Service Corporation International - Acquisitions And Aging Population Create Value

| About: Service Corporation (SCI)

Shares of Stewart Enterprises (STEI) are spiking upwards in Wednesday's trading session. Shares rose by a third after the company agreed to sell itself to Service Corporation International (SCI).

Shareholders in SCI are applauding the deal as well, based on generous synergy estimates. Operating in a still fragmented market, SCI is well positioned to benefit from the aging Baby Boom population.

The Deal

Service Corporation International announced that it has entered into a definitive agreement to acquire Stewart Enterprises. SCI offers shareholders in Stewart $13.25 per share in cash, valuing the firm at $1.13 billion. Including the assumption of debt, the deal is valued at $1.4 billion.

Shareholders stand to receive a 48 percent premium over the weighted average closing price over the past 30 calendar days. The deal will create a leading provider of funeral and cemetery services in the US. SCI and Stewart have a complementary geographic fit in a still highly fragmented industry.

CEO of Stewart Enterprises, Thomas Kitchen commented on the deal, "Our board of directors and management team believe that the merger with SCI offers superior value for our shareholders. We are looking forward to becoming part of an organization that shares our Best-in-Class vision of caring for families at their time of need."

For the year of 2012, Stewart generated annual revenues of $516.1 million, up 0.7% on the year before. Net income fell by 6.9% to $35.9 million. Stewart ended its latest quarter with $78.0 million in cash and equivalents and $323.0 million in short and long term debt, for a net debt position of $245 million.

Note that Service Corporation expects to realize $60 million in annual cost savings, two years following completion of the deal. Costs can be saved on a reduction in back office tasks, greater purchasing power and an elimination of management jobs. Service Corporation expects to take one-time charges of $30 million in the coming two years following the integration of the companies.

The equity portion of the deal values Stewart at 2.2 times annual revenues and 30 times annual earnings. Factoring in the expected synergies at statutory tax rates, and the earnings multiple is coming down to 15 times last year's earnings.

The deal is subject to shareholder approval of Stewart's shareholders, normal closing conditions and regulatory approval. Chairman Frank Stewart Jr. has already agreed to the proposed deal, holding 29.99% of the Class A and B shares. The deal is expected to close at the end of 2013, or at the beginning of 2014.


Service Corporation ended its first quarter of its fiscal 2013 with $185.5 million in cash and equivalents. The company operates with $1.95 billion in short and long term debt, for a net debt position of around $1.73 billion. Following the closure of the deal, for which SCI has already arranged committed financing, the net debt position stands to increase towards $3 billion.

For the full year of 2012, Service Corporation generated revenues of $2.41 billion, up 4.1% on the year before. Net income increased by 5.3% to $152.5 million.

Factoring in the 5% jump following the announcement of the deal on Wednesday, the market values the company at $3.9 billion. This values Service Corporation at 1.6 times annual revenues and 25-26 times annual earnings.

Service Corporation pays a quarterly dividend of $0.07 per share, for an annual dividend yield of 1.5%.

Some Historical Perspective

Over the past decade, investors in Service Corporation have seen some decent returns. Shares steadily rose from $4 in 2003 to highs of $14 in 2007 before the financial crisis hit. Shares fell all the way to $3 in 2009 to recover to recent highs of $18 following the announcement of the deal.

Between 2009 and 2012, Service Corporation has increased its cumulative revenues by some 17% to $2.41 billion. Net earnings advanced by 24% over the same time period to $152.5 million.

Investment Thesis

Investors on Service Corporation are enthusiastic about the deal, sending shares some 10% higher at the start of Wednesday's trading session. Shares did fell back a little during the session, to close with gains of 5%.

Clearly investors are enthusiastic about the sizable synergy estimates of $60 million, a sizable amount in relationship to the deal value. The incremental earnings create a lot of value for shareholders in this low interest rate environment.

Following the deal, Service Corporation is on track to generate annual revenues of around $3 billion. Net earnings of the combination could come in around $190 million, expected to increase to $230 million in two years time. This assumes the realization of synergy estimates at statutory tax rates. As such, Service Corporation would be valued at around 1.3 times annual revenues and 16-17 time pro forma earnings, factoring in the synergies.

The debt load of $3 billion is sizable, but manageable given the long term predictable cash flows and the sizable backlog of future revenues of around $9 billion.

While the deal itself is executed at rich valuation multiples, the large synergy estimates make it interesting for shareholders in both firms. While the debt load is on the high side, the predictable cash flows and fair valuation are quite attractive, as the Baby Boom generation continues to age.

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.

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