Serco Group plc (LON: SRP), the international service company, today announced that it has entered into a definitive Asset Purchase Agreement to acquire for $225m the Naval Systems Business Unit and a small number of related contracting entities, from Alion Science & Technology Corporation. NSBU is a leading provider of naval design, systems engineering, as well as production and lifecycle support services to the US Navy, US Army and Royal Canadian Navy. In the 12 months to September 2018 NSBU had revenues of $336m, which compares with Serco’s North American Defence revenues in 2018 of $453m; NSBU has an order book of around $600m and a new business pipeline of over $2bn.
Commenting on the Acquisition, Rupert Soames, Serco Group Chief Executive, said:
“This is an important step for Serco which materially adds to the scale and capability of our US defence business, and in particular to the maritime support segment. Serco employs some 6,000 people in North America, of whom 2,300 work in defence, and has been providing services to the US Navy for nearly 30 years, so we know this market well. NSBU, which employs around 1,000 people, brings world-class ship and submarine design, systems, and engineering services, production support and in-service sustainment capabilities, which are highly complementary to Serco’s existing skills in ship modernisation, hardware integration and naval logistics. The combined business will be a top tier supplier of services to the US Navy, which has recently announced plans to increase the fleet from 280 to 355 ships by 2034, and we see a long-term and growing demand for the capabilities that the combination of Serco and NSBU will be able to provide.
“We are financing the Acquisition through a mix of debt and equity which will allow us to maintain leverage well within our target range of 1-2x EBITDA, and we expect the Acquisition to be materially accretive to earnings in the first full year of ownership.
“We greatly look forward to welcoming our new colleagues to Serco. The current management team of NSBU will continue to run the business and lead the integration into Serco, and we know they are as excited as we are by the opportunity to create a major new supplier of maritime engineering services, combining our joint capabilities in ship and systems design, modification and sustainment.”
Summary of financing arrangements and financial impact:
· NSBU is to be acquired for $225m (approximately £173m – see Note 1) on a cash-free, debt-free basis, and subject to customary working capital and other relevant adjustments up to the date of completion.
· The Acquisition is expected to close in the second half of 2019 and is subject to regulatory approvals, including customary Hart-Scott-Rodino (‘HSR’) and Committee on Foreign Investments into the United States (‘CFIUS’).
· Financing is through a combination of a new committed debt facility of up to £75m, together with an equity placing for cash of up to 10% of existing share capital that is expected to raise gross proceeds of around £130m (based on yesterday’s closing share price) (the ‘Equity Placing’).
· Net Debt (see Note 2) for the end of 2019 was previously anticipated to be approximately £200m and leverage for covenant purposes around 1.3x; following the Acquisition, these will increase, respectively, to approximately £250m and, on a pro forma basis, to around 1.5x.
· In 2020, which will be the first full year of ownership, NSBU is expected to contribute revenue of approximately $370m (£285m), EBITDA of $28m (£21m) and Underlying Trading Profit (UTP – see Note 3) of $27m (£20m), resulting in transaction multiplies of 0.6x, 8.1x and 8.3x, respectively. This includes the benefit of sharing Serco’s fixed overheads across a wider revenue base in North America, which we expect to be worth $3-4m of UTP in the first year.
· The Acquisition is expected to be accretive to current analyst consensus of Underlying EPS by 7-9% in 2020, which will be the first full year of ownership.
Summary of NSBU and its combination with Serco:
· NSBU is a leading provider of ship and submarine design, systems engineering and integration, production support and through-life sustainment services for the US Navy. It is involved with every major ship class in the US fleet, and also provides equivalent services elsewhere within the US Department of Defense (DoD) and to other naval customers around the world, including the Royal Canadian Navy. It has an order book of around $0.6bn (£0.5bn) and a new business pipeline of over $2bn.
· NSBU adds high-end design and engineering capabilities to Serco’s international Defence businesses and brings additional scale to our business in the US.
· Serco Group’s revenue mix from Defence will increase from 30% to around 35%, which is equivalent to approximately $1.6bn (£1.2bn) on a pro forma basis for 2018, while the Americas division as a proportion of the Group will increase from 20% to around 26%, equivalent to approximately $1.2bn (£0.9bn).
· The Acquisition increases the Group’s weighting towards large and faster-growing markets. The US Navy plans to expand its fleet from around 280 to 355 ships by 2034, both by new build and life-extension of existing vessels, and this is likely to result in increased demand for NSBU and Serco’s core capabilities.
· The combination of NSBU with Serco’s existing maritime support operations will allow us to offer services that cover the entire lifecycle of a ship: from hull architecture, systems design and production support, through to in-service upgrades and modernisation. It also allows us to offer customers design and engineering services, as well as the ship-board installation and maintenance capability.
In summary, the acquisition of NSBU will:
· Broaden the capabilities and increase the scale of our North American and international Defence businesses.
· Increase our exposure to US Navy fleet expansion, which is one of the fastest-growing areas of public procurement.
· Enable us to generate synergies through sharing our fixed overheads across a wider revenue base in North America.
· Increase our Underlying EPS by 7-9% above current analyst consensus for 2020.
