Esterline Seen Reaping 37% With Bid as Value Bemoaned: Real M&A
Esterline Technologies Corp. (ESL), the aerospace supplier facing pressure from one of its largest investors to boost its valuation, is poised to hand shareholders a return of at least 37 percent as a takeover target.
Relational Investors LLC, Esterline’s third-biggest stockholder, said last week that the company needs to improve profitability and make better use of its capital as the shares trade at a “substantial discount” to its potential takeover price. Even after rising 17 percent this year, the Bellevue, Washington-based company was valued yesterday at a 7 percent discount to analysts’ estimates for next year’s sales, a multiple that’s 28 percent less than the average for North American aerospace and defense parts makers, according to data compiled by Bloomberg.
While Esterline has more net debt relative to its earnings than 91 percent of peers and generates the least profit from each dollar of invested capital, Stephens Inc. said the company could lure buyers as net income and sales climb to records this year and next. BAE Systems Plc (BA/) may be among interested acquirers for the maker of parts used in stealth aircraft and commercial jets, according to Penn Capital Management Co. Esterline, which closed at $65.49 yesterday, may command at least $90 a share in a takeover, said Stephens and Credit Suisse Group AG.
“Any of the big conglomerates that want to get bigger in defense could find Esterline attractive,” Eric Green, a Philadelphia-based fund manager at Penn Capital, which oversees $6 billion including Esterline shares, said in a telephone interview. “It’s trading at a very attractive valuation and the fundamentals and outlook are very good.”
Shares of Esterline today fell 1.4 percent to $64.59.
Brian Keogh, a spokesman for Esterline, didn’t respond to phone calls seeking comment.
The company, which traces its roots to Indianapolis in 1906, makes a range of products for the aerospace and defense industries such as sensors, flight management systems and noise- reduction headsets. It also supplies automakers, gaming companies and medical-equipment manufacturers.
From their all-time high of $81.96 in July, Esterline’s shares were down 21 percent as of May 23, the day before Relational disclosed in a regulatory filing that it had increased its stake in the company to 6.6 percent.
Relational said that the company’s stock is undervalued and called on management to improve operations, reduce debt and avoid costly acquisitions. The San Diego-based firm, which manages about $6 billion, cited Esterline’s “sub-optimal operating performance” relative to both margins and return on invested capital.
Esterline’s operating margin was about 10 percent in the last 12 months, lower than the 15 percent average among North American aerospace and defense parts makers with a market value of at least $1 billion, data compiled by Bloomberg show. It earned 7 cents in profit from every dollar of invested capital, less than any of its peers, while its net debt is 2.9 times earnings before interest, taxes, depreciation and amortization, more than twice the industry average, the data show.
Relational said that while Esterline’s shares could get a lift if the company improves its operations, “over time the shares will continue to sell for a substantial discount to the value available in a strategic sale to a larger company.” It said a potential premium from a strategic buyer “should form the backdrop of strategic planning and related decisions” made by the board.
Ralph Whitworth, Relational’s co-founder, said in a May 24 interview that while he hasn’t urged the company to put itself up for sale, he “wouldn’t want them to be eschewing offers.”
Whitworth wasn’t available to comment further, said his assistant Christina Martinez.
“Relational is doing the right thing,” Zachary Prensky, a New York-based fund manager at Little Bear Research LLC, said in a phone interview. “I think these guys are going to dig in.”
Esterline was valued yesterday at 0.93 times next year’s revenue, which analysts estimate will rise to a record $2.16 billion, data compiled by Bloomberg show. That compares with the industry’s average multiple of 1.29 times fiscal 2013 estimated sales, the data show.
The company offers potential acquirers both the opportunity to gain scale in the defense market and protection from cuts in U.S. military spending because of its commercial aircraft products, said Green at Penn Capital, which owned about 290,000 Esterline shares as of March 31.
Esterline, which generates 45 percent of its revenue in the commercial aerospace market by selling everything from pilot grips to radar display screens, may lure buyers seeking more commercial customers as its sales and earnings ramp up, said Eric Hugel, a New York-based analyst for Stephens. Esterline would also be appealing to suitors looking to increase their presence in the defense industry because 40 percent of its sales are military products such as infrared decoy flares used to confuse heat-guided missiles.
Acquirers would be getting a company that boosted its free cash flow in four of the last five years and is projected to produce a record of about $224 million this fiscal year, which ends in October, data compiled by Bloomberg show.
“You’ve got a company here that generates good, consistent free cash flow,” Hugel said in a phone interview. “They have a lot of good technology. It would be an attractive candidate for the right kind of business where there would be a fair amount of synergies.”
Esterline’s stock rose 10 percent on March 23, its biggest one-day gain since September 2009, after U.K. newspapers the Daily Mail and the Guardian said, without naming their sources, that aerospace and defense firms are interested in acquiring the company. The Daily Mail said one of the potential buyers was about to begin a bid of more than $95 a share.
The most likely suitor may be BAE, Europe’s largest defense company, Penn Capital’s Green said. A takeover of Esterline may add to earnings for BAE, which is already one of its biggest customers, he said.
Brian Roehrkasse, a spokesman for London-based BAE, said the company doesn’t comment on speculation regarding mergers and acquisitions, when asked whether it has considered a takeover of Esterline.
Esterline’s depressed valuation may not be enough to convince buyers to take on the entire company, said Michael Callahan, a New York-based analyst for Auriga USA LLC.
Callahan said acquirers may be interested in only certain parts of Esterline’s diverse product mix.
“It doesn’t fit a plain vanilla defense or commercial aerospace company,” Callahan said in a phone interview. “They have a lot more going on than just that.”
Still, Esterline’s market capitalization of about $2 billion is “in the sweet spot” for many potential suitors, said Julie Yates, a New York-based analyst for Credit Suisse.
Esterline has “a very attractive set of capabilities on the commercial aerospace side,” Yates said in a phone interview. “They have an accelerating organic growth profile.”
Takeover offers for the company may range from $90 to $100 a share, Yates and Stephens’ Hugel said. That implies a premium between 37 percent and 53 percent to yesterday’s closing price.
“The best way to solve the problems is to sell the company,” Little Bear’s Prensky said. Relational is “pushing these guys in the right direction. They will find somebody who will want the whole thing.”