U.K.-based aerospace, aviation and defense equipment provider Cobham is taking a big step toward repositioning itself now that the wars in Iraq and Afghanistan are winding down, with a proposed $1.46 billion acquisition of Aeroflex Holding, a Plainview, N.Y.-based provider of high-performance, radiation-hardened microelectronic components and test and measurement equipment.
The deal, expected to close in the third quarter of this year, is 80-year-old Cobham’s largest acquisition and is designed to help the company diversify revenue streams into "complementary" yet relatively hard-to-enter commercial markets.
The trans-Atlantic company, which enjoyed growth thanks to explosive U.S. and U.K. military spending during the wars in Iraq and Afghanistan, since then has been trying to find adjacent marketplaces and has said acquisitions would be a key tool, albeit with set requirements.
"Acquisitions have to contribute toward changing the shape of our portfolio to obtain more exposure to growing commercially driven end-markets in what we refer to as the connectivity space," Cobham CEO Bob Murphy told a New York City investor briefing May 20. And this deal specifically will "increase exposure to attractive commercial markets including wireless, space, medical and microelectronics."
The companies have a conditional agreement for Cobham to pay $10.50 per Aeroflex share and take on the latter’s $540 million in debt as of March 31. That means Cobham is paying about 10.5-times adjusted earnings before interest, tax, depreciation and amortization for Aeroflex, and providing a 26% premium over Aeroflex’s pre-announcement closing stock price.
Aeroflex’s private equity shareholders Veritas Capital, Golden Gate Private Equity and GS Direct – together representing 76% of voting share capital – support the deal.
Veritas, which owns the most, has been an Aeroflex "sponsor" for seven years, and although private equity owners like to exit after clear profits, Murphy indicated it may be about timing and opportunity in this case.
Aeroflex revenue was growing until 2011, when recession-related spending cuts curbed 4G network growth and the company’s prospects. But Aeroflex was executing on a plan to return to growth in 2015.
Cobham itself has been restructuring strategically for the last year and a half, Murphy noted, and that was when the company became interested in Aeroflex. Interest turned to action in the first quarter of this year, on the heels of Cobham’s acquisitions of mobile radio and satellite communication maker Thrane & Thrane in 2012 and Axell Wireless in 2013.
About 70% of Aeroflex’s business is focused on higher growth commercial segments, Cobham said. Adding Aeroflex increases Cobham’s exposure to these growth segments and boosts "key customer relationships" in wireless, space, microelectronics, industrial, energy and other sectors.
The result will be that Cobham’s commercially derived revenue will go from 35% of $3 billion total to 41% of $3.64 billion, on a pro forma basis.
Underpinning that, apparently, will be Aeroflex’s relatively high degree of private- and self-funded research and development. Murphy said Aeroflex invested $86 million in 2013 R&D, or 14% of revenue. "We expect to see new products emerge," he said.
Interestingly, however, Aeroflex’s R&D splurge may not ultimately affect Cobham’s final, total amount of R&D. Asked what Cobham’s R&D will be after the deal, Murphy said it will "not change dramatically." The CEO said Cobham will maintain the same R&D approach. "It will be driven by the opportunity set, so we won’t be slavishly driving to any particular number," he said.
In the end the deal is supposed to lead to $85 million in annual savings, although that comes after spending $215 million to make changes. Cobham CFO Simon Nicholls said management has identified several areas for cuts and cost savings across both legacy companies, including factory labor reductions, supply chain consolidation and getting better deals through a larger combined scale, as well as some corporate costs.
Half of the projected $85 million in eventual annual savings will come from internal site "optimization," while a quarter will be squeezed from the supply chain and the rest from corporate savings and other benefits. Cobham believes about 60% of the deal’s benefits will be achieved and 70% of the plan’s costs will be spent in the first three years of the merger, according to the CFO.
Cobham’s stock price in London dipped more than 4% on the news, while Aeroflex’s jumped 25%. But financial analysts seem largely sanguine about the deal.
"This seems to be a decent fit at first blush given what looks to be complementary products in a commercial end-market that should be faster growing than [Cobham’s] defense businesses," said RBC Capital Markets analyst Robert Stallard. "However, [Aeroflex’s] growth appears to have slowed recently in part due to 4G roll-out delays — revenue was down in is fiscal 2013 — which has caused it to do some restructuring, and we’d like to see more details about its growth strategy. That said, the run-rate synergies appear sizable and the multiple doesn’t seem too expensive if the Cobham’s estimates are accurate."