Events: Deal(s) Overview
August 7, 2016
- NYSE: JCI
- Recent PPS: $45.52
- Shares Out: 639.71 million
- Market Cap: $29,120
- Debt: $7,027
- Enterprise: $36,147
- 2016 EV/EBITDA: 7.9x
- 2016 PE: 11.5x
- NYSE: TYC
- Recent PPS: $45.32
- Shares Out: 426.18 million
- Market Cap: $19,315
- Debt: $2,559
- Enterprise: $21,874
- 2016 EV/EBITDA: 13.6x
- 2016 PE: 22x
Summary. Johnson Controls is merging with Tyco International in early September (S-4 went final 7/6/16; shareholder vote is 8/17/17) then spinning off its Automotive Experience segment (Adient) to NewCo shareholders soon after. Post-Adient (seat manufacturer), NewCo will be a diversified industrial with $31.9 billion of 2016 revenue derived from the following segments: HVAC & Controls (~45%), Fire & Security (~30%), and Power (~25%). The Companies expect $500 million of operational synergies within three years, as well as yet-to-be-quantified revenue synergies. On a combined basis (with some estimates on my end), JCI and TYC management teams project top-line growth of approximately 6.2% and EBIT growth of 11.8% thru 2020.
Adient is projected to generate $16.7 billion of revenue and $1.6 billion of EBITDA in 2016. Projected growth is ~0% thru 2020.
Capital Structure. Post TYC and Adient, NewCo will be modestly levered at 2.68x gross debt to 2016 EBITDA. Adjusting the balance sheet for TYC-related intangibles (including GW), tangible net operating assets are $19.4 billion. With an estimated $2.93 billion of 2016 NOPAT (before synergies), ROTC is approximately 15.1%. Excess OpCo cash will represent approximately 3.5% of NewCo (pre-Adient), assuming a $46 stock price.
Adient will be levered 1.85x net debt to 2016 EBITDA post-$3 billion dividend to NewCo ($3.5 billion total debt and $500 million of retained cash).
Tyco Deal Structure
JCI. Current JCI shareholders have the option of choosing $34.88 in cash, some combination of cash & NewCo stock, or all NewCo stock. With JCI currently trading above $34.88 the choice is moot. Approximately 110.8 million JCI shares will be converted into the right to receive $34.88 in cash ($6.04 pro rata to all shareholders), thus retiring the shares and leaving 528.93 million of equivalent NewCo shares, for an approximate ownership of 56.51%.
Because the cash portion is not a simple dividend, it can get a bit muddled. JCI’s current market cap of $29,120 can be broken down as follows:
- $29,120 Market Cap = 639.71 million shares x $45.52 stock price
- $3,864 Cash = 110.8 million ‘cash shares’ x $34.88 per share cash consideration
- $25,256 NewCo Stake = 528.93 million ‘NewCo shares’ x $47.75 implied NewCo (pre-Adient) stock price
As such, JCI’s current stock price is comprised of: $6.04 cash + $39.48 NewCo = $45.52.
(Important for later valuation calculations – 528.93 NewCo shares are 82.7% of total JCI shares out.)
TYC. Just prior to the merger TYC will effect a reverse stock split of .955 per current TYC share, leaving 407 million of equivalent NewCo shares, for an approximate ownership of 43.49%.
Using the $47.75 NewCo price as implied above, the ‘deal value’ for TYC shareholders is $45.60 (.955 x $47.75), versus Friday’s closing price of $45.32.
NewCo. Post-TYC transaction, NewCo will have approximately 935.93 million shares outstanding and can be broken down into the following parts:
- OpCo = Legacy JCI Industrial + Legacy TYC Industrial
- Excess Cash = 75% of pro forma cash on hand
Adient. Before looking at NewCo’s fair value and implied PE via JCI’s stock price, a quick fair value estimate for the Adient spin.
Per the S-4, Adient will generate $1.3 billion of EBIT in 2017. And assuming $3 billion of net debt at a 5% rate and a 25% tax rate, net income is $866 million, or $.92 per NewCo share. At an 8.33x fair value PE, Adient is worth approximately $7.70 per NewCo share.
NewCo. Using the three parts as outlined above, NewCo’s fair value is comprised of:
- OpCo: $55.44
- Excess Cash: $1.60
- Adient: $7.70
- Total: $64.74
Using management projections for JCI WholeCo, JCI RemainCo and Tyco, I use a DCF model to value the NewCo operating company (see JCI Analysis under the Documents section below). (The inputs and assumptions to the DCF can be debated ad nauseum; but as the last 18 months or so in the market have proven, any and every assumption to any and everyone’s analysis can be debated to the ‘nth’ degree…so do what works for you.) But IMO the real margin of safety lies in the very low expectations embedded within JCI’s current stock price.
JCI. As stated earlier, due to the ‘cash shares’ component of JCI’s current capitalization the NewCo calculations must be multiplied by 82.7% in order to convert into a per-current-JCI-share equivalent. With that in mind, NewCo OpCo’s implied 2017 PE based on JCI’s current stock price looks as follows:
- JCI PPS: $45.52
- (-) JCI Deal Cash: $6.04
- (-) Excess Cash: $1.32
- (-) Adient: $6.37
- Implied NewCo OpCo PPS: $31.79
NewCo OpCo will generate 2017 EPS of approximately $3.03 before synergies. Multiplied by 82.7%, the JCI-equivalent EPS figure is $2.50 for an implied 2017 PE of 12.7x. If Adient trades for 12.5x, the implied PE falls to 11.4x; and if it 5x, the implied PE rises to 13.7x.
Using the NewCo SOTP fair value, JCI’s current fair value is $57.
This is a rather boring, seemingly under-followed restructuring/event situation, which is why I believe it could surprise to the upside in the relatively near-term. Not huge upside, but decent nonetheless. The global macro economic backdrop is stable/improving enough to take economic-related operational downside off the table in the medium-term; revenue synergies are at minimum a free option; NewCo (ex. Adient) has material balance sheet capacity, IMO (3 to 3.5x leverage would be more appropriate given the revenue/cash flow profile); buybacks could surprise to the upside in the near-term; the Battery business could be divested or spun; Adient could be a sneaky home run; and who knows…NewCo could end up receiving a take-out offer.
The biggest risk is the tax authorities stepping in to block the ‘inversion’; but I believe investing via JCI as opposed to TYL largely takes this risk off the table. On a standalone basis JCI trades for less than 12x 2016 earnings and 8x EBITDA, versus 22x and 13.6x for TYC. Shorthand yes, but JCI is materially less expensive.
More to come…