‘Compelling’ space deal fails to lift BAE shares

A rare opportunity for BAE Systems (LSE:BA.) to accelerate its growth in key US markets was met with a £1 billion loss of value today as investors gave Ball Aerospace a cool reception.

Their caution is likely to reflect a cash price of $5.55 billion (£4.4 billion) for a bolt-on acquisition that is by far the largest deal by BAE in the last decade. It represents 12% of last night’s market capitalisation when including an expected $750 million tax benefit.

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The share price weakness is also driven by the usual risks that come from integrating an operation with 5,200 staff and a broad base of platforms. It is being funded by a combination of additional debt and existing cash resources.

The Colorado-based provider of spacecraft, mission payloads, optical systems and antenna systems provides BAE with $2 billion (£1.6 billion) in additional annual revenues.

It also has “trusted customer relationships” among the US intelligence community, Department of Defense and civilian space agencies. Over 60% of Ball’s staff have US security clearance.

Just under half of BAE’s revenues of £11 billion came from the United States in the first half of the year, with Ball offering the potential to advance next-generation solutions for a number of BAE’s businesses in electronic warfare and intelligence and surveillance.

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Chief executive Charles Woodburn called the strategic and financial rationale as compelling, with Ball Aerospace performing strongly and well positioned for sustained growth. 

He added: “It's rare that a business of this quality, scale and complementary capabilities, with strong growth prospects and a close fit to our strategy, becomes available.”

BAE said the value-enhancing financial effects of the acquisition included an expected revenue compound annual growth rate of about 10% over the next five years. It is also accretive to margins and earnings per share in the first year after the deal completes, which is likely to be in the first half of next year.

For UK investors, BAE stressed that its capital allocation priorities were unchanged and will continue to include the $1.5 billion buyback programme announced with half-year results.

Shares still fell 39.5p to 963p, leaving them just 30p higher than where they were before BAE posted better-than-expected interim results and increased full-year guidance on four of its key financial metrics.

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The optimism was underpinned by a record order backlog of £66.2 billion, reflecting the current elevated global threat environment as well as BAE’s international presence and diverse portfolio of products and services.

The stock had been as high as 1,037p in April but sentiment on leading defence names has cooled in recent weeks. Following the results on 2 August, Bank of America lifted its price target to 1,163p, driven by BAE’s strong capital allocation and mid-term growth outlook.

Morgan Stanley, which has a 1,251p target, said today’s deal was in keeping with the company's broad strategic vision, including the high-growth space market where management has been clear about its ambition to expand.