March 7, 2019 / 11:07 AM / 8 months ago

Breakingviews - Melrose’s latest deal is missing its magic touch

Air Quality & Home Solutions department of Melrose. HANDOUT

LONDON (Reuters Breakingviews) - Melrose Industries’ magic touch is missing from its latest deal. The UK engineer, which swallowed 8 billion pound rival GKN last year, boosted sales and margins without slashing investment. Still, a sluggish car industry could challenge its acquisition-driven model.

The battle for GKN, which Melrose narrowly won almost a year ago, could be a critical moment in UK corporate and political history. The hostile takeover drew critics including opposition leader Jeremy Corbyn, who attacked the company led by CEO Simon Peckham as debt-laden asset strippers.

Full-year results for 2018 should help dispel some of those doubts. Revenue at GKN’s aerospace, automobile and powder metallurgy divisions grew 2 percent, 3 percent and 6 percent respectively – more quickly than the businesses Melrose already owned. And, while Melrose’s managers have slashed overheads, they’re not starving GKN of investment. Research and development costs were about 300 million pounds on an annualised basis, according to Breakingviews estimates, or about 3 percent of sales. That’s well above the 2.2 percent threshold Melrose promised during the takeover battle. Debt, at 2.3 times EBITDA, is on the way down.

The profitability picture is fuzzier. Operating margins in the aerospace and powder metallurgy divisions rose to 8.2 percent and 10.8 percent respectively versus a year earlier. But in the automobile division they narrowed to 6.7 percent. That leaves Melrose well short of the 10 percent plus it promised at the time of the deal.

The 9 billion pound company says its model is to buy, improve and sell. While it’s achieved the first and is working on the second, disposals are proving harder. Melrose has already struggled to offload GKN’s powder metallurgy unit at an acceptable price. A prolonged trade war, or a further decline in car sales, would make improvements and disposals much harder.

Melrose shares rose by as much as 4 percent on Thursday morning. Yet at 185 pence they are still a fifth lower than on the day the GKN battle ended. They are also well below the 220 pence per share that Stifel analysts reckon is the sum of Melrose’s parts, assuming the company boosts operating margins to just shy of 11 percent. Investors will need to see more evidence of improvement before they believe Melrose still has its secret sauce.

Breakingviews

Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.


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