EADS had problems with the A380 launch and Siemens and BAe Systems have been investigated for bribery on a much larger scale and recovered. It’s nasty, but it’s not the end of the world. And the appointment of the Monti government would seem to be an opportune moment to replace the Chairman and carry out a much needed clean up.
First, what is the extent of the problem? Aeronautica has made provisions of € 753mln to cover the problems related to the B787. This should be the end of this particular problem. However, Aeronautica is also facing growing competition and needs restructuring, so is probably unlikely to return to see the EBITA margin return to normal at 9-10% immediately. Next, rolling stock. Finmeccanica says that this unit is not viable, a lack of size, economies of scale and ability to compete in a global market place. It will lose money this year and is likely to be loss-making in the future, potentially to the tune of around € 50mln per annum. Management is looking to sell to it, but its value is 0 or negative as it stands.
Then Selex Sistemi Integrati and the bribery scandal surrounding it. What is the damage here? To the reputation in Italy, huge. But the financial damage is potentially much lower than might be imagined. Selex Sisitemi Integrati S.p.A had revenues of € 762mln in 2010 with EBITA of € 104mln, or a 13.4% margin. The rest of the defence electronics sector, excluding Selex Sistemi, had a margin of 9.9%. Selex Sistemi has also seen a marked increase in revenues and profitability since 2005 when revenues were € 562mln and EBITA only € 43mln, a 7.3% margin. So I will assume that this increase is false and a result of bribes being paid. I would expect Selex under normal conditions to be earning the same now as it did in 2005, € 200mln less in revenues and € 61mln less in EBITA. Note I am assuming because I have not heard of any other companies being affected that the bribery is limited to Selex Sistemi. Given how long this has been going on, I would have expected other problems to have surfaced by now, if they were existent. Time will tell.
But what has to be remembered is that we are talking about 3 pieces of Finmeccanica here that only account for around 15% of revenues. What about the rest of the company? Yes, it is going to have problems because of the slowdown in government defence spending, but how much is it worth. I will look to use an EV/EBITA multiple to value each sector. As an idea of how I came up with this number for each part, EADS trades at around 11 times EV/EBITA.
- And I would value the helicopter business at these multiples. It is a global leader, even being chosen to provide the US Presidential helicopter, has grown its revenues to € 3.6bln in 2010 and has margins above 10%. At 11 times EV/EBITA, it is worth around € 4.5bln.
- Defence Electronics, revenues have been growing and stood at just over € 7bln in 2010, but there’s the question mark overhanging Selex Sistemi’s results and the slowdown in defence spending, margins have never been as high and are not trustworthy. I’ve made an adjustment for Selex Sistemi, reduced margins by 60% to include the effect of lower defence spending and put the company on 6x multiple, it is worth € 2.4bln.
- Aeronautics, the problem child. Though, the C27J, M-346 and ATR regional planes are all highly rated products and there have been no complaints about their other aerostructure work for the A380 or the European Fighter Aircraft. I have put this on a 4x multiple to reflect the need for restructuring and it is worth € 800mln.
- Space has had fluctuating margins and revenues, though generally improving. I put it on a 7x multiple and it is worth € 270mln.
- Defence Systems makes weapons systems, torpedoes and missiles. And does this very well from my understanding. Revenues are € 1.2bln, margins are between 8% and 11% depending on the year. I use a 9x multiple and it is worth € 960mln.
- Energy makes turbines for power stations and Finmeccanica has just sold a 45% to a private equity firm which valued the whole company at € 1.1bln. I’ll say its remaining stake is worth € 550mln.
- Transport, as above, has problems, so I’ll value the rolling stock at 0 and the stake in Ansaldo STS at market, or € 400mln.
Three final considerations: corporate costs every year subtract over € 100mln from EBITA, so this is a negative of € 1.2bln; an estimate for the company’s debt to subtract from the value of the units, I’ll say € 4bln for this year. The company has said that debt at the end of 2012 will be under € 2.5bln after € 1bln of sales, so I’m probably not far out; and I have not included any positive value for equity interests.
Before adding this up, it is worth taking another look at the divisions and seeing just how many of them there are. And realise that Finmeccanica will never have the capability to be compete with Lockheed Martin, Boeing or EADS, but it can turn out some very high quality products in the niches where it has built up specific competencies. Putting all this together, the market cap of the company should be somewhere around € 4.7bln, or € 8.5 per share. It looks like people are focusing too much on the problems and not considering the positives within the whole group.