Despite raising the worth of its bid from £7.4 billion to a final £8.1 billion and also the amount that GKN shareholders would ultimately own in Melrose to 60%, I remain in little doubt that GKN retains the upper hand in the unfortunate and opportunistic hostile bid situation that it faces.
In raising its offer by a relatively small and insignificant amount Melrose says that all attempts to engage in constructive discussions with GKN have been blocked. Well, given what the GKN Board has already achieved and that provides the potential of huge benefits to GKN shareholders as opposed to the presentation of high levels of risk inherent within the Melrose bid, it isn’t hard to see why GKN prefer to get on and run the business themselves.
Even in its raised form the Melrose bid seriously undervalues GKN and worse, based on its history and known strategy, if it was to be successful the bidder risks seriously damaging all aspects of future business and demoting real underlying value. Moreover, the Melrose bid fails to take account of the real and underlying value of GKN aerospace businesses.
So, it isn’t just the agreed deal that was announced on Friday between Dana with GKN Automotive Driveline that leads me to the conclusion that the Melrose bid for GKN has now been overtaken by events but also in relation to the ridiculously low value attributed by Melrose to GKN Aerospace assets. The bottom line is that by the speed of the well thought out strategy and actions that the GKN Board has already taken and that bring in significant additional value for its shareholders, I believe that GKN has already proved quite conclusively that it doesn’t need Melrose to show it how to add value for its shareholders.
Even though the proposed transaction with Dana values GKN Driveline at a total Enterprise Value (EV) of £4.4 billion, a basis that is equivalent to a 2017 EV/EBITDA multiple of 7.5x, it appears that in its original bid proposal Melrose was valuing GKN Aerospace and Powder Metallurgy businesses on a similar 7.5x EV multiple to that of the automotive Driveline interests. Whilst placing an EV multiple of 7.5x on Automotive Driveline may in that particular market be considered reasonable ample evidence exists to show that Aerospace activities, particularly when they involve specialist aero engines, can and do command EV multiples near double the level that Melrose has valued them within its offer for GKN. Indeed, as GKN noted in its own announcement on Friday, the company has already rejected approaches for the aerospace business at values well above that offered by Melrose.
The announcement on Friday of the proposed combining of GKN Driveline and Dana has in my personal view totally changed the dynamics of the current situation. Despite raising its bid this morning, by the actions it has taken over the past few weeks GKN’s Board have demonstrated a series of no risk moves that can provide exceptional enhanced value opportunity for GKN shareholders.
Even in raised form, not only does the Melrose bid seriously undervalue GKN as a whole but, as the above EV multiples clearly demonstrate, it seriously undervalued the sum of the parts. However one looks at it, under Melrose confidence and stability that is inherent across all GKN business activities and customer relationships would be replaced serious risk.
As to the announcement on Friday and with publication of its own formal defence document by GKN today and that was based on the original Melrose offer, GKN is in my view absolutely right to join the automotive Driveline component business activities with those of Dana to form a world class, world leading business. In doing so not only will the huge amount of investment in areas such as E-Drive be fully protected but in the process, thousands of jobs and skills will be protected. Moreover, any risk to the highly successful business model, customer base and for shareholders is eliminated at a stroke whilst at the same time, GKN shareholders will receive significant added value.
GKN Driveline has long history of successful international joint ventures with Dana and in an area where further consolidation is inevitable, the combining of the two organisation into a world leading organisation makes great sense. The two companies certainly know each other very well and the benefits of combining interests and achieving global leadership on an even larger and wider scale can be expected to produce strong benefits for GKN shareholders.
Combining the two major automotive component players manufacturing driveline equipment and axles will make the new combination global leaders in vehicle drive systems across light, commercial and off-highway vehicle disciplines. Importantly, by accepting the plan now put forward by the GKN and Dana Boards and by going along this route as opposed to accepting what must now be viewed as a very unattractive bid from Melrose, one that seriously devalued GKN assets just as it risked damaging international customer relationships built up in the Driveline business over many years, GKN shareholders will not only gain a substantial amount in terms of what they receive but they retain valuable benefits for the future.
In respect of financial detail of the proposal announced on Friday, the deal with Dana plc and which GKN will mean that on completion GKN shareholders will receive 47.25% of the fully diluted capital of the enlarged Dana plc. GKN will also receive £1.2 billion in cash, this after deduction for the transfer of £0.7 billion to cover GKN’s IAS 19 pension deficit.
From where I sit the deal announced on Friday is an absolutely compelling one and I can see no better one emerging. As already noted, the announced deal provides an enterprise value for GKN Driveline of £4.4 billion which is similar to the basis of the value placed on GKN as a whole by Melrose and that, as this clearly seriously undervalues aerospace activities that traditionally command much higher EV multiples than automotive components, confirm to me that the Melrose bid has been seriously overtaken by events and best avoided by GKN shareholders.
Note that the Dana plan is based on GKN shareholders owning 47% of what is clearly a very well invested and respected set of global automotive businesses that will not only have a combined revenue of $14 billion but will allow GKN shareholders to retain full ownership of the more valuable aerospace and other interests including those that GKN may dispose. GKN shareholders will, I understand, be asked to vote in favour of the planned combination of Driveline with Dana at a General Meeting to be called in due course.
As things currently stand, my understanding is that the Melrose bid which has not been amended and, without extension, remains open until the 29th March. Nevertheless, my own view on the Melrose bid is that it is now dead in the water. Indeed, from a value perspective alone, it seems to me inconceivable that GKN shareholders would choose to vote against the surety that is provided by the proposed transaction with Dana covering the Driveline division.
GKN shareholders should note that the company had previously announced in respect of Aerospace core target margin being at least 14% for the year ending 31 December 2020 (excluding corporate costs) and that the business will progress the work already started on Project Boost, a strategy that targets a £160 million of recurring annual cash benefit from the end of 2020. The company has also said that it believes that $13.5 billion of cash flow will emanate from aero engine RRSP’s (Risk Revenue Sharing Partnerships) – this being a reference to the Pratt @ Whitney 1100 and 1400 engine involvement from now until 2055. This should clearly be seen by GKN shareholders as a massive potential long term annuity.
The GKN Board remains fully committed to its previously announced target of returning up to £2.5 billion to shareholders over the next three years and that subject to approval by shareholders, following completion of the GKN Driveline/Dana combination, this will be further underpinned by the significant net cash proceeds received under the proposed transaction. Importantly, GKN Aerospace dividend policy will be to target an average pay-out of 50% of free cash flow over the period of 2018 to 2020, adjusted to take account of the Proposed Dana Transaction and other non-core disposals. GKN Aerospace also expects to distribute surplus cash to shareholders, subject to maintaining an investment grade credit rating.
Finally, looking to the future, it is I believe appropriate here to provide some detail on GKN’s primary Aerospace related activities:
GKN’s Aerospace is a leading global tier one supplier of specialty aerostructures, aero engine systems and specialist technologies, including wiring transparencies and ice protection systems. Its technology enhances the performance and efficiency of the world’s leading commercial and military aircraft. Over the last decade, the Aerospace division has increased the revenue from £0.69 billion in 2006 to £3.64 billion in 2017. The division has grown significantly in recent years and has diversified activities through acquisitions such as that of Filton (2009) from Airbus, Volvo Aero in 2012 and in 2015, that of Fokker Technologies.
Structures (Accounting for 51% of GKN Aerospace 2017 sales)
GKN Aerostructures is a trusted Tier One supplier of wing structures, fuselages, empennages and components to major OEMs, holding the number 2 global position in the global Aerostructures market.
Aero-Engines (Accounting for 33% of GKN Aerospace 2017 sales)
GKN Aero-Engines is a Tier One provider of high performance metallic and composite structural engine components. GKN Aero-Engines holds the number 2 global position in the Engine systems market and is a partner on 70% of all active aircraft engines in the commercial market. Approximately 60% of GKN’s Aero-Engine sales are derived from risk and revenue sharing partnerships (RRSPs) and net cash flows from RRSPs are expected to total approximately $13.5 billion from 2018-2055.
Specialist Niche Positions (Accounting for 16% of GKN Aerospace 2017 sales)
GKN’s Specialist Niche Positions activities comprise Electrical Wiring Interconnect Systems, Transparencies, Fuel & Flotation Tanks and Services businesses. GKN’s Electrical Wiring Interconnect Systems and Transparencies businesses are among the leading suppliers of wiring and canopies and GKN’s Services business is a leading supplier in third party aftermarket services for regional aircraft.
CHW (London – 12th March 2018)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785