BAE Systems PLC (LSE:BA.), the British defence giant, has set its sights on the stars with its proposed acquisition of Ball Aerospace for US$5.6 billion. This move, the company's largest transaction, marks a significant shift into the US space domain, a sector that has been rapidly gaining importance in the defence industry. But is this a strategic masterstroke or an overpriced gamble?
A strategic play
According to a research note from Shore Capital, the acquisition is "strategically sensible" for BAE. Despite the high entry price – BAE's shares dipped by 5% on the day of the announcement – Shore believes the premium paid is justified by the strategic benefits the acquisition brings. They argue that the current share price weakness presents an opportunity for investors to buy.
Ball, specialising predominantly in the space domain, accounts for roughly 70% of its revenue from this fast-growing segment. With this acquisition, BAE doesn't merely enter the space industry; it does so as a market leader, positioning itself for long-term growth.
Synergies and growth
The transition of Ball from its parent, Ball Corporation (NYSE:BLL), a packaging group, into a dedicated defence group under BAE, promises potential synergies. Shore Capital points out that within BAE's infrastructure, Ball will benefit from a global supply chain, lower manufacturing costs, and potentially stronger bargaining power. Moreover, Ball's existing relationships with the US Department of Defense and US Intelligence could pave the way for cross-selling opportunities within BAE's US-focused Electronic Systems division.
Financing the future
Financing such a mammoth deal does raise eyebrows. BAE plans to leverage its balance sheet, using US$4 billion of debt at a cost of 5.5%. However, Shore's analysis suggests comfort with the group's projected net debt to earnings before interest, tax, depreciation and amortisation (EBITDA) ratio of 1.7x post-acquisition. This ratio is expected to drop towards a more conservative 1.0x over the medium term. Returns are anticipated to exceed the cost of debt in the near term, with a brighter return profile projected in the long run.
Valuation and outlook
BAE Systems, in Shore's view, is a well-managed company with exposure to international defence markets that have clear structural tailwinds. Based on their revised figures, BAE is trading at a FY25F enterprise value to earnings before interest and taxes (EV/EBITA) rating of 10.2x, with a price-to-earnings ratio (PER) of 12.7x and a dividend yield of 3.6%. Shore's analysis suggests an undemanding FY25F EV/EBITA multiple of 12.8x, driving a Fair Value (FV) of 1,131p, indicating an 18% upside potential at the current price.
And finally
Charles Woodburn, BAE's chief executive, has described the deal as a significant enhancement to the company's space offering, allowing it to venture deeper and faster into the space domain. While the acquisition's price tag may have startled some, the strategic benefits, potential synergies, and growth prospects suggest that BAE's stellar ambitions might just be grounded in solid strategy. As always, only time will tell if this venture into the cosmos yields earthly rewards.