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Smiths/TA: low price shows why deal inspired foot dragging

Smiths Group PLC updates

In just over two months, new chief executive Paul Keel has achieved what his predecessors could not manage in years. UK engineering conglomerate Smiths Group has agreed the sale of its medical division.

Inevitably, the buyer is a US private equity firm, TA Associates. Less conventionally in an era of highball foreign buyouts, the £1.7bn ($2.3bn) price was less than investors expected. Smiths’ stock fell 8 per cent.

That should inspire belated sympathy for former CEO Andy Reynolds Smith, who was sometimes accused of foot dragging. Keel’s next task is to show that the remaining businesses, which include everything from making seals to scanners, are worth more together than they would be separately. In a stock market that favours specialisation, this would be no mean feat. 

The sale of Smiths Medical will net the group an initial £1.3bn in cash. A £140m earnout may follow. Smiths will maintain some upside by taking 30 per cent of the new medical devices holding company TA will create, a stake also valued at £140m.

The exit multiple of 9 times expected operating profits is well short of recent transactions in this fashionable sector. UDG HealthCare, which in part makes medical packaging, has for example been plucked from the London market by US private equity group Clayton, Dubilier & Rice for 21 times this year’s operating profits.

But Smiths Medical has shrinking margins and a stagnant top line. The business will at least get an upfront payment perhaps half of which can be returned to investors. The remainder will go towards debt reduction and growth investments. Pension schemes are now in surplus but will still suck in an estimated £38m of cash this year.

Any re-rating would take time. At a 20 times ebit, the shares are already at a premium to more cyclical peers such as Weir Group and IMI. Shareholders have their eyes on a rating akin to UK peers including Halma and Spirax-Sarco, trading at multiples in the mid-thirties. But these are specialised engineers. It is a category Smiths appears reluctant to join, despite this transaction.

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