Running the numbers on an Invensys pension deal

Posted by Neil Humeon Jun 15 09:54.

Invensys, the controls and automation group recently kicked out of the FTSE 100 to make way for Glencore, is a perennial takeover target.

But in recent weeks the speculation has centred on the disposal of a major division. This was fuelled by respected blogger Jim Pinto who claimed the majority of Invensys’ rail business was about to be sold to China’s CSR, which has just detailed plans to raise the equivalent of £1bn via a share issue.

Pinto may well be right but Invensys is unlikely to sell a business — or for that matter put itself up for sale — until it’s sorted out its pension fund. Specifically its UK pension scheme.

This accounts for around three quarters of group pensions liabilities as this table from Merrill Lynch shows.

Now, if Invensys tried to sell any of its businesses the pension fund trustees would want a significant dollop of cash either on disposal or before Invensys returned any proceeds to shareholders.

So there’s a clear incentive to do a deal.

Given the size of the liabilities, any pension fund deal would be a complicated transaction – probably done in several tranches – says Merrill. Fortunately, the new chief executive of Invensys is it’s former finance director, Wayne Edmunds, and he’s determined to do something about this poison pill, according to the Sunday Times.

Invensys plans to offload its £4.2 billion British pension scheme, a move that may pave the way to a takeover bid for the engineering group. Directors are evaluating pitches from three firms that specialise in taking over retirement schemes — Pension Corporation, Lucida and Rothesay, which is owned by Goldman Sachs. A winner will be chosen in the next few months. If the deal goes ahead, it will be the largest-ever transfer of an occupational pension scheme out of a British company.

So how much would it cost Invensys to dispose of the UK fund? Merrill reckons around £700m should do it (although it could cost as much as £1bn) and with net cash of over £400m it’s something Invensys could afford.

A deal would not only remove the cash pension charges related to the UK scheme — currently running at £85m a year — but would also clean up the equity story, remove a poison pill and allow Invensys to return a large chunk of disposal proceeds to shareholders, reckons Merrill.

Resolution of the UK pension scheme (£4.1bn of the total £5.5bn group pension liabilities (table 1) would be taken well by the market, in our view. It helps remove volatility from the group’s valuation (£2.5bn mkt cap vs gross UK pension liabilities of £4.1bn), reduces the potential value dilution from divestments (high probability that Invensys would have to contribute a % of any sale proceeds into the pension scheme), removes a perceived poison pill, should improve cash conversion given the annual top up charge into the UK scheme (£38mn pa until 2017) and cleans up the equity story.

Indeed it does.

Merrill thinks the rail business alone is worth £1.5bn.

SOTP analysis – every £100mn of buy out cost is worth 12p in the SOTP…Removing the UK funding deficit (we use the actuarial funding deficit of £230mn) from our SOTP and adding the mid-point buy out cost (£700mn), would reduce our SOTP FV from 420p to 362p:

but ignores the NPV benefit of lower cash top up charges
This analysis, however, ignores the NPV benefit of removing the cash pension charges related to the UK scheme looking forward (c.£85mn pa). We have not included this NPV benefit in our post pension SOTP – although it could be argued that higher multiples should be applied to the operational assets as a result. To get back to a 420p fair value post pension buyout at £700mn, we would have to assume a 16.0x EV/EBITA multiple on IOM and 13.0x EV/EBITA on Rail in the analysis.

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