rate of 3% on the newly issued debt.
Conclusion
A successful integration could create significant upside potential for Eaton's shares. This is particularly good news for Eaton's current shareholders which will have an expected 73% share in the new entity as a result of the cash portion in the bid for Cooper.
A 12% retreat in Eaton's share price in recent weeks as a result of the global equity correction and uncertainty about the execution of the deal provides long term investors with an excellent entry point.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
