Reliance Worldwide Corporation Ltd (ASX: RWC) has this morning announced a major $1.22 billion acquisition which it will support with a $1.1 billion capital raising.
The company has entered into an unconditional agreement to acquire 100% of John Guest Holdings, a UK-based leader in plastic push-to-connect (PTC) plumbing fittings, for £687.5 million, or approximately $1.22 billion.
The purchase price represents 12.4x John Guest’s 2017 Calendar Year Adjusted EBITDA (earnings before interest, tax, depreciation and amortisation), although Reliance expects to achieve synergies that will reduce that multiple.
Reliance Worldwide listed its shares on the ASX in April 2016 and has enjoyed a strong run-up in price in the time since. Today, it boasts a market capitalisation of almost $2.4 billion.
The company, which specialises in “behind the wall” plumbing and hot water systems, owns the SharkBite brand which offers brass PTC fittings and various other plumbing solutions designed to disrupt and transform traditional plumbing methods. Essentially, PTC fittings are designed to make the end user’s job quicker and easier and, in some cases, remove the need for the plumber altogether (although notably, in some markets a certified plumber is required to complete certain jobs).
Reliance believes that John Guest is highly complementary to its existing business. John Guest is a leader in plastic PTC fittings, having sold approximately 145 million fittings in 2017, while it also boasts strong research and development capability, high-quality automated manufacturing facilities and strong customer relationships, according to Reliance.
The company generated revenue of £168.6 million and adjusted EBITDA of £55.4 million in the 2017 calendar year, with an EBITDA margin of 32.9%. Its margins have grown in the past two years and compare to the 20.1% EBITDA margin reported by Reliance Worldwide in the 2017 financial year.
Reliance currently expects to generate total synergies in excess of $20 million EBITDA per annum and expects to largely achieve those synergies within the first year of ownership. Most of the synergistic benefits that are expected relate to cost reductions from business integration and improved operating efficiency. It also hopes to expand its new John Guest products into its North American and Asia Pacific channel networks, and expand the presence of SharkBite in Europe as a result of the tie-up.
The acquisition should also diversify Reliance’s revenue by channel, product category and geography, as demonstrated in the following chart:
Reliance will undertake a pro rata accelerated non-renounceable entitlement offer to raise up to $1.1 billion in new equity. An institutional component will account for $945 million of the raising with the remainder to be raised from existing shareholders. Eligible shareholders can subscribe for 1 new share for every 1.98 shares they hold, at an offer price of $4.15 (representing a 9% discount to yesterday’s closing price).
Notably, all of Reliance’s directors, including Chairman Jonathan Munz, have indicated they will take up their full entitlements under the offer.
Meanwhile, the group has also established a new $750 million syndicated debt facility which increases its available facility limits by $400 million.
This is a very large acquisition for Reliance. Although the company plans to utilise the same integration principles applied to the Holdrite business, which was successful, there is no guarantee they will realise the same success when integrating this business.
There’s also the risk of potential quality issues with John Guest’s products or the inability to generate as strong synergies as forecast, while adverse economic or regulatory conditions could also derail the success of the acquisition. And, there’s no guarantee Reliance’s or John Guest’s existing customers will continue to purchase the same number of products as they have done historically.
There are plenty more ways for this acquisition to go wrong. And, when the acquisition is worth $1.22 billion, there isn’t much room for error.
Investors will be pleased to see Reliance reaffirm its full-year earnings guidance, particularly with the increased input costs experienced by the business during the second half. The company expects to achieve EBITDA of between $150 million and $155 million for the year, excluding the impact of any transaction costs associated with John Guest and any earnings contribution from that business.
Reliance Worldwide looks to be a reasonable company to date, but it’s wise to be cautious regarding an acquisition of this size.
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