October 11, 2012 - 9:43am EST by
2012 2013
Price: 4.13 EPS €0.30 €0.60
Shares Out. (in M): 578 P/E 13.7x 6.9x
Market Cap (in $M): 2,387 P/FCF NA NA
Net Debt (in $M): 3,420 EBIT 1,110 1,230
TEV ($): 5,807 TEV/EBIT 5.2x 4.7x

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  • Sum Of The Parts (SOTP)
  • Italy
  • Government contractor


Finmeccanica is the leading Italian defense company, 30% owned by the Italian Treasury. It was once a diversified industrial conglomerate and still retains remnants of those assets but most have been sold/spun off and replaced with aerospace and defense assets, many outside Italy.  The Italian defense market accounts for less than 20% of group sales, the other large exposures include the UK (via Marconi which was purchased from BAE) and the US (mainly via the ill-timed DRS acquisition in 2008). Finmeccanica also has a large exposure to the civil aerospace market, principally via helicopters and aerostructures, where it is a large supplier to Boeing, especially for the 787. It remains the second largest industrial company in Italy.


Recent History
The company stumbled badly in mid 2011, as aerostructures and defense electronics both suffered large losses, requiring a large restructuring and write-offs of bad contracts. These were concentrated in civil aerostructures (€850m provision on the 787), defense electronics (lower volumes at DRS in the US, bribery scandal in Italy etc) and rail (losses at rolling stock).  As a result Finmeccanica had a pretax loss of €2.7bn in 2011 after a profit of €1.2bn in 2010 and many profitable years prior. Much of the loss was in the form of provisions that are being spent in 2012-13, so despite profit recovering quickly this year cashflow will be weak (but not negative) in 2012E and 2013E with the weakness most pronounced in the first half per normal seasonality of the business.  The company's specific troubles as well as the larger European/Italian contagion caused the share price to crumble from €10 to a low of €2.7.  The shares traded above €20 in more normalized times (early part of the decade as well as 2007 when it benefited from healthy earnings growth and a favorable aerospace cycle). 

The crisis described above resulted in a sweeping change of management. The new CEO since 2011 is Giuseppe Orsi, who formerly ran the Helicopter division (Agusta Westland) successfully and who has a more aggressive and hands-on approach than previous leadership. Other positively perceived appointments include Gian Cutillo last May as CFO (came from Energia) and William Lynn as head of DRS and FNC North American CEO (he was number 2 guy at Pentagon).

As things stand today, Finmeccanica has adequate liquidity (end year net debt is projected at €3.5bn) and there is only one maturity of €800m at the end of next year) but European investors are very skittish about financial risk, despite an asset disposal plan that management expects to generate €1bn by year end,  the proceeds of which will go to debt reduction. The part sale and spin off of the rail business is also possible by year-end. The recent rally in the share price is the result of reports that a sale of the company's 55% stake in Ansaldo Energia might get done.


Core businesses and recent trends:

Agusta-Westland Helicopters: extremely strong and profitable global market leader in military and medium size civil helicopters...this division is improving its margins and generating + cash flow and is the jewel of the group

Alenia Aeronautics: sell military aircraft (Eurofighter, jet trainers, military transports), civil aerostructures (Boeing, Airbus), smaller civil aircraft ...flat order growth (tough y/y comp) but recently had impressive wins including €850mm to Israeli Air Force

Selex Defence Electronic:, one of two European and UK leaders alongside Thales in radar, air traffic control, radio etc. Also 25% share in MBDA European missile JV....earlier innings in reorganization plan and still tough backdrop given budget cuts

Defense systems: armoured vehicles, naval guns, torpedoes – all strong niches

Thales Alenia Space, JV with Thales to build and operate satellites – Competes primarily with EADS



Ansaldo Energia (55% stake), power plant manufacturer, already part sold to PE shop First Reserve, balance expected to be sold to Siemens or state investment company ot other soon

Rail, includes the signalling business which has already had 60% taken public as Ansaldo STS (STS IM) and the loss making rolling stock business (Ansaldo Breda) which is wholly owned; the latter could be partly sold soon to allow Finmeccanica to deconsolidate rail...Hitachi and others have been mentioned as possible buyers

Real estate and other assets


The thesis for going long:  The process of fixing bad contracts and reducing costs to meet a lower volume environment is well under way.  In addition management is committed to divest non core businesses, reduce debt and refocus on the core aerospace and defense assets.  The improved profitability and liquidity should highlight the value of the simplified remaining pieces to investors.  The stock is cheap enough that one does not have to assume any significant pickup in market share or the aerospace cycle, all of which would be additional upside.


Broad restructuring plan in process

2013 savings target of €440mm seems achievable since most of it is from reduced headcount of 1800 people.  70% of actions necessary to achieve these savings have already been taken and €247mm of the total is expected in 2012.  If accomplished this should improve margins by 200bp.  So far the evidence of progress is positive based on better than expected 1H2012 results.  First half 2012 EBITDA up 10% and margins improved by 50bp to 5.7% with helicopter and aerospace improving, offset by weakness in defense and electronics and space.   


Plan to unify Selex (which has many subdivisions spread amongst avionics, military and secure communications) can add upside to savings.  New management has been hired and cost savings plans are being presented to the board in second half of 2012 with some disclosure likely by year end.


Balance sheet better than feared
Management expects to end 2012 with EUR3.4b in net debt excluding any benefit from disposals and FCF slightly above 0.  In fairness this does not include pension liability or the present value of cash flows owed to the government for grants received.  These have been included in the SOTP analysis below.
No liquidity issue until earliest 2015 (expiration of revolver which has no covenants and is syndicated among many banks)
EUR815mm due Dec 2013 on 8.125% bond in worse case can be met by drawing on fully undrawn EUR2.4B revolving credit line
Super cheap valuation on SOTP and post-restructuring normalized earnings
   -EV/sales of .35x  (peer average of .5x)...not irrelevant as they are underearning on their assets
   -P/E of 4.5x 2014 base case est earnings  (see scenario analysis below)
Sum of the parts value of €11 assuming 2011 was trough year and 2014 will be more normalised
Rich in monetizable assets :                    2014e EBITDA                multiple                  Value                 Assumptions
Helicopter division                                  660                               9.5                         6270                  premium valuation to txt, ba
Aeronautics                                           300                                8.0                         2400                 5% margins post savings...avg of civil and defense multiples
Defense Electronics                                750                                7.5                         5625                 low end of historical to reflect budgetary environment
Defense Systems                                   200                                7.0                         1400                 European average
Breda                                                   -65                                                              -100                  Low mult assumes can be fixed at some point
Stake in Ansaldo Energia (55%)                                                                                  680                  55% of 1,233 transx value in 2011 with First Reserve                                                
Stake in Ansaldo STS (40%)                                                                                       430                  40% of market value
Jv with Thales in Space                           110                               8.0                           880                  discount to LMT
Real Estate/Other assets                                                                                             300                  guesstimate from industry, balance sheet cost marked up
Capitalized R&D                                     -140                              8.0                           -1120               aer/defense avg
Advances net of interest benefit                                                                                   -5000              company reports
Net Debt                                                                                                                    -3100               yr end est assuming 50% asset disposal
After tax Pension Liability                                                                                             -725                assumes 80mm DTA and tax shield
PV of Law 808                                                                                                             -570
Corporate/HQ                                                                                                              -1000              fin stx and assumes modest savings
Shares outs                                                                                                                 578
Value/share                                                                                                                €11.00
Summary of earnings Scenario Analysis on restructuring program into 2014:
all numbers in miilions of €
A) Base case:  Combination of cost cutting and execution on aerospace and defense improve margins back to 6.5% by 2014
Revs           18,000
EBIT            1,170
Interest          375
Taxes             290
Net income     505
EPS               .87
Multiple          8x  (peer group in Europe including BAE, Thales, Cobham at 7-9x 2014)
Price Target    7.00  (+75%)
B) Bull case: Restructuring plan is successful, top line grows modestly and asset disposals raise 1.0-1.5B and margins get back to 7.5%
Revs           18,500
EBIT            1,387
Interest          295
Taxes             382
Net income     711
EPS                1.21
Multiple           10x
Price Target     12.30  (+208%)
C) Bear Case: Execution lags and budget backdrop worsens...margins decline from 1H2012 to 4.5% and revenues contract 5%
Revs           17,000
EBIT               765
Interest          395
Taxes             130
Net income     240
EPS                 .42
Multiple          5x 
Price Target     2.10 (-48%)
Bottom line, the upside-downside risk-reward is uniquely assymetric for what looks like a moderate risk cost cutting and conglomerate deleveraging story with plenty of asset value support below. 
Disposals are pushed out and ability to win contracts in defense becomes hampered by lack of liquidity to prefund
Broader European ills trickle down and further challenge Finmeccanica's fundamentals
Further defense budget cuts/sequestration risk-DOD is only 15% of overall business
787 pushed out further
 note: There is US ADR (FINMY) representing .5x shares of the local stock.
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.


Disclosure of Selex savings from restructuring on q3/q4 conf call
Sale of rest of Energia or other assets (parts of DRS, real estate, minority stake in Space)
Deconsolidation of Ansaldo Breda
New orders accelerate; Helicopter division recently won EUR300mm at Farnborough Air ShowEur and 93mm other across various subs
EADS-BAES merger looks to be terminated although can make argument its not a negative as it could hasten reorg plan
Longer term potetnial to reinstate dividend
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