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.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

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.

SEE: Understanding The Income Statement

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.

SEE: 5 Must-Have Metrics For Value Investors

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.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center