Takeover Bid Adds Up for Diebold

After Diebold rejects a $3 billion bid, United Technologies may launch a tender offer. But some analysts doubt the benefits of a deal

United Technologies (UTX) got tired of being rebuffed by the chairman of Diebold's (DBD) board and on Feb. 29 made an unsolicited offer to purchase all of Diebold's outstanding shares for $40 per share, or about $3.0 billion. Diebold's board met Monday morning and rejected the proposal, saying it significantly undervalues the company and doesn’t recognize Diebold’s growth potential.

It's fair to assume United Technologies won't be put off so easily and may do an end run around the Board by making a tender offer directly to Diebold shareholders.

A spokesman for United Technologies wouldn't comment on the next move except to say, "We are well advised by Morgan Stanley and we fully understand our options."

The news sent Diebold shares soaring 61% to 38.84 on Mar. 3, while UTC shares finished 1.6% lower at 69.40.

"It's not very often you get a 60% premium," says Paul Nisbet, an analyst at JSA Research in Newport, R.I., referring to the $40-per-share offer. "I can see [Diebold’s board] may continue resisting here a bit, but it seems to me a majority of their shareholders are going to be putting pressure on them" to accept the buyout offer.

Shareholders could be tempted by the bid given Diebold's own gloomy outlook for construction of new bank branches and expectations that its ATM and security service revenue will be flat to down 5% in 2008. A U.S. recession would further damage Diebold’s near-term prospects. Shareholders may also be growing impatient with Diebold’s lack of financial reporting since the first quarter of 2007 due to an ongoing investigation by the Securities and Exchange Commission (SEC) of the company’s methods for recognizing revenue.

That seems to have been United Technologies' objective in describing its two-year campaign to meet with Diebold’s board and in publishing the last few rounds of communication between the chairmen of the two companies. In the most recent letter, Diebold Chairman John Lauer refused to meet with United Technologies’ top management to discuss a possible combination.

After the market close on Mar. 3, Diebold said in a release that it would delay filing its fourth-quarter financial results with the SEC and plans to complete its internal accounting review before it resumes reporting of financial results on a regular basis. The review is expected to be finished by the end of the second quarter of 2008.

In February, Diebold provided a preliminary estimate of its revised 2007 revenue of $2.95 billion, up 0.7% from a revised estimate of $2.93 billion for 2006. The North Canton, Ohio-based company also projected revenue growth of 6% to 8% to around $43.0 billion this year.

Meanwhile, some analysts are wondering how United Technologies would benefit from acquiring Diebold, which generates more than two-thirds of its revenue from ATMs – a business that United Technologies is not in. Most analysts agree that Diebold’s security business would help United Technologies expand its fire and security division, which has been built entirely from acquisitions over the past five years.

While there's very little overlap between the two companies' products, there are parallels between the 50%-50% split in Diebold’s equipment and service revenues and the mix in United Technologies' Otis elevator unit, Goldman Sachs said in a Mar. 3 research note.

"We see the largest growth prospects in emerging markets, where Diebold is the No. 2 vendor of ATMs in India and China and No. 3 in Russia," Goldman analyst Deane Dray said in the note. She said the size of the bid is consistent with "the company's typical $2 billion annual placeholder for acquisitions." (Goldman Sachs does and seeks to do business with the companies covered in its research reports.)

In a Mar. 3 research note, Credit Suisse Equity Research expressed doubts about the proposed deal, citing the difficulty of accurately valuing Diebold's stock because of the lack of audited financial reports for the past year.

(Credit Suisse does and seeks to do business with companies covered in its research reports.)

Diebold may appear attractive from a cost/margin perspective -- assuming the depressed margins between 6% and 7% can rebound to the 20-year average of 12.1% -- and the revenue mix between equipment and services, Credit Suisse said. Given deterioration in the banking sector, which makes up more than 60% of Diebold’s revenue, and the company’s focus on the U.S., which is probably entering a recession, Credit Suisse questioned where the growth would come from.

"We weren’t expecting incoming CEO Louis Chenevert’s first big deal to be a North American-centric manufacturer of ATMs, safe deposit boxes and voting systems with relatively uninspiring growth prospects in the near term," Credit Suisse analyst Nicole Parent wrote in a note. Parent, who has a market weight rating on the stock, said a deal would slightly reduce United Technologies' 2009 profits at the current offer price.

Not everyone was as skeptical, however. To make the offer, United Technologies must be confident that Diebold's operating margin has the potential to return to 10% or more over time, Jefferies & Co. analyst Howard Rubel said in a note on Mar. 3.

Rubel predicted that an acquisition would boost United Technologies' revenue for its Fire and Security business to around $10 billion and an expanded presence in the U.S. While United Technologies' earnings wouldn't get a lift in the first year, they could gain five to 10 cents per share in the second year, he said. Rubel has a buy rating on UTC and analyst Yvonne Varano rates Diebold a buy.

Whatever his doubts about the fit between the companies' product lines, Nisbet at JSA Research said he doesn't question United Technologies' ability to turn around a business and make it much more efficient and profitable. At 21 times Diebold’s estimated 2008 earnings of $1.92 per share, the $40-per-share offer is expensive, but it's reasonably priced at about 11 times Diebold’s free cash flow, he said. He has a buy rating on United Technologies.

Nisbet adds that it's unlikely United Technologies is considering other acquisitions for now, as "this will keep them busy for a while."

Whether Diebold's board bows to any pressure from shareholders, United Technologies' offer may very well encourage competing bids from other players, and push up the takeover price.

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