Meggitt PLC (PH) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Parker-Hannifin announces offer to acquire Meggitt PLC. [Operator Instructions] I would now like to turn the call over to your host, Todd Leombruno, Chief Financial Officer. You may begin.

Thank you, Kevin. Good morning, everyone, and thanks for joining this webcast in which Parker is announcing a recommended offer all-cash acquisition of Meggitt PLC. As Kevin said, this is Todd Leombruno, Chief Financial Officer. Here with me today is Chairman and Chief Executive Officer, Tom Williams; and President and Chief Operating Officer, Lee Banks. If I could direct you to Slide 2, our usual practice of announcing an acquisition is a little bit different today. So I want to discuss this first. As Meggitt is a Public Listed Company on the London Stock Exchange, this acquisition falls under the rules of the U.K. Takeover Code. Under the U.K. Takeover Code, once the acquirer has a firm intention to make an offer, the issue, what is commonly referred to as a Rule 2.7 Announcement, which contains the terms and conditions of the offer, that announcement was released in the U.K. earlier this morning. The Takeover Code sets out various requirements, which govern such offers in which we will need to comply with. U.K. Takeover Code also requires Parker to only share information that has been already released within that announcement, and that requirement applies to information on our slides, what we share during today's call or in any discussions we may have later. No additional material information about this transaction can be shared. Slide 2 includes a disclaimer language related to these requirements. On Slide 3, you'll find our company's safe harbor disclosure statement addressing forward-looking statements as well as non-GAAP financial measures. Reconciliations to any non-GAAP measures are included in today's materials. These reconciliations, our presentation and additional information about this transaction, including the 2.7 announcement are available at aerospacegrove.com. On Slide 4, I'll touch on the agenda today. We'll begin with Tom providing the specifics of the offer and the strategic rationale of this combination, then he'll give an overview of the Meggitt business, show the strong fit and touch on expected synergies. Tom will then close with highlighting the compelling value for shareholders. And then Tom, Lee and I will allow some time for Q&A that falls within the details of the 2.7 announcement. With that, I'll ask you to direct your attention to Slide 5, and I'll turn it over to Tom.

Thank you, Todd, and good morning, good afternoon, good evening to everybody joining in. It's an exciting day for Parker and for Meggitt. I'd like to welcome all of our shareholders, analysts, Parker team members and a special welcome to all the Meggitt team members that might be listening in. Meggitt is a great company with a great history and heritage, and we've admired you for a long time, and we really look forward to you joining the Parker team. So on this page, I want to cover some of the highlights on the strategy and the expected financial benefits. First, this acquisition will nearly double the size of the Aerospace Systems segment, with highly complementary technologies, which I'll highlight later on in my presentation. It is well positioned on premier programs with our key customers. 70% sole sourced with reparatory products. It's going to expand our system and component capabilities. A nice reoccurring revenue. It's going to add 500 basis points to our aftermarket mix. And a very strong sustainable portfolio with some attractive electrification of low-carbon technologies. It's nicely positioned for growth potential with the combination of the aerospace, commercial recovery as well as the synergies, which we'll talk about a little bit later on. And this will be accretive to our organic sales growth, EPS and cash flow. So if you go to Slide 6, some details on a offer overview. So we're offering to acquire 100% of the Meggitt PLC stock. Here are some statistics on calendar '20 and calendar '19. So $2.3 billion in sales for '20, $3.2 billion sales in '19, so this would be pre-COVID, which would be probably more indicative of normal business conditions for Meggitt. EBITDA margins a little over 14% in '20, a little over 19% in '19. So the transaction is 800p offer per share results in a transaction value of about $9.9 billion. You can see the multiples there, and we did this on a pre-COVID basis. We think that's the best way to look at these multiples, as it's more indicative of an ongoing normal state for the business, 16.3x. And then 10.9x when you put in the costs and just sort of synergized the EBITDA being 10.9x, very similar to where we were with the CLARCOR acquisition. The financial impact, EPS accretive in the first 12 months after closing. Strong incremental sales growth on top line margins and cash flow. High single-digit ROIC in year 5 with continued expansion. I'll touch on the synergies, $300 million in the third full year, and we'll be funded with cash and debt, and we are committed to maintaining our investment-grade rating through the process. Closing, pending normal regulatory filings, is in approximately 12 months. If you go to Slide 7, I give you a quick introduction to Meggitt. Upper left-hand corner, provides proprietary content for airframe and engine, and I'll give you more details on that as we go through the next several slides. You can see their aftermarket mix at 45%, quite a bit higher than what we are, and I'll touch on what that does with the combination. Lower left is Sales by Application. I would just point out that we like the fact that they're very diversified as far as the applications [indiscernible]. On the right-hand side is two pie charts on sales by division and then sales by geography. Sales by division, you can see there's four divisions. I'll go through the three product divisions with pictures. The Service and Support division is a cross company full-service aftermarket organization, providing customer experience, smart support planning for all their technologies and they have three global hubs, one in Miami, supporting United States; and [ Steve ] Park Support, which is in England supporting EMEA and Singapore supporting Asia Pacific. And then if you look at the sales by region, you can see the largest region being the U.S. at 61%. Go on to Slide 8. In the next several slides, I want to talk about the various products that they have by division, starting with the Airframe System Products, and they provide braking systems which really can do the whole system. They can go from the control system to the brakes as well as provide brake system components at the component level. A lot of pictures on this page, I would just orientate you if you start at the nose of the plane, and I'm going to kind of give you natural groupings of their products. So at the nose of plane, you see, the nose wheel and they also provide the main wheel, so variety of wheel technology. Across the breaks, you can see carbon ceramic brakes, electric and steel, various valve technologies from the brake control valve to the server control for antiskid control. And then they have control systems and monitoring systems as well. If you go on to the next slide on Slide 9, continue on with the Airframe System Products. They have a grouping of products around power and motion, really power generation, conversion and distribution highlighted in the pictures that you see on the bottom of that page on the left. Then on the avionics and sensors, they have a very strong sensor offering providing sensor technology for air temperature, outside pressure, ice detection, position of the aircraft, which is very attractive for us. It's an adjacency that we're not in and it helps support the growth of digital products across the entire airframe or engine. If you go on to Slide 10. Again, the last slide for the Airframe Systems business. There's fuel products and composites. They have composite radomes, if you're not familiar with what that is. That's the structure that protects the radar equipment, anti-icing structures, heated elements of a coolant preventing ice build up, you see that picture and rotor blades in the bottom of that slide. And then fuel bladders that are self-sealing fuel bladders primarily for military applications. And then in our right, polymer seals, which is exciting for us because this offers additional adjacent complementary technology for our Engine Materials portfolio. They have structured ceiling, like the picture down to the bottom for door seals. They also have apartments just like the landing gear apartment door. And then fire-rated solutions, you see it picture of the engine seal there is a technology we do not have. So again, an adjacency that's very attractive. On Slide 11, move into a new division -- different division, Engine System Products. And everything on the left, fire protection and safety systems are all, again, complementary technologies. This will be both for the engine and the airframe, so smoke and fire detection, bleed air leak detection. And they have an environmentally friendly fire suppression that would be fighting fire suppression for the engine, APU and cargo compartment. And on the right, valves, sensors and thermal management. Again, the sensors would be both for airframe as well as the engine. On the engine, it's providing really health monitoring, in particular, here, they're looking at here is for vibration control to check for aero balance conditions. On the valves, again, a more distinct difference between our valve technology, which I'll highlight here in a minute. And a very nice portfolio of thermal management, heat exchangers, again, which becomes much more important for the higher heat loads that the aircraft and the engines will be enduring in the future. Go to the next slide on Slide 12, Energy and Equipment Products. On the left hand side, the military applications is really a combination of actuation solutions and thermal management. If you go to that picture on lower left, you see a weapon system actuation. This would be for an Apache helicopter in this particular example. And then thermal management system, this example for an M1 Tank, it's going to be providing cooling for electronics and for soldiers as well. And think of this as a supplemental cooling to the existing cooling system under particular application. And then like most aerospace companies, they take aeroderivative technologies and go into similar applications, primarily in power generation and industrial. So the heat exchanger technology they have the turbine health, RM technologies they have going on to gas turbines and looking at pressure and temperature and those applications. If you go to Slide 13, one of the things that's very attractive and a strategy that the Meggitt team has had in place is 2/3 of our innovation is targeted towards clean technology. So the move to a more sustainable aviation portfolio, something that's very much [indiscernible] with us, fits with our strategy, and we're going to continue this as we move forward. So just to highlight some of the areas that they're doing on sustainable aviation. Clearly, all the sensor technologies they have is creating a more efficient engine. The capabilities they have for more electric aircraft is very attractive. I mentioned how important the thermal management is as aircraft and engines become hotter and hotter. They have a portfolio of lightweight materials to help with the weight reduction for fuel consumption. And then they have environmental friendly fire suppression, which I've mentioned earlier. So they have technology to replace over time the Halon systems that are used in today's fire oppression. Go to Slide 14, they're on all the right programs. You can see in both commercial and military drive programs, a marquee lineup of applications with a growing build material that they've developed over a period of time. Moving to Slide 15. A blue-chip customer list, long-standing relationships that 70% sole-source position, very similar to Parker, this customer listen. And part of what we really like if I think about prior acquisitions that we've done, we like acquisitions that they have common customers, common end markets with complementary technologies, which is exactly what Meggitt has with this application. What's really important on Slide 16 is it -- success in a lot of acquisitions are tied around a common shared vision on values, culture and heritage. And we have very much that when we look at Meggitt and Parker. Both companies, engineering-led companies, strong innovation reputations. When you look at the win strategy, when you look at the Meggitt business system, a lot of similarity. Both companies focused on safety and a high-performance culture. And as I mentioned earlier, shared commitment to sustainability and their technology development and how they run their factories and what we do for society. Both of us are trusted defense partners. Both businesses have strong content with the U.S. Department of Defense, U.K. MoD as well as other international defense partners. And we view very strongly that this creates a long-term future that's very bright for the combined organization. On Slide 17, this gets at the aftermarket mix, and I've talked about this at the beginning. If you look at where on the left-hand pie Parker, today is 35% MRO, Meggitt being 45%. When you put that together, you end up with a 40% MRO. So a 500 basis point improvement. I think everybody understands what that means. It means less cyclicality, higher margins than the OEM and the recurring revenue stream is very attractive as we go forward. On Slide 18, really, when we do 18 and 19, we try to put as many of the technologies as we could on a page without making it too complicated, and this first one is on a airframe. And in blue is all the Parker technologies and in green are highlights of the Meggitt technology. And you can just see this fits very nicely hand in glove, how complementary they are and put a very strong offering will be able to give to customers, which will enable us to solve more problems and create more value for them. And then if you go to Slide 19, some are type of format that is [ flied ] just showing engine products, again, Parker in blue, including the new acquisition technologies with exotic in their and then Meggitt in green, again, a very strong offering for our engine customers as well. Now in 20, really gets at the heart of what makes it so attractive is the complementary technologies. We did the other slides because we couldn't list -- it got very complicated list all the Parker technologies on the slide. So really here, we're focusing on those pages on Meggitt technologies and how they compare to what Parker has with that particular product area. So you can see on braking systems, they have a much stronger offering. They add larger aircraft, regional jets, business jets, military and bring electric brake technology and have -- a stronger control system to component suite of technologies that we do. On advanced sensors, it's an area completely adjacent. We don't have any activity there, very attractive again for the whole IoT movement, digitization of everything, but also the ability to create more sustainable solutions for customers. Safety systems, another adjacent application, both fire detection and suppression. On the engine piece, a very distinct difference between our offerings. So we primarily do fueldraulic of valves, which would be using high-pressure fuel to actuate the valve, and their offering is more on the pneumatic side. So a distinct difference there as well as they have more of a concentration in the engine bleeder application. On electric power, basically, we have very little there, let our adjacency had into more electric capabilities going forward. And then thermal management, we have very little thermal spray activity there, and they have high capacity cooling and heat exchangers, which we find very attractive. So again, highly complementary to what we're offering. And on 21, if you lift it up and look at what does this do for the total company. On the left-hand side, it would be four Meggitt and the three external reporting statements that we have today. And on the right-hand side would be with Meggitt. And you can see that clearly, it balances it out the portfolio between the three: aerospace Systems, the first one in Industrial North America and Diversified International. But if you lifted higher and think about what we've been doing in the last 7 years, and the strategic acquisitions we've been doing to transform the portfolio. And all of you are familiar with these CLARCOR in filtration, origination materials, exotic and aerospace and now Meggitt again in Aerospace creating a portfolio that over the last 7 years is clearly less cyclical with higher growth rates, higher cash flow and higher margins. And you've seen that through our performance over the last 7 years, which has been a combination of The Win Strategy and our portfolio strategy. So we're very excited in the fact that this is going to double the -- almost double aerospace business and continue the capital deployment strategy and transform the portfolio. Moving to 22, talk about synergies. These are pretax synergies, and this is an estimate. At $300 million, this would be all cost synergies. And this will be at the end of the third full year, it's approximately 10% of sales. You can see the anticipated areas, The Win Strategy, supply chain, lean productivity in SG&A and continued footprint optimization. Our focus on footprint is going to be to execute Meggitt's footprint plan that they have in place. So they've been public about this. In 2016, they laid out a vision for their footprint strategy. At that time, they had 56 facilities, and they had a vision to reduce that in half. And their last public annual report, they were at 37 for 2020. So they made a lot of progress, and we will just continue to execute the plan that they have in place. And all these centers when you put it together will be margin accretive within the synergy period, which is what we're going to illustrate on 23 on the next page. So if you take where they were in calendar '19, again, a more normal state for the business pre-COVID, and you apply these $300 million of cost synergies, you would get to an approximate 30% EBITDA with these synergies, which is very attractive, which fits with the strategy you heard me talk about as far as being accretive within the synergy period on growth, margins and cash flow, and this will enable us to do that. And then lastly for me, just to sum up before we turn it over to Q&A, really a compelling value story for our shareholders, will be EPS accretive within the first 12 months, strong cost synergies of $300 million on the third full year. This will generate high single-digit ROIC by year 5 with continued expansion. This is a business that is positioned well with leading programs with marquee customers and positioned for strong growth as the industry turns. Strong capital deployment, again, part of the strategy that we've laid out very much in our wheelhouse and part of what we've been articulating for a number of years will create long-term shareholder value. On the dividend, we will maintain our payout ratio that we've articulated before and a 35% net income and continue our annual dividend track record. And we're committed to a strong balance sheet and maintaining an investment-grade rating as we go through this process. And with that, I just want to say thank you for your attention. I'm going to turn it over to Kevin to open up to Q&A.

[Operator Instructions] Our first question comes from Andrew Obin with Bank of America.

Can you guys hear me?

Yes, Andrew, we can hear you fine.

Yes. So I guess the first question is with the previous deals, the path was you're ready to do the next deal after two years. Clearly, this one is bigger, but there are more synergy opportunities. What is the delevering path for Parker over the next 2, 3 years?

So Andrew, I would expect you will see the same deleveraging -- this is Tom, by the way, that we saw with the last several deals. With the 2.7, we really can't go into specific quantities as we go forward. But I think you could just see the track that we had before. The leverage as we come out of this, obviously, will depend exactly when it closes will be very similar to where we started our initial leverage with [indiscernible] when we did LORD and Exotic. And I would expect to see a very similar glide path as far as reducing debt load.

Yes. No, that's great. And then the second question, as far as your exposure to engine manufacturers, GE, Pratt, ROS can you just tell us where we were prior to the deal? And how does Meggitt change your exposure to various engine manufacturers?

I would say with this transaction, probably more [indiscernible] turbofan applications. In general, if you would just look at the bill of material content, that you put -- make it and Parker together, it's just going to offer a stronger bill of material, whether it's on the airframe side or on the engine side. Exotic built out more of the Pratt & Whitney exposure to us, which wasn't very attractive. And I think this does the same kind of looking across really all three engine makers.

Congratulations.

Thank you, Andrew.

Thanks, Andrew.

Our next question comes from Joe Ritchie with Goldman Sachs.

Congrats. Yes, so my first question is really just around the synergies. So my understanding of Meggitt is that they've been kind of going along the path of some footprint consolidation, I think, in the prior call that you guys did this morning, you talked about some supplier consolidation. I guess if you think about the buckets of the $300 million, maybe just help provide a little bit more clarity of how you expect to get after it?

Joe, that's an area we won't be able to go into detail on, the 2.7 does not discuss that. So I won't be -- I'm not at liberty to discuss that as well. I would just maybe reference that Meggitt is recognized their supply chain opportunities already, and this is part of their publicly vision that they've had as far as looking to consolidate that supply chain, and clearly, we'll look for opportunities to put both of our supply chains together. But I can't go into detail on the various buckets that make up the $300 million.

Okay. Fair enough. Tom, maybe my second question, as I kind of think about where we are in the cycle and you think about aero hopefully being at the bottom of the cycle and hopefully starting to see some better growth in months and quarters to come. And I can't help us think of like the -- when you guys did the CLARCOR acquisition and there was there were some hiccups along the way, partly because of how strong the cycle was, and you had kind of like a bit of a ticking the pipe on problem back then. And I'm just would love to hear some thoughts on how you kind of plan to manage the upturn while also going after some of the synergies that you've highlighted today?

Yes, Joe, it's Tom again. So I mean Clearly, one of the things that is -- if you're in the aerospace industry today, ourselves and Meggitt, the worst is behind you. And the opportunity is in front of us and that you're going to see better times. And so that's very attractive. One of the things that is different, if you take CLARCOR. CLARCOR was a very heavy, heavy footprint consolidation type of acquisition. This will be nowhere near like that. We're going to execute Meggitt's plan, which has been very thoughtfully laid out and will be very digestible while we go through what is expected to be a recovery over a period of time going forward. But that's how it would contrast the difference. This will be -- and one of the challenges we have with CLARCOR, we are doing all the footprint, and we had volume going up and we won't have the same level of challenges with this.

Joe, just add to it. We're Looking at a 12-month close period. So both companies will remain separate for the 12 months, and we'll both deal with that spike over the next 12 months.

Our next question comes from Jeff Sprague with Vertical Research.

Congrats, everyone. Maybe just a little bit more just thinking about the synergies from the different angle comb and understand your hands are somewhat tied. But to what degree does this allow you to also just kind of further re-evaluate your own supply chain on the Parker side of the house. and what you might be able to do different. And perhaps that's rolled up in the $300 million anyhow, but could you comment on that to any degree?

Clearly, these synergies are not just looking at Meggitt per se. It's looking at where it makes sense with the combination. So that would be supply chain. And we did call out in the 2.7 that with the footprint will be executing their plan, but then -- means that we'll also look at where it makes sense when we look at the total combined footprint as well. So yes, we'll be -- the $300 million is looking at opportunities for both businesses.

And just to understand just on the accounting side. The difference between the GAAP and the IFRS, I think, is the capitalized R&D on wheels and brakes, is that it? And is there -- just anything else from a modeling standpoint we should be thinking about as we kind of try the pieces together.

Yes, Jeff. This is Todd. That's a good point. You're right, that's the biggest piece of it. There's also treatment of leases and some pension -- to a smaller extent, the pension side of it. We've got a reconciliation in the deck. So that should be able to help you out.

Our next question comes from David Raso with Evercore ISI.

I was just curious if you can give us some color on how this deal came together? Any key regulatory hurdles we should be thinking about? And milestones of how to get to closing from here?

David, it's Tom. So the how, I would say we've been admiring Meggitt for a long time. And this has been part of our capital deployment strategy that we would look at opportunities to be a consolidated choice within motion control. And you've heard me talk about the kind of the priorities within that motion control portfolio was aerospace filtration, engineered materials and instrumentation. And you've seen us do transactions all in those areas that we focused on. The other part that we've been clear on we like companies that have a common customer list, common end market exposures with complementary technologies, and that's exactly what Meggitt has. So it's something we've been looking at for a while. And I won't go into the details of our discussions, but we did approach them and this has been in, and what I would say, a very friendly, either respectful manner and we have full support from the Meggitt, forward on this transaction. As far as regulatory, we'll be filing doing all the necessary filings. And by the nature of these two businesses be very complementary we feel very good about it.

And lastly, regarding some of the challenges that are greater or opportunities that are easier. When you look at the roughly 10% of revenues that you expect to take out in cost synergies, I know you mentioned a footprint heavy lifting you had on CLARCOR. But they've also both had the targeted initial synergies about 10% of revenue, so it's sort of the same baseline assumption of how much you could take out. How would you rank the challenge to take out this 10% versus LORD in particular, and I assume CLARCOR was a little -- obviously, it was more challenging, right? You were trying to close a lot of factories, just when demand was that surprising to the upside. So I'd like to think this one's maybe a little easier than CLARCOR, but maybe compared versus LORD, if you could?

Yes, David, I would say this is very similar to LORD as far as how this approach will go. And we always approach these things in a collaborative fashion. We have, obviously, to build these models and to decide what would be appropriate for our shareholders. We had to come up with our own thoughts on this. But as we go forward, we'll be doing this jointly with the Meggitt team and coming up with what makes sense for both businesses. And the idea here is -- with every acquisition is to take the best of both companies, the one plus one equals three strategy, and that's the approach we'll take with this.

Our next question comes from Julian Mitchell with Barclays.

Congratulations. Maybe just my first question on the synergy aspect. If you could just sort of clarify your confidence around getting those gross synergies while balancing those commitments to the U.K. government that you've laid out this morning in terms of sort of reinvestment in Meggitt. And also I wanted to clarify is that Meggitt facility reduction program, the savings from that, are they included in the $300 million or perhaps you said they were additive? And sort of above the $300 million, what percent do you think drops through? I know in defense, synergies often the customer can get a good chunk of the synergies.

Yes. So Julian, their footprint consolidation is included in this $300 million. And this is Parker-Meggitt's $300 million, not something that is shared outside. So this is what Parker-Meggitt will enjoy. What was the first part of your question, again? Say again, Julian.

Yes, Tom. Just around balancing, you've got some sort of commitments around things like R&D. And obviously, the U.K. government is very sensitive to takeovers right now, domestic assets.