3M Takes On A Little Risk For A Potentially Great Deal

By Stephen D. Simpson, CFA | October 01, 2012 AAA

Although I've owned 3M (NYSE:MMM) for years and have great respect for the company's consistently excellent returns, I nevertheless was not too impressed with the acquisitions announced under former CEO Buckley's tenure. By and large, I thought the company was too cautious and too focused on uninspiring tuck-in deals. It looks, though, like current CEO Thulin is much more willing to push the envelope, and the company's acquisition of Ceradyne (Nasdaq:CRDN) looks like the sort of deal that could quietly pay off very well in the years to come.

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The Deal That May Be
As 3M's ongoing challenges in getting approval for the acquisition of Avery Dennison's (NYSE:AVY) office and consumer products reminds us, no deal is a done deal until its done. When it comes to 3M's proposed acquisition of Ceradyne, though, I don't think there will be equally significant challenges.

In any case, 3M proposes to pay about $860 million in cash for Ceradyne, a leading supplier of technical ceramic products. At $35 per share, 3M is paying a 43% premium to Friday's close, but less than two times forecast 2012 sales and just over five times trailing EBITDA. Those multiples don't sound too heroic, and for good reason - with sizable exposure to weak defense markets, Ceradyne is well removed from its go-go growth days when investor expectations were fired by strong demand for ceramic armor components.

A Sneaky-Smart Deal for 3M
There's a lot of lazy journalism when it comes to conglomerates like 3M; most articles about this diversified conglomerate just reduce it down to "maker of consumer products such as Post-It notes." Consequently, a lot of investors may not realize that ceramics are an important area of focus for 3M, with applications not only in traditional markets like abrasives (sandpapers and so on), but also in specialty fibers, textiles and components for a range of end markets like healthcare, electronics and industrial applications.

I don't think that the acquisition of Ceradyne is the beginning of a big push by 3M into the defense industry. Instead, I believe that 3M will look to leverage Ceradyne's ceramics expertise and R&D to expand its offerings to end markets like solar, oil/gas, autos, and electronics. Given the strength, temperature, wear, and corrosion resistance, and insulating capabilities of ceramics, there are numerous potential applications for 3M across its existing platform of businesses, and the benefits of this deal could "seep" across the enterprise for a long time to come.

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Is This a Fair Deal?
Although 3M's deal for Ceradyne nearly matches the 52-week high, it is true that the multiples in question aren't that high, and some long-time Ceradyne investors may resent that the company is selling for much less than the double-digit EBITDA multiples of yore. The key question I think Ceradyne management had to consider was whether key markets like defense and solar were going to recover in a reasonable time frame.

I'd say the prospects of such a recovery aren't looking great, and 3M can leverage Ceradyne's capabilities arguably better than Ceradyne could on its own. So it's true that 3M could have paid more, but without a motivated competing bidder, there was no reason to do so, and this deal was probably the best shot of Ceradyne's stock seeing the mid-$30s again for the next year or two.

The Bottom Line
At a minimum, this deal makes me feel better about 3M's corporate direction - it looks like CEO Thulin is willing to be more aggressive and pursue deals that not only leverage current capabilities, but also take the company in new directions. That puts it in somewhat better company with other conglomerates like Honeywell (NYSE:HON) and General Electric (NYSE:GE) that have not been shy about buying their way into new growth opportunities.

Disclosure: Author has owned shares of 3M for more than five years

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