Lacking Thrust

A Hedge Fund's French Showdown

Safran counter-punch is weak on fairness and financial logic.
At Closing, May 23rd
100.60 EUR

Safran SA has launched a weak counter-attack against hedge fund TCI Fund Management Ltd.'s opposition to its proposed 9.7 billion euro ($10.3 billion) takeover of Zodiac Aerospace. The French jet engine maker is still short on strategic and financial justifications for the deal. Nor has it addressed the strong common-sense argument for giving shareholders a simple vote on the whole shebang.

TCI thinks Zodiac would dilute the quality of Safran's business. After all, Zodiac mainly makes aircraft interiors such as passenger seats, while its suitor is in the higher-tech activity of making jets fly. For Safran chairman Ross McInnes, that misses the point. He's not making bold claims for commercial synergies. Rather, the deal is about preventing Safran being a "one-horse bet". Zodiac brings new recurring revenue streams, plus expertise in electrical systems.

There's some logic to this. Electrical systems are replacing aircraft pneumatics. Diversification would help Safran if there was a shock to its propulsion business. But that still doesn't explain why Zodiac is the best deal, especially at this price.

Safran's claim that the deal will cover its cost of capital in three years is still open to doubt. It rests on assumptions not revealed by the company. Shareholders need to take it on faith that Zodiac's organic growth and margins will expand rapidly in the next three years and that the deal's savings will be delivered. Safran says the operating profit multiple is only 13 times when you factor in a recovery at the target. Based on Zodiac's actual 2016 performance, the multiple is much closer to a heady 40 times.

Tough Sell

Safran's shares have taken lagged peers since unveiling its deal for Zodiac in mid January

Source: Bloomberg

Finally, the approval process for the transaction remains flawed. Safran plans to make an initial cash bid for a controlling stake. Assuming enough Zodiac holders sell out to that offer, only then do Safran shareholders get a vote on buying the rest of the company for stock.

By then, Safran might have already committed up to 5.8 billion euros on the project. That puts shareholders in a tricky position on the merger vote. They would be under huge pressure to support the mop-up operation to facilitate full integration, or be left with just a controlling stake that's hard to sell. It's not a neutral choice. Far better to give shareholders a vote on the whole project before trying to buy the controlling stake, as TCI wants.

Safran dismisses all this as philosophical and says it is just complying with local law. That doesn't answer the fairness argument that shareholders deserve a proper say, with no underlying coercion, on a deal worth one-third of Safran's market value.

With TCI planning a protest vote at the annual meeting, Safran's refusal to grant a proper ballot on the transaction may be seen as a provocation.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Chris Hughes in London at

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