Takeaways From a $15 Billion Buyout Bust
(Bloomberg Opinion) -- Arconic Inc.’s failure to sell itself after months of negotiations doesn’t bode well for a sale of General Electric Co.’s jet-leasing unit. The alleged buyer in both of those situations is Apollo Global Management. In the case of Arconic, the private equity firm beat out a rival consortium only to see its $15 billion bid for the metal-parts manufacturer fail at the one-yard line. Apollo has also reportedly been talking to banks about a purchase of all or part of GE Capital Aviation Services, or GECAS.
Personally, I think Apollo dodged a bullet when the Arconic deal fell through; loading up a cyclical company with debt just as the economy appears to be cooling seems like a questionable strategy. But according to the Financial Times, the Arconic deal fell apart because the board felt Apollo wasn’t committing enough funding for the company’s pension liabilities and was concerned that the added leverage from a buyout would raise red flags with pension regulators. The two sides had reportedly reached an agreement for handling potential liabilities related to London’s Grenfell Tower fire, whose rapid spread was blamed on Arconic-made combustible cladding. A GECAS deal and an Arconic buyout are apples and oranges, but I think it’s fair to point out that the former would require meaningfully higher capital commitments and entail a higher degree of risk.
Apollo does own a jet lessor already in Merx Aviation, but a deal for all of GECAS would represent a significant escalation of its ambitions and be a major bet on the sustainability of air-traffic demand. An investment-grade credit rating is quite helpful for jet lessors, so a leveraged buyout in and of itself is an odd way to go. JPMorgan Chase & Co. analyst Steve Tusa has pointed out that the debt at GE Capital is tied to the parent company, so there’s no GECAS-specific debt that can travel with a stand-alone entity. That means Apollo would need to raise enough cash up front to fund the entire deal, with Tusa estimating an enterprise value in the ballpark of $30 billion. Apollo’s Arconic bid was reportedly fully financed at a valuation of $10.7 billion excluding debt, but high-yield debt markets are only just showing signs of thawing and a meaningfully higher equity check could prove difficult to fund. Reuters reports Apollo may tap its investors and annuity provider Athene Holding Ltd. It’s also worth mentioning that GECAS is on the hook to fill committed orders and that would obligate Apollo to make heavy capital expenditures.
MIDNIGHT TRAIN GOING ANYWHERE
Elsewhere in GE news, the company announced on Friday that it was rejiggering the terms of its transportation unit’s merger with Wabtec Corp. GE is reducing the equity interest in the combined company that its shareholders will receive via a spinoff and keeping a bigger stake for itself. The point here is to give GE more cash that it can use to chip away at its estimated $100 billion in net liabilities. I give new CEO Larry Culp credit for recognizing that the breakup plan his predecessor John Flannery carefully crafted to give equal consideration to shareholders and creditors was lacking. The Wabtec deal rethink suggests we could see a similar revision to GE’s planned divestiture of its health-care business. Flannery had proposed selling a 20 percent stake via the public markets and spinning off or splitting out the rest to shareholders; it would be financially wiser for GE to scrap the spinoff part of that plan and raise more cash, or hold on to the business as one of its best cash-generating assets and do an equity raise instead. Apart from the mechanics, it’s hard to avoid the impression that the last second do-over on the Wabtec deal and a string of other drastic cash-raising activities signal greater balance sheet woes than investors are currently pricing into the stock.
A MIXED BAG
Earnings were all over the map this week in the industrial sector. On the one hand, you had companies like United Technologies Corp. and United Rentals Inc., which reported strong numbers and gave generally upbeat 2019 outlooks for themselves and their industries (although United Technologies did call out Europe as a region to watch). On the other hand, Stanley Black & Decker Inc. saw the biggest-ever plunge in its stock after the company’s weaker-than-expected 2019 earnings guidance and warnings of decelerating growth spooked investors who may have viewed it as a more of a defensive stock in a slowdown. “Reality is setting in,” said Stanley CEO Jim Loree. Industrial distributor W.W. Grainger Inc. also declined amid signs of wobbling volume growth and ongoing margin pressure as it adapts to competition from Amazon.com Inc. So what to make of this? I think Loree is right that economic momentum is waning, but that doesn’t mean there aren’t still pockets of strength, and it’s logical that this slackening would first hit shorter-cycle companies like Stanley and those with structural challenges like Grainger. Elsewhere, here’s an interesting read on the Bloomberg Terminal about the correlation between semiconductor and machinery stocks and Citigroup’s prediction that the deep estimate revisions in the latter sector are creating buying opportunities.
DEALS, ACTIVISTS AND CORPORATE GOVERNANCE
United Technologies Corp. addressed the shelved sale of its Chubb fire-safety and security business on its earnings conference call this week. “Frothy” markets last year convinced the company to explore a divestiture of the business, but “choppy” markets in November and December kept it from getting the price it wanted, said CEO Greg Hayes. “We weren’t going to give the business away,” he said. The Chubb divestiture would have been relatively small in the context of United Technologies: the company was reportedly seeking about $3 billion for the business. More significant are the potential implications from this stalled sale for a bigger deal for United Technologies’ Carrier building-controls business. Hayes says keeping Chubb in the fold won’t hamstring Carrier’s ability to participate in consolidation opportunities. A combination with Johnson Controls International Plc or Lennox International Inc. are two possibilities that have been debated by analysts.
RPC Group Plc agreed to sell itself for $4.3 billion to Apollo Global Management, which is really making the rounds in this week’s newsletter. The U.K.-based packaging company is accepting a measly premium from Apollo, notes my Bloomberg Opinion colleague Chris Hughes, but it likely had limited leverage to push for more given the slump in its share price of late amid questions about a roll-up M&A strategy that seems to have added more complexity than cash flow thus far. Apollo must be more comfortable with RPC’s future-cash generating abilities than the bevy of short-sellers wagering against the company, Chris notes. Some shareholders are now saying they, too, felt confident in the company’s growth prospects and think RPC should have pushed for a price that would compensate investors for that recovery.
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Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
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