EPD purchase positions Ultra in new expanding market
Ultra's acquisition of Kratos’s EPD business reflected electronic warfare as a growth opportunity in which it was underrepresented and where the model was suited to its approach. The business bolts on to the Communications & Security division.
EPD provides access to growing market
EPD, renamed as Ultra Electronics Herley Industries, designs and manufactures RF and microwave integrated systems and subsystems for use in Electronic Warfare (EW), radar, communication, missile, flight test and simulation applications. The acquisition positions Ultra in the expanding US EW market, forecast to grow at >3% pa, with several sole source positions on a wide range of platforms such as the P-8A Poseidon, Trident II D5 Missile, F-16 Fighting Falcon, EA-18G Growler, SEWIP and Eurofighter Typhoon. While certain programmes are winding down, in particular the EA-18G Growler, the business is well positioned for opportunities on important future programmes such as the F-35 JSF and other key US national defence and security programmes.
Blue chip customer base further strengthens Ultra’s relationships, provides opportunity
EPD operates as a Tier III/Tier IV supplier into customers ranging from Tier 1 defence primes such as Northrop Grumman, which accounted for c 25% of revenue over the last three years, Lockheed Martin (13%), Raytheon (5%) and Boeing (3%) to a broader range of government and Tier II players, none of which account for more than 2% of sales. Ultra has established relationships with a number of these players through its C2ISR segment. However, the mission-critical nature of EPD’s products provides even closer ties. Through Ultra’s due diligence, management confirmed that the business was well respected for its technical solutions, as shown by a 96% business retention rate. Key to Ultra’s opportunity is increasing the win rate on new business, which stood at around 54%, and driving additional cross-selling opportunities.
Terms of the deal, earnings enhancing in first full year
Ultra paid $260m on closing on 24 August after receiving US antitrust and CFIUS clearances. An additional $5m cash is likely to be paid as a result of a long-term tax election expected to be made within 12 months. EPD generated revenues of c $118m in 2014, EBITDA of $22m and PBT of $11m with annual capex and depreciation of c $4m pa. Cash conversion is broadly in-line with that generated group-wide at Ultra.
While EPD’s revenues have declined over the past three years in line with much of the US defence industry, this stabilised over the previous two years and margins have been maintained. We forecast a broadly stable trend during our forecast period with $8m of recurring pre-tax synergies to be delivered in outer years from production efficiencies, site rationalisation and eliminating duplicated overheads. These will begin to kick in from 2017 and are tied to the planned cessation of certain programmes such as the EA18-G Growler.
Following the early refinancing of the £100m facility that is now extended to August 2019 at a rate matching the favourable pricing of the £200m facility, we expect a modest benefit to interest payable. Ultra’s headroom on current facilities is £157.2m with an additional £79.5m on the uncommitted Pricoa bilateral facility. Post-acquisition, we forecast that 2016 net debt:EBITDA will be c 1.7x, providing a comfortable level of headroom on covenants.
The deal will be funded from Ultra’s existing facilities and a new four-year term loan provided by Ultra’s banking group on similar terms and covenants to its existing facilities.
Furnace Parts acquisition a small technology bolt-in to nuclear
In early October, management announced the much smaller $12m bolt in acquisition of Furnace Parts, a manufacturer of thermocouple-based sensors that complements Ultra’s existing nuclear portfolio. In our view, while relatively small in terms of financial impact, this again highlights a determination to develop the eight clusters that now drive Ultra.
Exhibit 3 below summarises our updated forecasts.
Exhibit 3: Updated Edison forecasts
|
|
2014 |
2015e (old) |
2015e (new) |
2016e (old) |
2016e (new) |
Sales (£m) |
|
|
|
|
|
|
Aerospace & Infrastructure |
198.6 |
- |
187.4 |
- |
193.0 |
Maritime & Land |
290.7 |
- |
300.9 |
- |
306.9 |
Communications & Security |
224.4 |
- |
242.8 |
- |
297.9 |
of which EPD |
|
- |
- |
16.1 |
- |
64.4 |
Total Sales |
|
713.7 |
715.8 |
731.0 |
734.4 |
797.7 |
Operating Margin |
|
|
|
|
|
|
Aerospace & Infrastructure |
14.9% |
- |
14.9% |
- |
14.9% |
Maritime & Land |
17.7% |
- |
17.2% |
- |
17.5% |
Communications & Security |
16.5% |
- |
16.2% |
- |
16.8% |
Group Margin |
|
16.5% |
16.5% |
16.3% |
16.5% |
16.6% |
Underlying operating profit (£m) |
|
|
|
|
|
Aerospace & Infrastructure |
29.6 |
- |
27.9 |
- |
28.8 |
Maritime & Land |
51.5 |
- |
51.7 |
- |
53.7 |
Communications & Security |
37.0 |
- |
39.3 |
- |
50.0 |
of which EPD |
|
- |
- |
2.7 |
- |
11.6 |
Total Underlying Operating Profit |
118.1 |
118.2 |
119.0 |
121.4 |
132.5 |
Underlying finance costs |
(6.0) |
(6.0) |
(8.5) |
(5.0) |
(13.8) |
Underlying PBT (£m) |
|
112.0 |
112.2 |
110.5 |
116.4 |
118.7 |
Tax |
|
(26.0) |
(25.8) |
(25.4) |
(26.8) |
(27.3) |
Underlying Tax rate |
|
23.2% |
23.0% |
23.0% |
23.0% |
23.0% |
Minorities |
|
14.3 |
0.0 |
0.0 |
0.0 |
0.0 |
Underlying net income |
|
100.3 |
86.4 |
85.1 |
89.6 |
91.4 |
EPS (p) |
|
123.1 |
122.7 |
121.6 |
127.3 |
130.6 |
Source: Edison Investment Research
We see a broadly neutral EPS impact of the acquisitions in 2015, followed by a c 2% accretion in 2016. As further synergies are delivered in outer years, we anticipate further growth potential beyond our forecast horizon. Our forecast for the continuing businesses in FY15 is modestly reduced, reflecting the modest margin pressures at the half year. However, we expect this to start reversing modestly in H116.