Description

London listed Meggitt PLC is being acquired by Parker-Hannifin Corp at 800p per share in cash. It trades at 772p, leaving a 3.45% spread. This sounds unimpressive, but it is possible the deal is not that far away from the finish line. Another reason I like to put forward an M&A event is that I'm currently not in love with general longs given Fed tightening.   

Here are some of the

Key things to know:

• 800p offer
• PH likely doing this deal to become a bigger player in the attractive higher-margin aerospace aftermarket.
• Transdigm made an unsolicited 900p offer August 2021 but ultimately did not go through with it 
• EPS accretive within 12 months to PH
• 300m synergie opportunities according to PH
• Aerospace & Defense industry share prices have surged since deal announcement
• financing in place (currency risk is hedged as well) 
• PH is an experienced acquirer. 
• Shareholders approved the deal
• On 11 April 2022, the European Commission cleared the proposed acquisition by Parker-Hannifin conditional on divestment of Parker's Aircraft Wheel and Brake division.
• The acquisition has been approved, without any conditions, by: a. the Australian Foreign Investment Review Board; b. the Australian Competition and Consumer Commission; c. the Competition and Consumer Commission of Singapore; d. the Saudi Arabian General Authority for Competition; e. the Danish Business Authority; f. the German Federal Ministry for Economic Affairs and Energy; g. the Presidency of the Italian Council of Ministries (Presidenza del Consiglio dei Ministri); and h. the Turkish Competition Board.

• The takeover is still awaiting developments in the investigation being conducted by the UK Competition & Markets Authority

• The CMA submitted its report to the UK's Department for Business, Energy & Industrial Strategy on March 18. 

Interesting color

Comments about regulatory process last PH earnings call(this predated the European OK):

So if you go to the next slide, give you a quick update on the Meggitt transaction. We continue to make progress. There's really four main work streams that we're working. There's two -- the economic and national security review that we're working on with the UK government. I would characterize those as constructive and positive and on track. And then the antitrust and FDI filings are proceeding as we had anticipated. We're still anticipating a Q3 calendar 2022 close and we're really excited about this.

Note PH is quite positive about the U.K. process.  

But there's a – you're going to have a lot of positives going forward. You've got the recovery, we've got Meggitt, and the continued good things we're doing in aerospace as a whole, so we're very positive. If we weren't so positive, we obviously wouldn't have bought Meggitt. We think there's a great space to invest in.

TransDigm decided not to proceed outbidding PH and cited the following reason:

TransDigm Chairman W. Nicholas Howley stated, "We have long admired and studied the Meggitt business and believed that a combination between the two companies could provide value to investors of both companies. However, based on the quite limited due diligence information that was made available and the resulting uncertainties, TransDigm could not conclude that an offer of 900 pence per Meggitt share would meet our long-standing goals for value creation and investor returns. TransDigm and our advisers put substantial time, effort, resources and expense into evaluating a potential transaction. We reached a memorandum of understanding with the Meggitt Pension Plan trustees, arranged the necessary financing for the acquisition which we anticipated would position us roughly in the range of leverage levels that we have used historically for larger acquisitions, and communicated our willingness to make commitments to HM Government comparable to those offered by the other bidder for Meggitt. However, consistent with our disciplined approach to capital allocation, we make acquisitions only when we see a clear path to achieving our investment return goals with a reasonable degree of certainty." Under Note 2 on Rule 2.8 of the Code, TransDigm (and any person acting in concert with it) reserves the right to set aside the restrictions in Rule 2.8 of the Code in the following circumstances: (i) with the agreement of the board of directors of Meggitt if such agreement is given after the offer announced by Parker-Hannifin Corporation is withdrawn or lapses; (ii) if a third party announces a firm intention to make an offer for Meggitt; (iii) if Meggitt announces a "whitewash" proposal (as described in Note 1 of the Notes on Dispensations from Rule 9 of the Code) or a reverse takeover (as defined in the Code); or (iv) if there is a material change of circumstances (as determined by the Panel on Takeovers and Mergers). 

Downside potentially mitigated

If I go back to a point in time before the deal had an impact on the stock price and I'm tracking price development of VTI as well as a number of European Aerospace & Defence type firms, I observe an interesting pattern; defense firms are up big! Here's a recent FT article talking about this trend (due to Russia's invasion of Ukraine) and an illustrative chart:

This suggests that the break price in case of deal failure may not be as low as 450p but quite a bit higher. The lesser performers seem to be large U.S.-based firms while some of the smaller European-based defense firms have surged spectacularly. Sometimes up 80% or 158%. VTI went nowhere over the same period. Meggitt is up about ~60% because of the deal.  

Timeline

Originally the company guided to approximately 12 months to close the deal. That gives me a target of August 2, 2022. That's actually only around ~90 days away. The company is also still guiding to a Q3 close indicating at worst a close in ~150 days. In my experience mergers can close a bit faster. There's a chance this gets delayed considerably but that risk seems small to me.  

Risks 

• Phase 2 CMA review wouldn't be great. The risk doesn't seem that high because of the positive European review and planned divestitures.  
• Additional divestitures by either party are required (worst case causing PH to abandon ship) 
• CMA is taking a tougher stance on competition and my historical data on transaction completion could paint too rosy a picture in terms of deal closures. 
• There is a new National Security review process that I don't have a lot of data on and don't have any experience with. 
• There is a small risk that the deal is dragged beyond 150 days from here. That hurts the profitability. 
• Note that I don't have an M&A background and evaluate positions with a model I built on PAST global data. If there are big changes in how regulators approach deals or market circumstances my numbers are more likely to be off. 
• It is possible (although unlikely) the deal gets shut down. If I'm wrong on the downside mitigation the shares could fall to 450p or so.  

Conclusion

If this deal closes in 100 days it should translate roughly to an 11% expected annualized return. If it closes in 150 days the return looks more like 7%. My model indicates the deal could even close in 50 days. If we're so lucky that would translate into an expected 23% annualized return. A lot depends on the failure-to-close rate as well. I don't believe this deal gets called off a lot. That's because of the European OK and proposed remedies. But also based on past data like firm sizes etc. The higher you estimate the odds of the deal failing the more the break price matters. It's the performance of the peer group, because of Ukraine/Russia, that leads me to believe this is an interesting situation to be involved with. The downside risk could easily be somewhat overestimated. 

Catalyst

Deal closes succesfully