Reuters | DealTalk: After L-3, activists drool over Textron
June 29, 2011 § Leave a comment
By Soyoung Kim and Nadia Damouni
Published: 28 June 2011
(Reuters) – Cessna aircraft maker Textron Inc (TXT.N) could be a prime target for activist investors scouring the aerospace and defense industry for breakup targets as activists move up the food chain.
Until a few months ago, shareholder activism in defense was largely focused on smaller targets, as investors took positions in companies with niche security technologies that larger military contractors might want to buy.
But emboldened by some success, activist investors are increasingly trying to shake up larger contractors, whose shares have languished on fears of softening military spending as the U.S. wars in Iraq and Afghanistan wind down.
Textron, a $6.2 billion diversified conglomerate, makes products ranging from Bell helicopters and Cessna aircraft to automotive parts and golf carts, while a subsidiary finances sales of them.
Over the last several years, each one of Textron’s major business lines has been a drag on the overall company at some point, making it vulnerable to breakup pressure, several activist investors, bankers and industry experts said.
“There is no one in the activist space who hasn’t looked at it and licked their lips,” one activist investor said. “It falls under the rubric of what the activists do a lot — which is the diversified conglomerate doesn’t get a fair multiple unless it is a mega cap.”
“The only people that make it work is United Technologies (UTX.N) or Honeywell (HON.N),” the investor said, referring to the other conglomerates with big presence in defense.
Cessna continues to suffer from weak business jet demand as well as increased competition from new and existing rivals, while the financing division has been burning cash several quarters. Although defense-related contracts have supported Textron’s earnings lately, that division is also facing headwinds from military spending pressures.
Textron did not respond to requests for a comment.
Other defense names that could face activist pressure for a sale or breakup include Motorola Solutions Inc (MSI.N) and Harris Corp (HRS.N), people familiar with the industry said. Activists could still also look at smaller targets like Comtech Telecommunications Corp (CMTL.O) or Kratos Defense and Security Solutions (KTOS.O), they added.
Last year, hedge fund MMI Investments LP urged longtime takeover target Applied Signal Technology to solicit buyout offers, resulting in a $490 million sale to Raytheon Co (RTN.N). MMI was also behind the $506 million sale of satellite firm EMS Technologies (ELMG.O) to Honeywell this month.
But Ralph Whitworth of Relational Investors LLC set his sights higher earlier this year, when he pressured the large industrial conglomerate ITT Corp (ITT.N) to split up.
Relational returned last week with yet another high-profile push in the sector, reporting a nearly 6 percent stake in L-3 Communications (LLL.N) and urging the defense contractor to divest assets to unlock value.
Activists are also circling Motorola Solutions, which has a market value of $15.4 billion and makes safety communication products and services for government and enterprise customers.
Hedge fund ValueAct Capital recently reported a 5.9 percent stake in the company, which was split off from handset maker Motorola and already counts billionaire investor Carl Icahn as its top shareholder.
BIG BET ON CESSNA?
The argument for breakup is not that clear for some other companies, however, as any upside from a split would have to be big enough to offset a tax hit.
ITT was a textbook case since it had three very different segments — water purification, industrial components and defense electronics. While defense generated only half of total revenue, uncertainly about U.S. budget cuts held back the entire company’s share performance.
In contrast, L-3’s businesses are all defense-related and depend heavily on the U.S. government. The company was already planning to divest some lower-margin services assets to focus on electronics and intelligence.
Moreover, with an enterprise value of around $12.7 billion, L-3 trades at 6.7 times estimated 2011 earnings before interest, taxes, depreciation and amortization. That’s more expensive than giant defense conglomerates like Lockheed Martin Corp (LMT.N), Raytheon or Northrop Grumman Corp (NOC.N), which trade at multiples of 5 to 6.
Some activist investors and bankers questioned whether Relational’s involvement would make a marked difference to what L-3 was already planning on doing.
“I’m not sure if there’s going to be a significant value creator,” said an industry banker who requested anonymity because he was not authorized to speak with the media. “It’s already trading at a decent premium to peers.”
Like ITT, Textron has diverse businesses that do not necessarily fit with one another. But at around 7.4 times estimated 2012 EBITDA, Textron is trading like an aerospace company, rather than a defense company. United Technologies and Honeywell trade at about 8.5 times 2012 EBITDA, above the sector average of about 8.
Textron would look cheap, activist investors and experts said, if one believes that the Cessna aircraft unit is in for a big turnaround as commercial aviation picks up.
“The difference between Textron and ITT is that Textron is expensive and for you to believe it you are betting on a recovery in commercial aviation. Whereas in ITT, you didn’t have to bet on anything,” said a second activist investor who declined to be identified.
“Textron could make sense if the Citation business comes back. It has fallen off the cliff,” the activist said, referring to the Cessna business jet unit.