In a brief trading update BAE has announced it's agreed to acquire Collins Aerospace's Military GPS business, for $1.9bn. The group's also agreed to buy Raytheon's Airborne Tactical Radios business for $275m.
Completion of both deals is subject to the successful closure of the Raytheon-United Technologies Corporation merger, as well as regulatory approval.
The shares rose 2.9% following the announcement.
This round of deal making came as a bit of a surprise, but we think the move makes sense on a couple of levels.
President Trump's been ramping up defence spending, so it follows that BAE's redoubled focus on the US. But apart from the added exposure to American end markets, these deals would bolster what is currently BAE's second biggest division. They could lead to a more efficient capital structure, and as a plug and play option, execution risk is reduced (although we should point out this is never totally eliminated).
We shouldn't overlook the fact this has come as an opportunistic move either. Collins is a forced seller, which adds to the argument these are high quality assets, rather than dud divisions looking to be flogged. All those potential merits have come with a sizeable price tag attached, but it doesn't look like plans would over-stretch the balance sheet.
It's worth remembering though, raising debt levels to pay for the bulk of the deal means there's a chance extra returns to shareholders could be delayed.
Things have been progressing in the core business. After some tough years in global defence markets, BAE has finally seen several large orders come through. Qatar, Canada, and Australia have called on BAE to boost their air forces and navies.
That's not to say it'll be plain sailing from here.
The current US administration hasn't always been the most consistent on policy, while tensions with Saudi Arabia mean a deal to sell The Kingdom a further 48 Eurofighter Typhoon jets for around £10bn could be under threat.
We're also mindful that modern warfare has changed the landscape, leading to more importance being placed on cyber tools. Because of this, the Cyber & Intelligence business should be an important driver for future growth, but it's not yet making a substantial contribution to group profit, and has been forced into some restructuring.
Cashflow hasn't been exemplary either. If the group's to reach its target of £3bn+ in free cash by 2021 things will need to improve.
However, we still think BAE has some real strengths. The multi-billion pound order book provides excellent revenue visibility, while the balance sheet still looks robust, despite the sizeable pension deficit adding an unwanted burden. Should the deals go ahead, we can see the potential for meaningful strategic benefits. The shares currently offer a prospective yield of 3.9%, although of course there are no guarantees.
Collins Aerospace's Military GPS is the leading provider of mission critical military GPS receiver solutions. It's expected to generate revenue growth over 10% (compound annual growth rate) over the next four years, and revenue of around $359m and adjusted cash profits of about $127m for 2020.
BAE believes strong customer demand for the business will be driven by an increased demand for precision munitions.
The gross acquisition price is equivalent to 15 times estimated adjusted cash earnings for 2020, and it's believed the deal would be immediately positive for BAE's earnings and cash flow. The acquisition would be funded by new debt, and would incur a tax benefit of around $365m.
Raytheon's Airborne Tactical Radios business on the other hand is the leading provider of airborne tactical radio solutions, manufacturing and supplying communication systems to the US Department of Defense.
The business is expected to generate revenue of approximately $125m in 2019, with growth potential said to be underpinned by demand from the US Department of Defense and NATO.
The deal would be paid for using existing cash on the balance sheet.
Upon completion, both businesses would be integrated into BAE's Electronic Systems division.
Third quarter trading details (7 November 2019)
The F-35 programme continues to ramp up, with around 140 aft-fuselage sets expected to be completed this year and full production on track for next year.
There continues to be substantial activity in the UK Maritime business, including the Dreadnought, Offshore Patrol Vessel and Type 26 programmes. The Queen Elizabeth Class aircraft carrier programme is approaching completion, with HMS Prince of Wales commencing sea trials in September. New ship programmes for the Australia and Canadian navies are underway.
Production is increasing across several US Combat Vehicle projects, including Amphibious Combat Vehicles and Armoured Multi-Purpose Vehicles. The division continues to win new projects.
Electronic Systems has continued to make good progress, including an initial $184m award for BAE's Advanced Precision Kill Weapon Systems (APKWS).
The low bond yield environment continues to weigh on the groups pension scheme, and that is expected to present a headwind in 2020.
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
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