Harris Corporation has signed a definitive agreement to acquire US aerospace and defence engineering firm Exelis for US$4.75bn.
Under the terms of the transaction, Harris will pay a total purchase price of US$23.75 per share, split 70/30 in cash and…
Harris Corporation has signed a definitive agreement to acquire US aerospace and defence engineering firm Exelis for US$4.75bn.
Under the terms of the transaction, Harris will pay a total purchase price of US$23.75 per share, split 70/30 in cash and stock. The offer represents a 34% premium on Exelis’ closing share price the day before the deal was announced and a 36% premium on the 3-month trailing average.
The price also represents a valuation multiple of 9.3 times Exelis’ 2014 EBITDA guidance.
Exelis shareholders will receive US$16.625 in cash and 0.1025 of a share of Harris common stock, based on Harris’ closing price as of 5 February 2015, for each share of Exelis common stock they own.
Upon closing, Harris shareholders would own 85% and Exelis shareholders 15% of the combined company.
The takeover has been unanimously approved by the boards of both companies and is now subject to approval from Exelis’ shareholders as well as customary closing conditions. The transaction is expected to close in June 2015.
Commenting on the deal, William Brown, chairman, president and chief executive officer of Harris, said: “Acquiring Exelis is transformational for Harris. The combination of the two companies’ highly complementary core franchises creates a competitively stronger company with significantly greater scale.
“We are expanding in a market where we have decades of success and a workforce dedicated to providing our customers with innovative and cost-effective solutions for some of their most complex challenges.”
To fund the deal, Harris has secured a US$3.4bn fully committed bridge financing from Morgan Stanley. The company expects to put in place permanent financing in the form of term loans and unsecured bonds prior to closing.
The debt will give the combined company a leverage of around 2.9 times net debt to pro-forma adjusted EBITDA. However, Harris expects to rapidly de-lever over the next couple of years and believes it can bring net leverage down to 1.5x by year three. This will be supported by anticipated free cash flow generation of up to US$1bn within four years of the merger.
Harris believes the transaction will be slightly GAAP EPS accretive in the first full year and a significant contributor thereafter. The company has identified pre-tax cost synergies of between US$100m and US$120m, with savings expected to achieve annual run-rate by year three.
These savings are mainly expected from consolidating headquarters, eliminating public company costs and an improvement in operational and functional efficiencies, including potential overhead reductions.
On a pro forma basis for the latest twelve months ended 31 December 2014, the combined company would have had more than US$8bn in revenue and about 23,000 employees globally, including 9,000 engineers and scientists.
Morgan Stanley is financial adviser to Harris on the transaction with Sullivan & Cromwell its principal legal counsel. JP Morgan is advising Exelis and Jones Day is its legal counsel.
Kick starting defence contractor consolidation?
The acquisition of Exelis significantly shifts Harris’ position as a US defence contractor. The combined company will become the second largest tier 2 contractor behind L3 Communications and it will be better far positioned to compete for much larger, more complex DoD programmes.
Harris also believes that the merger will position it to take advantage of a shift in US defence spending, which has notably declined in recent years.
In an investor call, Harris CEO Brown said: “The timing is also excellent from an external point of view. The US government spending cycle has bottomed, and recent world events only stress the importance of defence and national security spending. The President’s DoD base budget for FY16 is up about 8%, and even under sequestration, is up modestly with steady growth in the out years.”
The squeezed budgets of the past couple of years predominantly benefitted the prime defence contractors like Lockheed Martin, Boeing and General Dynamics. The lack of organic growth for the smaller players led to a host of analysts predicting that a wave of consolidation was inevitable.
However, until last year’s merger of ATK and Orbital Sciences, transformational M&A in the sector was conspicuous by its absence.
With the defence budget now thought to have hit an inflection point and the cost of financing deals at historic lows, some analysts are back beating the consolidation drum.
The Pentagon has indicated on numerous occasions that while it would not support a merger of the major players, it does not have the same hang ups about mid-tier defence contractors. Maintaining competition is key but if the ATK – Orbital and Harris – Exelis deals pass without regulatory intervention then more horizontal deals could follow.
