Ge and wabtec merger good news already priced in – general electric company (nyse ge) seeking alpha gas up shawty


General Electric ( GE) is making progress to reduce the complexity of the business and raise much needed cash in the process. The company announced that it is merging its transportation business with pure-play Wabtec ( WAB) in order to create a giant in rail equipment, services, and software.

The deal makes sense for both businesses, mainly as a quarter of a billion in synergies are being projected. I like the deal although much good news has already been priced in. While GE stresses the high price received for the assets, I fail to see how this helps GE to deleverage a great deal as much of the proceeds will directly go to GE shareholders who are granted a direct share in Wabtec, thereby not solving a lot of financial headaches for GE, despite a near three billion one-time payment. The Deal

GE has reached an agreement to merge its transportation business with that of Wabtec, as it will hold 50.1% of the shares in the combined company, as well as receive a $2.9 billion cash component for the business. Both companies report a deal tag of $11.1 billion based on Wabtec’s share price dated April 19, the last day before media reports surfaced about a potential deal (unaffected price). Note that the vast majority of GE’s stake will be spun off to investors in GE, as GE itself will own just 9.9% of the shares going forward.

The company announces that the deal will create an $8 billion business which will become more diversified and furthermore see a 15% accretion to cash earnings per share in year one. The greater diversification is a major plus as $250 million in synergies make the deal interesting as well, equivalent to roughly 3% of combined revenues. Who Is The Winner? Both?

The reason for that is simple, as GE Transportation reports adjusted EBIT margins of 18%, some five points more than Wabtec. Hence the reason why the GE business is valued at $11.1 billion. In comparison, Wabtec itself was valued at $8.1 billion at $84 per share ahead of the deal. Including $1.6 billion in net debt, Wabtec was valued at $9.7 billion.

That suggests that GE was awarded a 15.8 times EBIT multiple, while same logic dictates that Wabtec traded at a 19.1 times multiple. At least both sets of shareholders have something to be happy for in that case, being very reasonable multiples, while they share equally in the synergies.

The pro forma business operates with $4.4 billion in net debt following the cash payment to GE. This works out to a 3.1 times leverage ratio based on pro forma EBITDA of $1.4 billion, so that should probably be no major cause for concern, especially as this excludes synergies, and both businesses seem to enjoy some operating momentum currently.

Adjusted EBIT margins for 2017 came in at 15% on a combined revenue basis of $7.8 billion, for an adjusted EBIT number of $1.17 billion. Assuming 4% cost of debt on $4.4 billion in net debt and working with a 20% tax rate, after-tax earnings might come in at $795 million. With the share count of 96 million essentially doubling, that works out to $4.15 per share in earnings power on a pro forma basis. That is indeed much greater than the $3.43 per share in adjusted earnings being reported for 2017 by Wabtec. The calculations show that earnings per share might increase by 21%, confirming the outlook of both businesses which calls for earnings per share growth of at least 15%.

Furthermore, cost synergies of $250 million could boost after-tax earnings by $200 million. That would be equivalent to another $1 per share in potential earnings accretion, creating a road map for $5 in earnings per share in the years to come.

I have been constructive on Wabtec in the past, given that it made nice bolt-on deals, margins were high and stable, while it operates in a niche segment. This mega deal is really a transformative transaction, essentially doubling the business.

While synergies might be worthwhile, they are not massive and thereby not a game-changer in this respect. As discussed above, the deal has the potential to boost earnings to $4-5 per share in the coming years, but trading at $100, one can hardly argue that shares are very cheap amidst upcoming integration charges, a +20 times forward multiple, with leverage standing at 3 times already.

Part of the "lack of appeal" at these levels in the share price of Wabtec is the result of the run higher seen already. Since rumours about a deal started a month ago, shares have risen some $15 which is equivalent to nearly $3 billion in shareholder value being created (including the shares issued to GE/GE’s shareholders). This amount is very substantial in relation to the advertised synergies.

For investors in Wabtec, most of the good news has been priced in. For GE, that is a bit different. While everyone is very enthusiastic on the side of GE, it seems that this needs some second thoughts. GE will own a combined 9.9% of the business going forward, which works out to roughly 19 million shares with a current value of $1.9 billion. Including the cash component of $2.9 billion, the company could see cash inflows of $4.8 billion, if it monetised the stake in Wabtec. The other shares which represent the slight majority of the deal tag will be granted to GE’s shareholders directly. That works out to 77 million shares, or less than 0.01 share of Wabtec for every share held by shareholders in GE. While that sounds like a lot, that is still equivalent to $0.85 for each share of GE.

So, I fail to see how this makes things look much better for GE. For starters, the transportation business was no real "problem child¨ in terms of the finances (to the degree the power business or GE Capital is), while it was a reasonable earnings contributor. As such, the business is shedding $700 million in adjusted EBIT for cash proceeds of just $4.9 billion, while the company´s shareholders will directly receive the remainder of the proceeds through a share ownership in Wabtec. So while absolute debt levels of GE will come down, I doubt that the same can be said for the relative leverage ratios, thereby warranting my cautious reaction to the deal announcement from GE points of view.