Aerojet Rocketdyne: Inventory Purchase Thesis Performs Out, $4.7 Billion Acquisition

In a current report, I mentioned the quarterly outcomes of Aerojet Rocketdyne (NYSE:AJRD) and marked shares of Aerojet Rocketdyne a purchase on account of their strategic positioning for weapon system functionality and nationwide safety in addition to house exploration. Reuters reported that L3Harris Applied sciences (LHX) is near asserting the acquisition of Aerojet Rocketdyne and an announcement might observe as early as Monday. On this report, I shall be specializing in what this acquisition means for Aerojet Rocketdyne share costs and why this acquisition has larger probabilities of receiving regulatory approval than the mixture with Lockheed Martin that was known as off earlier this 12 months.

Aerojet Rocketdyne: A Market Outperformer

Whereas I’ve been following Aerojet Rocketdyne for a while, it wasn’t till August this 12 months that I wrote my first report protecting the producer of protection and house rocket thrusters. Again then, shares of Aerojet Rocketdyne had tumbled following a large Q2 2022 earnings miss. Nevertheless, again then I famous that the miss was largely attributable to damaging changes on the Customary Missile program for which Aerojet Rocketdyne elevated capability to facilitate elevated buyer demand into 2024 and 2025 which clearly is an effective factor however pushed the Customary Missile program right into a loss place for the portions that have been beneath contract. Excluding this adjustment, margins would even have expanded.

I additionally famous the next:

The state of affairs with Russia positions Aerojet Rocketdyne extraordinarily properly with its involvement in house and protection, extra significantly hypersonics.

So, I consider that the selloff was not justified given the character of the Customary Missile adjustment, which was in anticipation to facilitate future demand, and the corporate’s involvement in house and protection and significantly hypersonics was very promising for its prospects. Till November 30^th, the inventory had already gained 20% so the purchase ranking was a justified one.

On that day, the information broke that Basic Electrical (GE), L3Harris Applied sciences, Textron (TXT) and Veritas Capital have been exploring alternatives to accumulate the corporate and I marked shares of Aerojet Rocketdyne a purchase primarily based on concurrent uptick in house and protection demand. The house half is pushed by lunar exploration whereas the protection half is pushed by the state of affairs in Ukraine leading to elevated rocket use and protection budgets whereas improvement of latest weapon system functionality additionally performs a big function:

Is Aerojet Rocketdyne Inventory A Purchase?

The quick reply is “Sure”. We see vital alternatives in house and in protection, with new weapon functionality and capability enlargement alternatives. These parts make Aerojet Rocketdyne enticing as an acquisition goal, and due to this fact, must also be of curiosity to buyers. Much more so, whilst a stand-alone enterprise, the corporate affords vital alternatives for progress, making it enticing to purchase shares. Wall Avenue has a purchase ranking on Aerojet Rocketdyne inventory, however its consensus goal is 4 to five % beneath present buying and selling ranges. That’s attributable to the truth that we’ve not seen any changes to scores since April this 12 months. So, gadgets just like the positives on capability enlargement, alternatives and positioning as an acquisition goal in addition to power as a stand-alone firm will not be sufficiently mirrored within the present value targets.

I additionally famous that Aerojet Rocketdyne had hit its EBITDAP margin of 14%, so future progress ought to primarily come from larger manufacturing volumes and additional effectivity initiatives. So, this appeared like a great second to think about the corporate an acquisition goal.

Higher Deal, Restricted Upside For Aerojet Rocketdyne Inventory

It’s mentioned that Aerojet Rocketdyne shall be acquired for $4.7 billion or $58 per share. In comparison with the earlier closing value this offers a 5.7% premium. That’s not enormous, however nonetheless represents 40% premium measured from the purpose I marked shares a purchase and 42% measured from the purpose I wrote the article. So, a big premium as measured from these factors and it must also be stored in thoughts that shares of Aerojet Rocketdyne began appreciating in October partially as a result of inventory markets recovering considerably and early indicators that Aerojet Rocketdyne might be a really attention-grabbing acquisition goal. So, the market already positioned for an acquisition and that drove costs up in October and even additional by the top of November and December.

So, a 5.7% premium shouldn’t be weak. The market simply already began loading this premium into the inventory value for a while now. It isn’t unusual to see that taking place and significantly for an acquisition of Aerojet Rocketdyne buyers knew what to anticipate. Lockheed Martin was ready to pay $56 per share representing a 33% premium earlier than the mixture was finally known as off on account of regulatory hurdles. It appears that evidently with $58 per share, buyers might be getting a greater deal than what Lockheed Martin supplied.

Will Aerojet Rocketdyne Acquisition Be Blocked?

So, the large query is whether or not this acquisition might face regulatory hurdles. In idea, every acquisition can. Nevertheless, an acquisition of Aerojet Rocketdyne by L3Harris Applied sciences is materially totally different than the one which Lockheed Martin had in thoughts when it made a proposal for Aerojet Rocketdyne. For L3Harris Applied sciences, this shall be a diversification of its enterprise whereas for Lockheed Martin buying the rocket motor specialist was a vertical integration that might stonewall competitors. An outline of the Protection contract awards from the evoX Defense Contracts and Budget Monitor exhibits that over the previous 5 years Aerojet Rocketdyne obtained 15 contracts valued $674 million.

The desk above completely demonstrates why the acquisition of Aerojet Rocketdyne by Lockheed Martin Applied sciences was blocked. Seventy % of all gross sales come from three events. Lockheed Martin is by far the most important with a 3rd of the gross sales adopted by Raytheon Applied sciences (RTX) and NASA, every with roughly 20%. So, an acquisition by Lockheed Martin would create the undesired state of affairs through which Lockheed Martin would personal a strategic provider through which mentioned provider would additionally provide to the competitors. In a great world, this isn’t an issue. Nevertheless, we don’t stay in a great world and having a competitor personal the corporate that’s your provider might be problematic, particularly in a supply-constrained setting as now we have witnessed for a while now.

L3Harris doesn’t have that problem. They’ve nearly no overlap or provide agreements with Aerojet Rocketdyne and as a part of L3Harris, Aerojet Rocketdyne would keep its impartial place as a strategic provider.

Conclusion: Aerojet Rocketdyne To Be Acquired After All

After a failed takeover try from Lockheed Martin two years in the past, plainly Aerojet Rocketdyne shall be acquired in spite of everything. Not by Lockheed Martin, however by L3Harris offering a impartial acquisition of the strategic provider maintaining the specified competitors within the Protection panorama in place. For Aerojet Rocketdyne, this acquisition does make sense because it hit its long-term EBITDAP margins excluding changes and can be extra reliant on value optimization and capability enlargement going ahead, which it may now do beneath the wings of L3Harris Applied sciences. Now we have no insights into any value synergies, however for buyers I do consider this finally is an effective deal.

Jefferies lately put a $62 value goal on shares after the corporate didn’t obtain any vital analyst protection for a while. Whereas a $58 per share acquisition value is beneath the value goal Jefferies put, I feel it’s nonetheless a great deal. The $62 value goal seemingly is predicated on a $5 billion acquisition value of Aerojet Rocketdyne which might indicate a 50% premium in comparison with pre-acquisition hearsay costs and whereas Aerojet Rocketdyne is a strategic provider, I don’t assume a 50% premium is justified primarily based when viewing the whole panorama. So, $58 per share is an effective deal and additional upside solely exists if that is the beginning of a bidding warfare.

Assuming that costs soar on Monday in direction of the $58 stage, I’m marking shares a Maintain (from Purchase) and that is solely an attention-grabbing purchase for those who need to park their money to reap the hole that can seemingly stay between the inventory value and the acquisition value till the transaction is accomplished.