Put that Brexit gloom aside for just a moment. Here's one British company that's raising funds in pounds on the stock market to buy a U.S. business.
Melrose, a British turnaround specialist and M&A junkie, agreed on Monday to buy Nortek, an over-indebted U.S. ventilation company, for $2.81 billion.
The pound's slide after the vote to leave the European Union didn't get in the way of the deal. Ironically, Melrose's chairman was a private backer of the "Leave" campaign. What's more, the associated financing will be a small validation for London's capital markets, still reeling from the Brexit vote.
Melrose was set up in 2003 as a shell to buy underperforming industrial companies, lift their performance and sell them on. It lurks quietly on the stock market until an opportunity pops up. Then it raises cash from shareholders to do the deal.
Nortek fits the strategy. It fell into the hands of creditors during the financial crisis after taking on too much debt in a leveraged buyout. The U.S. earnings stream looks immune to Brexit woes.
Debt funds led by Ares Management nursed it back to health before taking it public in 2010. But Nortek still labors under a debt pile that that's more than five times Ebitda. Recent share price performance has been poor.
Nortek would clearly benefit from reduced borrowings, more investment and the operational expertise of an industrial owner.
Enter Melrose. Its offer of $86 a share is 38 percent more Nortek's previous close. It's just 6 percent below the stock's all-time high. Ares and other top shareholders have grabbed the chance to get out at close to peak value.
At first glance, this is no bargain. Nortek made $220 million of operating profit before exceptional items last year. Adjust for tax, and that suggests a starting return on acquisition of only 5.9 percent. What's more, Melrose may have to inject more funds over time -- perhaps one-third of the all-in purchase price, or about $900 million, if previous deals are to go by.
The good news is that some of this can be funded by cutting Nortek's interest bill. Melrose plans to cut Nortek's leverage by 50 percent to 2.5 times Ebitda, thereby reducing the interest rate on its debt to 3 percent versus today's 7 percent. There will also be savings in central costs too -- Melrose reckons those are 23 percent higher than comparable businesses.
Can Melrose pull it off? It has done so before, and that track record means investors are likely to stump up for a jumbo 1.61 billion-pound ($2 billion) rights offering to pay for it all. Melrose shares have jumped 31 percent.
This deal is a small boost to the City of London as the Brexit vote brings dealmaking to a near standstill -- but it's most likely an outlier.
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