ST Engineering’s Acquisition – Would this move the needle?

Last week, ST Engineering announced an acquisition deal that caused its stock to go up by a mere 3%. I studied this new deal to find out if it’s actually beneficial for the company and most importantly, for us investors.

What’s the deal and why should we care?

Singapore Technologies Engineering Ltd (ST Engineering) signed an agreement with Roper Technologies Inc. to purchase all of the ownership interests in TransCore Partners, LLC and TLP Holdings, LLC (collectively known as TransCore). The total purchase price for these acquisitions is US$2.68 billion (S$3.62 billion). 

This is a significant development because prior to the announcement, the company’s market capitalisation was at S$11.73 billion (volume-weighted average price of S$3.76 per share), and this transaction will now represent 30.8% of ST Engineering’s market capitalisation.

The net income of the acquisition also accounts for 21.3% of ST Engineering current’s net income.

As of closing on 22 October 2021 and right after the announcement, ST Engineering’s stock price rose by a modest 3%, which can imply some repressed excitement. Let’s look at why this is the case.

ST Engineering’s Business Overview

Before we jump to the details of the acquisition deal, let me give you a quick rundown of ST Engineering’s operations.

ST Engineering (S63) was founded in 1967 as a Singapore munitions manufacturer. As it began to diversify its portfolio, it established other businesses related to aircraft and shipbuilding. To date, the company has grown into a global technology, defence, and engineering giant with operations in Asia, Europe, the Middle East, and the US and customers in over 100 countries.

According to its revised segment report, ST Engineering has three segments: Commercial Aerospace, Urban Solutions & Satcom, and Defence & Public Security.

All of these are broad categories, and each one can be further divided into sub-segments.

Commercial Aerospace

ST Engineering offers engineering solutions for every stage of an aircraft’s life cycle, including design and engineering, original equipment manufacturing, nose to tail aftermarket and maintenance, and asset management and leasing.

Aside from that, it is able to convert or refurbish aircraft using its passenger-to-freighter conversion and refurbishment capabilities. It’s also worth noting that they’re the world’s largest provider of airframe MRO (Maintenance, Repair, Overhaul) solutions.

Urban solution & Satcom

This is the market segment that ST Engineering is aiming to grow through its recent acquisitions plan. The Urban solution and Satcom segments help cities prepare for a smarter future by becoming more connected, resilient, and sustainable. This is accomplished by providing them with technological solutions to handle challenges such as connectivity, mobility, security, infrastructure, and environmental concerns.

Smart Metro, Intelligent Transportation, Public Transportation Fleet Management, Electric Vehicle Solution, Autonomous Transport solutions, Mobility services, Autonomous Transport for Seaport, Smart Security and Automation, IoT and Utilities, are just a few of the things the company does. Essentially, most of the issues are related to smart cities implementation.

This is complemented by its satellite solution, which assists in powering telecommunication networks, providing imagery and geographical analytics, among other things.

Defence & Public security

This is ST Engineering’s core business, as the company has been supporting Singapore’s defence capability since its inception. From the air, land and sea, ST Engineering provides advanced defence and security solutions and equipment to the Singapore Armed Forces and its international partners. Some examples of what the company is working on are aircraft, avionics modifications, combat mobility platforms, soldier systems, navy boats, and your favourite SAR-21.

Nevertheless, the revenue generated from this segment is not as significant as before since the firm has been divided.

Defence & Public Security accounts for 54% of the group’s income in the first half of 2021. This is followed by commercial aerospace, which accounts for 31% of the total, with the remaining 15% coming from the Urban Solution & Satcom market.

Revenue for the first half of the year was $3.65 billion, up 2% from $3.57 billion last year. At the same time, net profit increased by 15% to $296.1 million from $257.4 million. This is an improvement over last year’s full-year results, when its sales were $7.2 billion, down 9% from $7.9 billion a year before. Additionally, its net profit was $521.8 million, down 10% from $577.9 million.

The increase in revenue and net profit was due to a partial recovery of businesses in Urban Solutions & Satcom and Defence & Public Security. This offsets the decline in Commercial Aerospace, which has been impacted by the subdued aviation sector even after receiving government support since the second quarter of 2020.

Moving forward, we should expect a recovery in the Commercial Aerospace segment as more countries combat Covid-19. We should also expect a decline in government grants, which will most likely be reflected in its second half 2021 report.

ST Engineering has received $1.82 billion total in new contracts, including $874 million from Commercial Aerospace, $284 million from Urban Solutions & Satcom, and $660 million from Defence & Public Security. The entire new contract value for 1H2021 (excluding undisclosed contracts due to client confidentiality) was $3.37 billion, which includes $1.55 billion for the first quarter. Combined with previous contracts secured but not revealed, these new contracts bring the group’s order book to a healthy $16.8 billion as of 30 June 2021, after revenue delivery and project cancellation adjustments. In the remaining months of 2021, the company intends to deliver around $3.6 billion from the order book.

ST Engineering appears to be doing well based on its sales, so why didn’t the news about the deal result in more upside?

ST Engineering’s Acquisition Target, TransCore

TransCore is a market leader in electronic toll collection, congestion pricing, Intelligent Transportation Systems, back-office solutions, and RFID technology for transportation. The company, currently based in North America, has been in operation for 80 years.

ST Engineering chose to acquire TransCore because of its focus on road transportation solutions and ST Engineering’s goal to seek out a market in the smart city market. The advantages of TransCore’s acquisitions are detailed below and is based on its company reports:

• Enhances Smart Mobility offerings

TransCore’s electronic toll collection, congestion pricing and ITS solutions complement ST Engineering’s smart, integrated mobility solutions and will result in a comprehensive suite of world-class Smart Mobility offerings for customers.

• Accelerates growth and fuels innovation

ST Engineering’s growth in the Smart City sector will be accelerated as a result of the acquisition. ST Engineering’s strong technology know-how and engineering core, combined with TransCore’s deep capabilities, including a range of patents and IP rights in electronic toll collection, congestion pricing, and ITS solutions, would propel the company forward.

• Strengthens commitment to sustainability

ST Engineering’s commitment to using technology and innovation to help cities cope with the effects of urbanisation and climate change resonates with TransCore’s mobility solutions for reducing traffic congestion and vehicle emissions.

• Achieves synergies through cross-selling

TransCore’s electronic toll collection and congestion pricing segments in North America opens up a new market for ST Engineering. ST Engineering’s current ITS products, such as smart road junctions, transportation operation centres, and road traffic optimisation systems, can be cross-sold to North American clients as a result of this acquisition. At the same time, TransCore’s electronic toll collection and congestion pricing systems can be made available to customers in Southeast Asia, where ST Engineering has a substantial presence.

• Generates cash and provides earnings accretion

The transaction is expected to generate positive cash flow in the first year and earnings growth in the second year. This is undoubtedly beneficial to the company’s shareholders.

Potential Growth

Congestion pricing schemes, such as those offered by TransCore, would present a huge chance for the company’s revenue to increase as more cities aim to reduce pollution and improve their sustainability. In fact, Seattle, Portland, San Francisco, Los Angeles, and Chicago are among the cities that are now considering similar solutions.

Overall, we can estimate a 7% CAGR in this market segment from 2021 to 2030, with a global market value of US$8 billion to US$15 billion. This figure isn’t spectacular, but it is a promising sign for the company’s future.

ST Engineering’s TransCore Acquisition details

As mentioned above, the purchase price for these acquisitions is US$2.68 billion (S$3.62 billion). 

This transaction will be funded with internal cash and debt instruments issued by the company and will be paid in full in cash on the date of completion. ST Engineering currently has S$583 million in cash and cash equivalents, suggesting that at least S$3 billion must be raised from the debt market, which is a sizable sum.

As a result, this transaction will definitely put a dent on ST Engineering’s balance sheet. According to TransCore’s unaudited financial statements for the past six months which ended on 30 June 2021, the company’s net asset value and net tangible asset are about US$584 million (S$788 million) and US$219 million (S$296 million) respectively. You can see that intangible assets, which are assets that are not physical in nature, account for around S$500 million. Goodwill, brand awareness, and intellectual property rights are all examples of this.

With the transaction valued at S$3.62 billion, ST Engineering’s Net Tangible Assets (total assets minus intangible assets minus liabilities) will be negative following the acquisitions, as indicated below.

A negative tangible book value does not always imply that it is a poor deal. This sum may simply demonstrate that ST Engineering has tremendous value that is difficult to quantify by accountants, especially in a sector where intellectual property and trade secrets are the norms.

However, investors should be aware that if ST Engineering fails and goes into liquidation, its shareholders and creditors would likely receive nothing because intangible assets cannot be sold for cash and tangible assets are worth less than its debts.

Looking at the net profit from the TransCore 1H2021 Financial Statements, it is approximately US$54 million ($72 million in SGD). At this amount, the earnings per share for ST Engineering based on FY2020 will increase after the acquisitions. However, take note that EPS for FY2020 has dipped slightly due to the pandemic. If we use FY2019 EPS, which is 0.19, this acquisition doesn’t improve the group’s earnings per share in reality.

As this is a major transaction approval exceeding 20%, under Rule 1006(b) and Rule 1006(c) as defined in Chapter 10 of the Listing Manual, approval must be obtained from the shareholders during an Extraordinary General Meeting. Nevertheless, at the date of the announcement, Temasek holdings, which is the majority shareholder (51.4%), has already agreed to vote in favour of the transaction. This makes the deal very likely to pass through.

Moreover, ST engineering has to seek regulatory approval from the Committee on Foreign Investment in the United States (CFIUS) and U.S. antitrust regarding the acquisitions. If all goes smoothly, this transaction is expected to close by the end of 1Q 2022.

Parting Thoughts

This is a huge step forward for ST Engineering. While the agreement may not appear to be as beneficial at first glance due to insignificant change in earnings per share, it does open up a massive market for ST Engineering to penetrate and gain substantial operational efficiency and scalable economies.

One thing’s for sure, ST Engineering isn’t going anywhere.

Singapore will always require defence and ST Engineering will continue to provide this need to help our little island state meet its defence objectives. Thus, we should keep an eye out for more information about the acquisition’s financing and then analyse whether or not this deal is financially sustainable for the business.