All Signals Go for This Little Engine

04/19/2011 12:09 pm EST


Peter Shearlock

Editor, Growth Company Investor

UK industrial controls and railway-signal specialist Invensys is a value play on track for a buyout bid, writes Peter Shearlock in The IRS Report.

Evolution Securities’ valuation assumptions for Invensys (London: ISYS) are worth a good look for any value investor who likes to buy undervalued assets.

Using a sum-of-the-parts approach, the firm reckons the high-tech engineering outfit is worth 497 pence ($8.10) a share—a long way ahead of the recent 318 pence.

That valuation, it reckons, could be achieved either through organic growth or “corporate activity.” In other words, if Invensys doesn't get its share price up through its own endeavors, it is likely to be bought out.

One reason for that vulnerability is that each of the company's three divisions is a small-ish fish in a very big pond. In its primary areas of operations management—providing the controls that make power stations or refineries work—and rail signaling and control systems, Invensys is competing with the likes of General Eelectric (GE), Siemens (SI) and Thales (OTC: THLEF).

It does so, and very effectively, but it still looks a tasty morsel for any number of multinationals to snap up.

The profit turnaround in recent years has been mirrored in the balance sheet. Invensys had £336 million net cash at the halfway stage last September. The lingering fly in the ointment is a £600 million pension deficit. If that hole can be plugged—and the new chief executive has been working on that—it will remove one of the few deterrents to a takeover bid.

An Emerging Market Play As Well
The key to Invensys' turnaround in recent years is the breakthrough it has achieved in emerging markets—particularly the Middle East, Southeast Asia, and China. Three years ago, emerging markets made up about a sixth of the order book. Today, they account for nearly half.

Certainly, the orders are flooding in. In November, the operations management division reported a record £1 billion order book, with a £4 billion pipeline of prospects.

Big projects in emerging markets, and especially China, account for a large chunk of those orders, but Invensys has also been benefiting from an upsurge in spending in North America by big oil and gas companies.

The rail division saw a downturn in first-half orders, but the situation was expected to reverse in the second half. Here the pipeline of prospects amounts to £9 billion, which is not bad for a business turning over £700 million a year.

Invensys' third division is its controls business, which makes components and systems for domestic appliances, heating, air conditioning, and refrigeration units. Here, a strong first half is likely to have been followed by a more sedate second half.

And the Fundamentals Are Strong
Shares appear to offer good value on a number of measures. Although they sell for about 15 times likely 2010-2011 earnings, within two years the multiple could fall to about 11 on anticipated profits growth.

With no debt, Invensys has an enterprise value equivalent to about 0.8 times annual sales. An EV/sales ratio of anything less than 1 denotes good value.

Then there is the sum-of-the-parts valuation that takes the underlying businesses and tots up what they are worth. Clearly, Evolution's calculations suggest a break-up bid could prove highly profitable—even though some of that value may be heading the way of the company pension fund.

Only the lack of a worthwhile dividend yield mars the picture. The shares currently yield a little over 1%. However, this may be about to change. At the half-way stage, the company raised the interim payment by a half and is committed to a progressive payout.

It is also promising to spell out a formal dividend policy when it reports its full-year figures in May. It may need to keep shareholders sweet if a bidder materializes.

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