Eaton’s Auto Roots Fade in $11.8 Billion Cooper Purchase

Eaton President and CEO Sandy Cutler
Eaton Corp. President and Chief Executive Officer Sandy Cutler. Photographer: Jin Lee/Bloomberg

Eaton Corp.’s $11.8 billion acquisition of Cooper Industries Plc means electrical products such as equipment to illuminate buildings will generate the majority of the manufacturer’s sales, marking the biggest move yet away from its 101-year-old roots in auto parts.

Founded in 1911 to build truck axles, Eaton expects to draw 59 percent of its sales from electrical equipment, based on 2011 sales of the combined companies. Sales of auto and truck parts will drop to 20 percent from 27 percent last year and 43 percent in 1999, the year before Sandy Cutler became chief executive officer and decided to diversify.

Moving further away from auto and truck parts will help drive up the stock price as investors begin to value Eaton more as a multi-industrial company, said Jeffrey Sprague, the Vertical Research Partners co-founder who predicted in September that Eaton might buy Cooper.

“Eaton has always maintained its valuation around some of the more cyclical truck-related businesses and machinery-related businesses,” Sprague said in a telephone interview. “Bringing the company’s sales to about 60 percent electrical will help improve Eaton’s valuation over time.”

In the transaction announced yesterday, each Cooper share will be exchanged for $39.15 in cash and 0.77479 Eaton share. That offer is valued at $72 a share based on Eaton’s May 18 closing price, 29 percent more than Cooper’s price that day, Eaton said.

The deal is Eaton’s biggest and expands its markets to include providing lighting gear for utilities and commercial buildings, along with boosting residential-construction sales. Cutler has predicted housing may grow by 25 percent annually in the next couple of years.

Complementary Products

“The combined company leverages complementary products, accelerates long-term growth opportunities and increases exposure to high-potential end markets,” Ajay Kejriwal, an FBR Capital Markets analyst in New York, wrote in a note yesterday.

Eaton’s purchase is the largest in at least a decade in miscellaneous manufacturing, based on data compiled by Bloomberg. It is paying about 14 times earnings before interest, taxes, depreciation and amortization, exceeding the median of about 8 times in more than 100 similar takeovers since 2002.

Cooper had been the focus of takeover speculation for months. The shares jumped the most in more than two years in September after Sprague suggested that the company would be a good fit with Eaton. Eaton’s price-to-earnings ratio is 10 times and might climb to 14 times as investors alter their assessment of the company based on its increased focus on electrical equipment, he said.

Additional Bidder

Eaton fell 0.7 percent to $42.09 at the close of trading yesterday in New York, extending the stock’s decline to 10 consecutive days. Cooper rose 25 percent to $69.88 after advancing 3.1 percent this year before the announcement.

Another bidder for Cooper may surface as European companies seek to expand in the U.S., Kejriwal said. Zurich-based ABB Ltd.’s $3.9 billion purchase of Thomas & Betts Corp. this year left Cooper and Hubbell Inc. as the only two large independent electrical-equipment companies in the U.S., he said.

Eaton said the transaction will boost operating earnings by 35 cents a share in 2014, and 45 cents a share in 2015. The deal will lower earnings by 10 cents next year. The combined company will be based in Ireland, where Cooper is now incorporated.

“The stock can work really well from here on the core earnings growth of the company and the accretion,” Sprague said. “If you can add the valuation improvement on top of that, you really boost the returns quite substantially.”

Little Overlap

Eaton’s manufacturing portfolio also includes hydraulic products and aerospace parts. Cooper, which operates from Houston, gets 60 percent of its sales in the U.S., Eaton said.

Cutler said Eaton and Cooper have little overlap, allowing expansion into industries such as oil and gas where the stand-alone Eaton had little penetration.

“This is a real transformative deal in terms of bringing together two complementary companies in the electrical space, and helps create a larger and more capable firm,” Cutler said in a telephone interview.

The combined companies had 2011 revenue of $21.5 billion and earnings before interest, taxes, depreciation and amortization -- a measure of cash flow known as Ebitda -- of $3.1 billion, according to Eaton’s statement.

Deal Financing

Eaton obtained a $6.75 billion bridge financing commitment from units of Morgan Stanley and Citigroup Inc. The banks are acting as financial advisers to Eaton, while Goldman Sachs Group Inc. is working with Cooper. Eaton plans to replace the bridge loan with $5.1 billion of term debt with different maturities. Cutler said repaying debt will be a priority.

Standard & Poor’s Ratings Services and Moody’s Investors Service both said they may lower Eaton’s credit rating because of higher debt related to the acquisition. Eaton’s debt is rated ‘A-’ by Standard & Poor’s and an equivalent A3 by Moody’s. Both are four notches above junk.

Eaton’s “credit quality measures are currently somewhat subpar compared with ratios we expect for the current rating,” S&P said in a statement. “We expect the partly debt-financed acquisition of Cooper to weaken credit measures further on the close of the acquisition.”

Joel Levington, managing director of corporate credit at Brookfield Investment Management Inc. in New York, said a credit-rating reduction of one level is likely.

Deal Savings

“A downgrade might be an opportunity for new bondholders to get a high-quality company that will be focused on debt reduction,” he said.

After the transaction, Eaton expects its debt rating will rise one level to ‘A’ over the “medium term” from S&P’s rating of A-, according to a company presentation. S&P lowered Eaton’s rating to ‘A-’ from ‘A’ in January 2009.

Eaton said its shareholders are expected to own about 73 percent of the combined company, which may be called Eaton Global Corp. The company said the transaction is expected to close in the fall of 2012.

Eaton projects savings of $535 million, with $160 million of that coming from global cash management and tax benefits related to incorporation in Ireland. Another $260 million will be achieved through cost cuts and $115 million through “sales synergies.”

Eaton expects $200 million of acquisition integration charges, with most of that coming in 2013 and 2014.


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