I can't fault Danfoss A/S for trying to join in the spirit of the Christmas shopping season and score a sweet bargain, but I have a feeling that this privately-held Danish company is going to have to do better if it wants to make Sauer-Danfoss (NYSE:SHS) all its own.
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The Deal That May Be
Sauer-Danfoss shares spiked the afternoon of November 28 after an SEC filing revealed that Danfoss A/S CEO Niels Christiansen sent a letter to Sauer-Danfoss' board offering to buy the shares it does not already own (about 24% of the outstanding total) for $49 a share - a roughly 24% premium to the close on November 27. Not surprisingly, the deal offered is an all-cash deal for Sauer-Danfoss shareholders.
Not the First Time Danfoss Has Tried to go Low
Danfoss A/S, a conglomerate involved in fluid controls and transmission, valves and pumps, has tried before to buy up the remainder of the shares it doesn't own in Sauer-Danfoss (a hydraulics, pumps and motion control company created through the merger of a Danfoss subsidiary and Sauer back in 2000).
Back in 2010, Danfoss A/S offered $14 a share in cash - a deal which may have seemed decent enough to investors who saw the stock slip below $5 in the worst of the 2009 recession. Sauer-Danfoss' board thought the deal was too chintzy, though, and Danfoss A/S walked away - and the stock topped $20 just six months later before hitting in the dollar range of the high 50s in early 2011.
Once again, it looks like Danfoss A/S is trying to wrap this up as Sauer-Danfoss fights through a lull in the market. Admittedly, third quarter results were pretty ugly - revenue was down was down 15% as reported, operating income fell 28% and orders plunged over 30% as the company saw major weakness in demand for off-road vehicles (construction, agriculture, mining, etc.) in Europe and Asia.
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But here's the thing - management had already more than prepared investors for that awful performance. And while Sauer-Danfoss' performance has been more dramatic than the likes of Eaton (NYSE:ETN), Parker-Hannifin (NYSE:PH) and Honeywell (NYSE:HON), it has cut both ways (meaning Sauer-Danfoss also did a lot better in the good times). What's more, nothing has really changed regarding the company's leading positions in closed-circuit hydrostatic transmissions, low-speed/high-torque motors and steering units. When the markets recover, it seems quite likely that the company's orders, revenue and profits will follow suit.
How Fair Is This Deal?
As I suggested above, Danfoss A/S seems to have a habit of showing up with an offer that looks good relative to what's happened over the past year or so, but may not be so fair given the long-term prospects of the business.
The offer from Danfoss A/S would value Sauer-Danfoss at about six times trailing EBITDA, well below the going multiples for Eaton or Parker-Hannifin. Even allowing that the company's much smaller scope and scale merits a discount, that doesn't sound like much of a premium for selling out.
The deal likewise doesn't seem to hold up on a free cash flow basis. I had modeled a sizable year-on-year decline in free cash flow this year (down to less than $200 million) and pretty modest mid-single digit growth thereafter, such that the compound annual growth from 2011 to 2022 was in the very low single digits. But even with that bearish growth outlook and an above-market discount rate (11%), fair value still would seem to be in the dollar range of the high 50s or low 60s - well ahead of the $49 offer from Danfoss A/S.
Perhaps not surprisingly, Sauer-Danfoss shares are trading above that $49 offer price as of this writing. It wouldn't surprise me, frankly, if this deal follows the trajectory of the deal between CNH Global (NYSE:CNH) and Fiat Industrial, where Fiat Industrial already owned a majority stake but ultimately had to up its deal by about 20% to get the CNH board to sign off - add 20% to the current Danfoss offer and it starts to look a lot more fair.
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The Bottom Line
I'm a shareholder of Sauer-Danfoss, so I don't pretend to be neutral or unbiased in this matter. Nevertheless, I think Sauer-Danfoss has made significant strides from its 2009 lows, and I don't think the offer from Danfoss A/S fully acknowledges that progress, nor the fact that Sauer-Danfoss is in strong enough shape that it doesn't need to be "rescued" from the current difficult environment for capital equipment OEMs and component suppliers.
The ongoing malaise in Europe and Asia will pass, and when it does I believe Sauer-Danfoss will re-emerge as a high-quality (albeit ridiculously under-followed) small industrial company. While I never mind seeing a stock in my portfolio garner a fair takeout price, I would much rather see the board hold out for a better offer or have Danfoss A/S go away than take a low-ball bid that leaves substantial value on the table.
At the time of writing, Stephen D. Simpson owned shares of Sauer-Danfoss since 2011.
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