13 December, 2019
Recently I discussed the developing situation in shares of HP and Xerox. In the article I proposed to take a critical look at the proposed acquisition of HP. Despite the conclusion that the proposed deal is not attractive to HP shareholders, I think that such situations provide investors the opportunities to manage equity investment risk better.
In my book Risk Investing I argue that one of the ways for investors to address the risk problem and “the observer and the observed paradox” is to look at investment situations where there exists a certain “risk-structure” at the level of the equity and company itself. If investors can make themselves and stocks they invest in less dependent on general market, for example, the risk profile could be improved. Current situation in shares of HP presents such an idiosyncratic opportunity: buyout offer in place (which might be increased), share buybacks, ongoing restructuring and cost-savings process.
To contrast HP/Xerox case, there is currently a similarly transformative transaction in shares of ams AG (AMS), Austrian-based manufacturer and provider of sensor solutions. The company is in the middle of the acquisition of OSRAM Licht AG (OSRAM), German-based manufacturer and provider of various lighting products and solutions.
AMS already acquired more than 55% of OSRAM shares through a tender offer at EUR 41 per OSRAM share, and aims to acquire more. It is possible that AMS will have to raise the offer price, and for valuation purposes, we assume a EUR 48 per share price for the remaining 45% stake (which I believe is a conservative estimate and the actual price might be lower).
Similar to Xerox/HP case, by making this acquisition AMS takes a major action that will significantly transform both the company as well as its capital structure and equity risk-return profile. Assuming AMS will raise additional capital of EUR 1.5 billion through equity offering at a price of EUR 40 per share (a 7% discount to Dec 11th, 2019 closing price of EUR 42.9 per share), company’s market cap (at EUR 40 per share) will equal EUR 4,877 mil, while net debt according to our estimates will equal EUR 4,454 mil, which translates into an enterprise value of EUR 9,331 mil.
Despite the transformative nature of this transaction it looks like a fairer game compared to Xerox/HP deal. Sure, AMS is taking advantage of recent unsatisfactory business and share price performance by OSRAM, but this is business and one has to take responsibility for his actions and decisions.
If OSRAM transaction will be completed at the price outlined above, and assuming a EUR 1.5 bil equity offering at EUR 40 per share, we estimate that at EUR 40 per share, AMS will be valued at an EV/EBITDA multiple of x9.45. Under assumption that combined annual free cash flow will be EUR 400 million and EBITDA will grow at a rate of 12% per annum, in three years EBITDA will grow to EUR 1,387 mil. At an EV/EBITDA multiple of x10 the equity could be valued at EUR 87 per share, for a potential upside of 118% percent.
Such transactions offer investors unique opportunities to improve risk-return profile of equity investments by taking advantage of “structure” that is in place at the level of an individual security and company. I believe that such approach provides an excellent alternative to dealing with risk by a top-down approach of position, industry, volatility and other limits.