Finmeccanica Market Cap (as of 11/10/13): €3.23bn
Fondo Strategico Italiano (FSI) Market Cap: N/A
Italian defence and industrial conglomerate Finmeccanica has agreed to sell its 55% stake in Ansaldo Energia, a maker of thermoelectric turbines, to Fondo Strategico Italiano (FSI), an arm of state-owned lender Cassa Depositi e Prestiti (CDP), for a total cash consideration of around €430m to be paid between 2013 and 2017. FSI has also acquired the remaining 45% stake from US private equity fund First Reserve. The total price tag paid by FSI tops €770m.
The deal has been appreciated by investors, as Finmeccanica continues to push for the refocusing of its investment portfolio amidst corporate scandals and adverse macro dynamics like decreasing defence expenditure in the developed world and increased dependence of the industry on the use of offsets.
Finmeccanica is the 8th largest defence conglomerate in the world, with €17bn in expected sales for 2013. The whole industry sized up to €1.3trn in 2012, but SIPRI research indicates the beginning of a long term global shift: the western world is decreasing its total expenditure, while countries in the Middle East and Asia are ramping up budgets.
The defence sector has also become accustomed to the questionable practice of attaching offsets to its contracts. Offsets are “side deals”, mostly unrelated to the main contract, in which the contractor commits to investments and projects which benefit the country that commissioned the contract. These arrangements, totaling €55bn today, and expected to grow to €370bn over the next decade, are basically off-balance sheet sweeteners, and as such they may pose opaque risks to investors. Finmeccanica has €2.5bn in offsets.
Finmeccanica has recently suffered a difficult period. Its share price has been simmering below €4 for most of the past two years, one-fifth of pre-crisis figures. The reasons should be traced back in capital structure, political influence and management. The former refers to its enormous outstanding debt, that reached a peak of roughly €4.9bn in Q2 2013. The company has been trying to raise at least €1bn via asset sales in order to consolidate its financial position, but the management reshuffle that followed recent boardroom scandals, i.e. the arrest of former CEO Orsi accused of bribery over the sale of helicopters to India, and the uncertain Italian political environment and a strong oppositions by unions have delayed the process.
When Finmeccanica decided to reduce its debt burden via a policy of portfolio streamlining, i.e. selling assets to reduce the debt pile, it singled out its energy unit Ansaldo Energia as one of the assets on sale. Last month, Finmeccanica reached a preliminary agreement with South Korea’s Doosan Heavy Industries, which was however blocked for political reasons and unions’ opposition. This showed how things can get very complicated when dealing with a company like Finmeccanica, which is partly State-owned (30%, therefore Finmeccanica needs government backing for sensitive issues like disposal) and is the second largest employer in Italy (the sole Energy unit employs 3000 people).
FSI has acquired 85% of Ansaldo Energia, 40% from Finmeccanica and 45% from the U.S. fund First Reserve. The remaining 15% owned by Finmeccanica will be acquired by FSI through an option to be exercised from 30 June 2017 to 31 December 2017. As far as the pricing of stakes is concerned, the operation will amount to a total of €777m: €675m for the initial 85% and roughly €116.5m deferred to 2017 for the other 15%. In addition, the deal includes performance compensation of €130m, linked to the achievement of profitability targets by 2016. Finmeccanica will also deconsolidate €220m in debt.
Finmeccanica considers the sale as a contribution to the consolidation of the capital structure and a further step in the implementation of the strategic plan of the company, which includes strengthening of the governance, reorganization of operations and reduction in the portfolio of non-core activities. Accordingly, Finmeccanica has also signed a memorandum of understanding with FSI that envisages the possibility of an industrial partnership for the lossmaking Ansaldo Breda train maker and the profitable Ansaldo STS rail-signalling unit.
FSI, on the other hand, is pursuing its main objective of sustaining the national economy by favoring the growth and the technological innovation of a key company for the Italian economic environment. The fund is nevertheless under a provision that prevents it from taking majority stakes for a prolonged period of time. Therefore, both FSI and Finmeccanica are looking for an industrial partner. They designated Doosan as the preferred partner, also considering previous negotiations entertained with Finmeccanica. Doosan may eventually acquire control of Ansaldo.
The market has reacted positively to the news. Finmeccanica shares were up 29.2% to €4.69 in the last month as market participants focused on the prospect of a sale of Ansaldo Energia and of consolidation in the capital structure. More importantly, the share price has been increasing for the last seven days, both before and after the contract was signed on Oct 4th, reaching a peak of €5.82 on Oct 10th.
Overall, Finmeccanica will benefit from the transaction. However, its net financial position still amounted to almost €5bn at midyear. The situation might look brighter if the target of €3.3bn in net debt at year end is met and other disposals are carried out, like the lossmaking Ansaldo Breda unit. Yet, even if group revenues and profitability are in line with expectations thanks to well-performing core units, the forecasted FOCF for 2013 is only €100m out of €1.1bn EBITA. Furthermore, exposure to Italian political vagaries and US defence spending remains.
Finmeccanica was advised by Banca IMI and Deutsche Bank. FSI was advised by Lazard.