By Ilya Korzinkin, Mihir Gupta, Hugo Tay, Siddharth Sharma (University College London) | 4/03/20
Overview of the deal
Acquirer: Woodward Inc.
Target: Hexcel Corporation
Estimated value: $6.4bn
Announcement date: January 12, 2020
Acquirer Advisors: JP Morgan Chase LLC
Target Advisors: Goldman Sachs & Co.
Woodward (WWD) will combine its operations with Hexcel (HXL) in an all-stock transaction that gives it a controlling stake in the merged entity, creating one of the world's biggest aerospace and defense suppliers.
The transaction, which the suppliers to Boeing (BA) and Airbus (EADSY) assure is a merger of equals, will create a company under the Woodward-Hexcel name with annual revenue of more than $5 billion. While suppliers are hurting because of Boeing's issues after the 737 Max disasters, executives assure that they are driven by the pursuit for more-efficient engines over the next 20 years, and by no means by Boeing’s recent troubles. Hexcel shareholders will get 0.625 of Woodward stock for every share held, which values Hexcel at $6.4 billion or about $76.23 a share, based on Woodward's closing price the date of the announcement, a 4.5% premium from Hexcel's last traded price. Woodward investors will continue to own the same number of shares, or about 55% of the combined company. The new entity will be headquartered in Fort Collins, Colorado, where Woodward is based, while Hexcel is located in Stamford, Connecticut. Woodward's Chairman and CEO Tom Gendron will take the role of executive chairman for one year from the close of the deal, then switch to non-executive chairman for another year before handing the reins to Stanage. The board of 10 will include five directors from each company.
The deal extends a years-long rush to consolidation within the defense industry. It's the sector's ninth merger of at least $1 billion announced over the past year, according to data compiled by Bloomberg. Woodward itself has previously been the subject of deal speculation, and in 2018 the company denied a Wall Street Journal report that it was in talks with Boeing.
Woodward, Inc. is the world's oldest and largest independent designer, manufacturer, and service provider of control systems and control system components (e.g. fuel pumps, engine controls, actuators, air valves, fuel nozzles, and electronics) for aircraft engines, industrial engines and turbines, power generation and mobile industrial equipment. Woodward parts were notably used in the GE engine on United States military's first turbine-powered aircraft. Starting in the 1950s, Woodward began designing electronic controls, first analog and then digital units.
Founded in: 1870
CEO: Thomas A. Gendron
Number of Employees: 9000
Market Capitalization: $ 6 830 M EV: $7 587 M
Revenue: $2 900 M EBITDA: $119 M
EV/Revenue: 2.62x EV/EBITDA: 63.75x
Hexcel Corporation is an American public industrial materials company, based in Stamford, Connecticut. The company develops and manufactures structural materials including carbon fiber. The company sells its products in commercial, military and recreational markets for use in commercial and military aircraft, space launch vehicles and satellites, wind turbine blades, sports equipment and automotive products. Hexcel works with Airbus Group, The Boeing Company, and others. Since 1980, the firm has publicly traded on the New York Stock Exchange under the ticker symbol HXL.
Founded in: 1948
CEO: Nick L. Stanage
Number of Employees: 6260
Market Cap: $ 5, 760 Million EV: $6 561 M
LTM Revenue: $2 370 Mil LTM EBITDA: $132 M
LTM EV/Revenue: 2.76x LTM EV/EBITDA: 49.7x
Projections and Assumptions
Short Term Consequences
Questions arise surrounding workers and job security naturally arise, due the risk of diseconomies of scale being realised by Hexcel- Woodward’s largely overlapping operations. However, in an official statement to its workforce Hexcel dispelled any fears of redundancy or career collateral in: “We do not anticipate layoffs in our manufacturing operations as a result of the merger.” This largely due to Management’s the belief that the increased overall operations volume resulting from this merger will eliminate any need for department cross- cannibalisation, as the NewCo is projected to target a larger market overall.
The merger is also likely to create a stronger strong cash flow position, and a more robust balance sheet for the NewCo. Woodward Hexcel will have more than $5 billion in revenue, management- projected industry-leading EBITDA margins, and approximately $1 billion of free cash flow in the first full fiscal year. The more robust balance sheet is expected to result in roughly $1.5 billion of capital expected to be returned to shareholders within 18 months of merger completion, demonstrating the merger’s potential value creation.
Long Term Consequences
From the strategic point of view, this deal creates three main areas of synergies in the long run.
The merger creates a leading company best placed to build forward-looking technologies to meet the changing needs of customers. The deal brings together industry leaders in innovative materials and control systems to create a leading aerospace and industrial group well placed to satisfy customer demands for aircraft aerodynamics, energy efficiency, improved safety, and pollution and noise reduction. The combined company plans to spend about $250 million on research and development in the first full year after completion. It will have more resources to invest in emerging technologies to help next-generation aerospace customer projects and drive progress in aerodynamics, propulsion, and energy efficiency.
The merger also creates a more diversified and well-balanced portfolio. This allows the company to access a broader customer and investor base given the strong positions of each company on the best-in-class product markets, allowing the company to have greater depth and alignment of customer relationships across the aerospace and industrial sectors, with substantial potential for cross-selling and improved customer relationships. The deal incorporates the excellent OEM positions of both firms, Hexcel's structural composite dominance, and Woodward's industry-leading aftermarket positions to achieve consistent top-line growth and cash flow production through system life cycles.
Finally, Woodward and Hexcel share similar values and strong track record of high-impact R&D activity and can combine the strengths of their teams and a mutual view on operational excellence to bring innovative products to the market while improving on operating margins. Financially speaking, The merged company is expected to generate more than $125 million in annual cost synergies by the end of the second full fiscal year, mainly through competitive procurement initiatives, reducing duplicative operational expenses, optimizing its global footprint and resources, and expanding shared service networks.
Risks and Uncertainty
In the light of the all- stock deal structure, one of the primary risks that would arguably be posed to both firms is their supply side consolidation in an industry where both of them are OEM’s in their own capacities (Original Equipment Manufacturers). The risk is that of a trade-off between choosing less complexity and potentially accepting higher risk. In an industry with the likes of aerospace and aircraft building whereby both custom and complex manufacturing is required, one of the main questions to be asked is the viability behind management’s decision to reduce the number of specialist suppliers and amalgamate it with the risks of shrinking the overall supply base.
Secondly, both of the companies have deep roots with Boeing. While Boeing is Hexcel’s second biggest customer, accounting for 25% of its annual sales, Woodward too gets approximately 15% of its annual sales from Boeing making it its biggest customer. Given this state of dependency, it is for obvious reasons that one would worry the potential struggles the merged company might have to face because of the after effects of the grounding and halted production of Boeing Company’s 737 Max. Even if we were to keep the 737 Max issues aside, there has been a growing pressure on the overall aerospace supply chain, whereby Boeing in the recent years has been moving towards in-sourcing more components in order to lower costs and discount inventory, which has had and can have a deeper negative impact on the balance sheets of the component suppliers.
Thirdly, following the announcement of any merger, pertinent questions surrounding the issue of job security tend to rise and Woodward in that case has issued a rather loose-ended statement with regards to managing its employee base post the merger. This has allowed analysts to garner a speculative stance with regards to the employee situation. Lastly, following the remarks of Tom Gendron who is the present CEO of Woodward Inc., with regards to the “huge pressure on the aerospace industry to reduce greenhouse gas emissions,” there is thought to be great pressure on behalf of climate lobbyists on the manufacturing unit to improve its combined propulsion and aerodynamic efficiency in order to reduce the carbon footprint.