The acquisition makes sense on two fronts – first, it will give Reliance entry into a new market, and second, it will strengthen the company’s offering in plastic push to connect (PTC) fittings.
Reliance is currently predominantly a brass fitting manufacturer, and we have previously noted that a meaningful risk is increasing competition from plastic fittings.
On that front, the acquisition makes a lot of strategic sense. That means the key elements to think about are price and management.
Can Reliance achieve an attractive return over the next 10 years from this acquisition?
Reliance paid 12.4x earnings before interest, tax, depreciation, and amortisation (EBITDA) for John Guest. That is a high price for a manufacturer, although if Guest earns a similar return on invested capital as Reliance, it may prove an opportunity.
Additionally, once ‘synergies’ come out and the potential for cross selling (selling Guest products in the US and Reliance products in the UK) are considered, the price multiple will come down. Even so, it looks like Reliance has paid fair value for John Guest, and it will need to be able to use the business capably to deliver a return on its investment.
Can Reliance handle a major increase in the size of its business?
This is a softer aspect and not easy to discern from the outside. Can Reliance successfully integrate a major acquisition, with its own culture and operations, into its own operations? Can Reliance management handle a major increase in the size of their fiefdoms? Are Reliance management capable allocators of capital?
I’m not suggesting that they are not, but the larger a business gets, the more important that capital allocation decisions become. So far it has probably not been hard to determine the best use of Reliance’s capital. The complexity and range of decisions available will increase significantly from here, especially if the acquisition starts to struggle.
The decision to invest in Reliance is also made harder by the recent jump in its share price. The market is fully aware of the business’ potential and is already pricing in a significant amount of success. That makes it harder for an investor to figure out what it is worth. Big acquisitions also typically come with risks that are not always immediately obvious from the share price. I like Reliance, but I’ll likely remain on the sidelines for now.
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Motley Fool contributor Sean O'Neill has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.