3M - Acquisition Of Ceradyne Is A Decent Addition For Its Energy And Advanced Materials Unit

Oct. 2.12 | About: 3M Company (MMM)

3M (MMM) announced on Monday that it will acquire Ceradyne (CRDN) in a deal valuing the company at $35.00 per share, for a total deal value of $860 million. Shares of Ceradyne rose 43% in Monday's trading session to $34.97 per share, the highest level of 2012. Shares of MMM rose 0.9% in Monday's session.

The Deal

3M announced that it will acquire Ceradyne, a worldwide leader in the development and production of advanced technical ceramics for demanding applications in the automotive, oil and gas, solar, industrial, electronics and defense industries. The $35.00 offer for Ceradyne, implies a gross valuation of $860 million for Ceradyne. Net of cash, equivalents, short term investments and debt, the offer values Ceradyne at $670 million. Ceradyne will be integrated in 3M's Energy and Advanced Materials Division within the wider Industrial and Transportation Business. By joining forces, 3M can enable new technologies and innovation for tailored materials requiring advanced ceramics.

Executive Vice President Chris Holmes commented on the deal: "Ceradyne is a strong company with a great reputation, world-class technology in advanced ceramics, and leadership positions in the markets it serves. Ceradyne is an excellent complement to our existing businesses in transportation, energy markets and defense."

Ceradyne generated annual revenue of $572 million in 2011. The company net earned $83.9 million. For the first six months of 2012, Ceradyne reported revenue of $237 million. The company net earned $10.6 million. Based on the net deal value of $670 million, and a full-year revenue estimate of $500 million for 2012, the deal values Ceradyne at 1.3 times annual revenue. Full year earnings could come in around $20 million, valuing the firm at 33 times annual earnings.

3M estimates that the acquisition will be dilutive to earnings per share by $0.05 in the first 12 months after the completion of the deal. Excluding purchase accounting adjustment and integration charges, the deal will be accretive by $0.01 per share. 3M expects to close the deal in the fourth quarter of 2012. The deal is subject to regulatory approval and the usual closing conditions.

Valuation

3M ended its second quarter of 2012 with $4.9 billion in cash, equivalents, and short-term marketable securities. The company operates with $6.3 billion in short and long term debt, for a modest net debt position of $1.4 billion. Given the size and financial strength of the company, the acquisition can be easily financed.

For the first six months of 2012, 3M generated annual revenue of $15.0 billion. The company net earned $2.3 billion, or $3.25 per diluted share. Annual revenue could come in around $30 billion, on which the company could earn $4.5 billion 3M is currently valued at $64.5 billion. This values the company at 2.1 times annual revenue and 14 times annual earnings. Currently, 3M pays a quarterly dividend of $0.59 per share, for an annual dividend yield of 2.5%.

Investment Thesis

Year to date, shares of 3M have risen some 14%. Shares have moved in a $83-$93 trading range since the start of the year, now exchanging hands at $93 per share. Over the past five years, shares are trading roughly flat. Shares fell to $40 in the beginning of 2009, but quickly rose back trading between $70 and $100 over the past three years. Between 2008 and 2011, 3M boosted its annual revenue from $25.3 billion to $29.6 billion. Net income rose from $3.5 billion to $4.3 billion.

3M's deal with Ceradyne is rather modest, given the size of the industrial conglomerate. The net deal value is merely 1% of 3Ms own market capitalization. Ceradyne will add roughly half a billion in annual revenue, or roughly 1.7% of 3M's annual revenue.

In September, 3M had to abandon the proposed acquisition of Avery Dennisons' Office and Consumer Products Group. The Justice Department announced the news, as the agency threatened to sue the company on antitrust rules. The proposed $550 million merger, would have given 3M an 80% market share for the US business in labels and sticky notes.

This deal hardly affects 3M's operations, but might be a useful addition to boost the Energy and Advanced Materials division. The deal value is rather fair on a revenue multiple, despite the 43% premium. The deal values Ceradyne at just 1.3 times annual revenue, compared to a valuation of 2.1 times for 3M. Owned by 3M, Ceradyne has time and resources to restore the company's profitability. While Ceradyne's shareholders most likely will welcome the deal, shares are still trading some 60% below their peak of 2007, as shares have been hit hard by the malaise in the solar industry.

Shares of 3M are a decent addition to any long-term portfolio. I see few short-term triggers for the shares. Investors should expect modest capital gains, and in the meantime receive their annual dividend check, yielding 2.5% at the moment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.