Teledyne: Doubling Down On Digital Imaging With FLIR
- Teledyne has been a serial acquirer, as savvy deals and a sound positioning have created great value for long-term investors.
- Despite Covid-19, valuation has only increased; in fact, quite a bit.
- Breaking with its tradition of pursuing in bolt-on acquisitions, the company started 2021 with a huge $8 billion deal for FLIR.
- This deal looks compelling on a relative basis, yet the overall valuation remains quite demanding, too demanding.
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Teledyne (NYSE:TDY) is a long-term value creator, one which started 2021 with a big bang as it announced the $8.0 billion acquisition of FLIR Systems (FLIR) back in January already. Both companies have been on my investment radar in recent years as I have been quite constructive on both names for quite a while, although their quality did come at a price.
My last take on Teledyne was in the summer of 2019 when the company acquired some assets on the cheap from 3M (MMM). With shares trading at $250 at the time or 30 times earnings, I applauded the quality yet looked for more appeal at an entry point around the $200 mark. As it turned out, we have never seen that entry target as shares traded within reach of the $400 mark in the weeks ahead of Covid-19. Despite a fierce and short pullback, shares have made up all lost ground, currently trading essentially at an all-time high of $417 per share.
The Old Thesis
Teledyne is a conglomerate focused on technologies, allowing for sensing, gathering, transmission, and analysis of information. Back in 2019, when I looked at the company the industrial conglomerate generated $3 billion in sales from a variety of sectors and geographic regions.
With a strong focus on instrumentation and digital imaging, this R&D powerhouse was very profitable and had grown sales at a steady and impressive pace. With 61 deals made in the period 2000-2019, the company quadrupled its sales as it announced a $230 million deal with 3M to acquire $102 million in additional sales on top of that in the summer of 2019.
As shares were trading around $250 at the time, I pegged the enterprise value at around $10 billion, at 3.3 times sales, 19 times EBITDA, and 27-28 times earnings. The impact of the latest deal announcement and another bolt-on deal announced earlier in 2019 led me to peg earnings power at roughly $10 per share, thereby reducing the earnings multiple to 25 times earnings.
With my desire to buy at 20 times earnings, I saw appeal at $200 at the time, yet shares continued to rise throughout 2019 and early in 2020 with the arrival of Covid-19. Unfortunately, we have never seen my targeted entry levels, largely driven by excellent operating performance. In January 2020, the company posted strong 2019 results. GAAP earnings of $10.73 comfortably surpassed my $10 per share run rate, with the company guiding for earnings at a midpoint of $11.25 per share for 2020, not knowing what pandemic was nearly hitting our global society just a few weeks later.
In April, the company posted a 5% increase in first quarter revenues as the company cut the 2020 outlook to earnings at a midpoint of $9.65 per share to reflect the impact of the pandemic. After second quarter sales fell just 5%, the company hiked the midpoint of the guidance as it increased the lower end of the earnings guidance by fifteen cents. Third quarter sales fell by 6% and change yet despite the worsening year-on-year sales trends, the company hiked the midpoint of its earnings guidance again to $9.85 per share.
The company started 2021 with a bang as it announced the $8 billion acquisition of FLIR, but first, let's look at the annual results. Fourth quarter sales were down just 3%. Following a strong final quarter, the company squeezed out full year earnings of $10.62 per share, down just 11 cents, as the company guided for a midpoint of $11.35 per share in 2021. Besides this strong earnings power, an existing net debt load of just around $100 million is close to peanuts for a company the size and profitability of Teledyne.
With 38 million shares trading around the $400 mark ahead of the FLIR deal, Teledyne is valued at approximately $15 billion as a very modest net debt load does not really change this. This works down to roughly 5 times annual sales of $3.1 billion but moreover works down to a very elevated 37 times earnings multiple.
The fact that the company replicated its 2019 earnings per share essentially in 2020 despite the pandemic is a testament of the strength of the underlying business. This added confidence undoubtedly led to the management team announcing an $8.0 billion acquisition for FLIR, which at $56 per share in terms of FLIR stock is exactly 50/50 paid for in cash and Teledyne shares, with investors in FLIR obtaining 0.0718 shares in Teledyne for every share they own.
This marks a steep 40% premium over the unaffected share price justified by the combination of world-class expertise in sensor technologies, with operations being largely complementary despite the fact that both companies are active in a similar field. Both companies hope to squeeze out $40 million in synergies from the get go, a number anticipated to rise to $80 million over time.
Unlike Teledyne, which generates a third of its $3.1 billion in sales from digital imaging, FLIR is a 100% play in digital imaging and its $1.9 billion in revenue contribution means that the combination will generate 60% of sales from this segment, complemented by smaller exposure to instrumentation, aerospace, and defense, and engineered business.
With FLIR generating $1.9 billion in sales the $8.0 billion deal tag works down to a 4.2 times sales multiple, nearly a turn cheaper than Teledyne. Based on adjusted earnings of $2.48 per share, the company is awarded a mere 23 times earnings multiple, although FLIR's earnings are typically quite adjusted. Based on both these metrics, FLIR is valued quite attractively, certainly after this already reflects the premium paid by Teledyne.
With Teledyne trading at a multiple of 37 times, the synergies are very lucrative as well, as $40 million in pre-tax synergies could warrant a billion in value creation already with today's multiples. The relatively cheaper acquisition and potential for synergies is likely the reason why shares of Teledyne have hardly moved despite the sizable premium paid for the shares.
A Final Word
Having been a holder of shares in FLIR, I have decided to take profits following the deal instead of rolling my position over into Teledyne. Teledyne becomes a much larger conglomerate, yet it only earned $10.62 per share or $402 million based on a share count of 38 million last year. While FLIR will add $212 million in actual earnings (GAAP basis), the share count will increase by approximately 9.5 million to 47.5 million.
That logic reveals earnings accretion to $12.90 per share as a result of the cheaper multiple of FLIR, yet the $4 billion cash (and thus debt) component will not just push up leverage ratios to 4 times, it likely comes at $160 million in pre-tax interest expenses as well (assuming 4% cost of debt).
That means that earnings likely are flattish just above $10 per share. Synergies and deleveraging certainly have the potential to improve earnings in 2021 and beyond, but that will take some time.
While earnings multiples will likely compress to their low thirties by year-end, we are still left with quite some leverage. I simply fail to see a very compelling entry point here, although this deal likely adds to the very long-term potential for Teledyne, as acquisitions have typically done in the past.
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