What follows is the final comment on GKN from me prior to the hostile Melrose bid closing at 1pm on Thursday. I am not going to second guess a possible outcome. We know that it will be very tight and I live in hope that common sense will in the end prevail.
Melrose requires 50.1% acceptances from GKN shareholders if it is to win. The current value per share of the Melrose bid is 451p while the GKN share price sits at 429p – an unusually wide spread due to uncertainty in regard of who will win. Interestingly, the value of the Melrose bid stands at a 38% premium to the immediate Melrose bid approach offer back in January. Note also by contrast that Cadbury had gone to Kraft Foods at a 50% premium and that Melrose itself paid a 71% premium for FKI.
Having said almost all that needs to be said I am not going to repeat the many arguments made in support of GKN remaining as an independent and of why in my view and that of many others its main shareholders should back the new GKN Board. Of course, hedge funds and what many like to call vulture investors have piled into GKN shares during the bid process in the hope of making a killing on the shares. Indeed, these may well account now for as many of 25% of the issued shares. I doubt that they will have made that much money in the process when and if they are forced to sell but they will carry the responsibility for thousands of Job in the UK, Continental Europe, Asia and America on their shoulders. The pity is that I don’t suppose they will care much about that!
In attempting to fight off this unsolicited hostile bid, one that in my view seriously undervalued GKN and forced Melrose senior management to raise the price by a miserly amount, all that I can say is that I believe the GKN Board has done their stuff, in other words all that they possibly could to get the message that they understand what needs to be done and will do it. They have undoubtedly presented a very strong case why shareholders should stay with GKN as it goes through the process of proposed and agreed change and that are, as far as I can see, risk free. Melrose, on the other hand, presents formidable risks for both its own and GKN shareholders.
Having previously pursued the undervalued bid argument in some detail and of why GKN shareholders should not allow Melrose to walk off with GKN on the cheap, it was particularly pleasing for me to see Pelham Capital, who own approximately 2% of the GKN stock, suggesting last week that “we believe the combination of GKN Driveline with Dana (a move that has been agreed by GKN and Dana and that will not only return cash and provide a sizable 47.25% chunk of the combined new entity to GKN shareholders) together with the plan for the Aerospace Business justifies a fair value closer to 600p as opposed to the current offer from Melrose which at the close of play on Friday valued GKN shares at 451p. In its statement supporting the GKN Board, Pelham Capital added that “this upside is not currently reflected in the revised Melrose offer”. This is certainly my belief as well.
With no pension deficit to carry forward together with the plan for Aerospace which, as I have previously pointed out Melrose chose to value on the same basis as GKN Driveline (an EV Multiple of 7.5x) when, without beating about the bush, almost anyone in the engineering and manufacturing arena will tell you, aerospace companies particularly those with sizeable aero-engine businesses command an EV multiple double that of Driveline. Why? Very simply because of levels of potential growth and margin attainment in aerospace being very much higher than automotive.
Having left the ‘city’ in 2012 and because I have done my bit, it is rare that I would attempt a full equity valuation. However, in an attempt to back-up the near 600p valuation placed on GKN shares by Pelham Capital, I have been crunching a few numbers over the weekend in order to see how close I could get to the 600p. I can tell you that it wasn’t that hard to do either!
In order to achieve a fair value for GKN shares I have assumed 1.7 billion shares in issue and taken stated values and other detail in respect of cash and pension payment from the GKN Driveline/Dana merger agreement. In case you may have forgotten, GKN shareholders will, if GKN survive from the clutches of Melrose, receive 47.25% of the new Dana/GKN Driveline Business. The total enterprise value of GKN Driveline is, as stated in that document, worth £4.4billion, approximately 235p per share and based on Dana bid value, the Equity Value is 217p.
Before moving on to GKN Aerospace, it is worth noting that following the agreement in respect of removal of GKN Driveline pension deficit through the planned £0.7 billion transfer arrangement and that because GKN Aerospace itself is free of any pension deficit, that the overall GKN pension deficit will following completion have been totally eliminated.
Using the disclosed GKN preliminary results for the year end December 2017, GKN was carrying a total net debt figure of £889 million. For immediate fair value purposes, by placing net debt onto the core future aerospace business provides for an implied equity value of aerospace alone of £4.5 billion (note that equity value indicated on Day 39 of the bid process was 252p) and on my figures this equates to an implied share price for the ongoing aerospace business of around 268p per share. Note that my figures appears to be well in line with the majority of analyst Equity Valuation estimates, some of which are much higher than my own and closer to £5 billion.
In addition, I cannot ignore other extremely valuable non-core assets within GKN plc that the company has itself said will be disposed. The main reference here is to the Powder Metallurgy business and which I personally believe that, given the importance of this business internationally could, on a conservative valuation basis, be sold for a sum in the region of £1.7 billion to £2 billion – 110p per share.
Add the three figures together provides an implied valuation of 579p. Contrast that with the 451p per share that the Melrose bid is worth and then add on or should I say subtract, the significant customer and many other potential risks. Note too that after all this time Melrose senior management has so far failed to talk about future investment in the business let alone putting forward a strategy of future intentions and how it will seek to obtain growth. So, it probably has not taken you long to see why GKN shareholders would be very much better off supporting the GKN Board and dismissing the unwanted seriously undervalued bid from Melrose.
CHW (London – 26th March 2018)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785