3M Shareholders Ask and They Receive
Ask and you shall receive, 3M investors.
The deal comes less than a month after investors polled at a Barclays Plc conference told 3M Co. CEO Inge Thulin he should prioritize large M&A over other uses of cash. A $2 billion purchase may not sound that big for a $113 billion company, but 3M has largely built itself through small deals and organic growth. In fact, this is the second-largest acquisition in 3M's 115-year history.
It's unusual for industrial investors to be so gung-ho about more aggressive M&A, particularly at companies that have a reputation for conservatism. Honeywell International Inc., for example, has gotten mixed reviews from shareholders for ditching its queasiness over $1 billion-plus deals as integration costs have crimped margins in the short term.
But 3M is trying to achieve a cost of capital that's more in line with its multi-industrial peers, and using debt to fund takeovers and buybacks would help it do that. It's been clear about its intention to do just that so investors are prepared and ready to reap the resulting valuation benefits. 3M's sales growth could also use a little acquisition-fueled help after the strong U.S. dollar and a drop-off in demand for its consumer-electronics products fueled the first back-to-back annual revenue declines since 1980.
As far as deals go, the Scott Safety purchase is a pretty good one. It's sizable enough to make a difference at 3M, but because it fits with the company's emphasis on high-margin revenue and plays to its existing strength in safety gear, the integration process should be relatively smooth. Investors can take comfort from the fact that 3M went through a similar process after its last big deal, when it paid $2.5 billion in 2015 to acquire Capital Safety -- a maker of harnesses and fall-protection equipment.
Scott Safety generated $155 million of Ebitda on sales of $570 million over the course of the last 12 months, implying an attractive 27 percent margin. RBC analyst Deane Dray notes that's a touch dilutive to 3M's company average Ebitda margin of 30 percent. But there may be room for improvement in the Scott Safety business through cost synergies, which the company has yet to specify. Excluding purchase-accounting adjustments and one-time deal expenses, 3M estimates the Scott Safety takeover will add 10 cents to its earnings in the first year after it's completed. (It's expected to close in the second half of 2017.)
The Scott Safety takeover isn't cheap per se, but it's not crazy expensive either. On a trailing 12-month basis, the implied Ebitda multiple is essentially in line with the median paid for U.S. industrial companies of more than $1 billion in the past five years, according to data compiled by Bloomberg. 3M estimates the multiple works out to more like 11 times based on its projections for Scott Safety's Ebitda in the first year under its ownership and taking into account potential synergies. That compares with a similarly calculated valuation of 14 times Ebitda for the $2.5 billion purchase of Capital Safety.
Honeywell was also reportedly interested in the Scott Safety business, but the odds of a counterbid are low. The company is getting a new growth-hungry CEO, but bidding wars might be too much of a diversion from Honeywell's typical M&A strategy for investors to stomach.
Meanwhile, for 3M, the acquisition soaks up about a third of the more than $6.5 billion in M&A capacity that Bloomberg Intelligence estimates was implied by the company's 2017 capital allocation plan. If it keeps coming up with more purchases like this, investors should be pleased.
Johnson Controls acquired Scott Safety as part of its merger with Tyco International last year.The company plans to use the proceeds to pay back part of the $4 billion in debt that Tyco took on to help facilitate the transaction. That debt can only be paid with legacy Tyco cash flow, according to Bernstein analyst Steven Winoker.
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