ST Engineering - DBS Research 2021-10-04: Big Acquisition For Smart City Ambitions

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SINGAPORE TECH ENGINEERING LTD (SGX:S63)

ST Engineering - Big Acquisition For Smart City Ambitions

• ST Engineering announced US$2.7bn (S$3.6bn) acquisition of US-based transportation solutions leader, TransCore.
• Complements and enhances ST Engineering’s suite of smart mobility offerings, opens door to big new market.
• Significant earnings accretion likely from FY23 onwards, as ST Engineering leverages its balance sheet.
• Dividends should continue as usual, maintain BUY.

Biggest ever M&A deal for ST Engineering.

• ST Engineering (SGX:S63) today announced that it has entered into an agreement to acquire all the ownership interests in TransCore Partners, LLC and TLP Holdings, LLC (collectively TransCore) from an indirect wholly owned subsidiary of US-listed diversified industrial technology giant Roper Technologies, Inc., for US$2.68bn (~S$3.62bn).
• According to a press release from Roper, the divestiture of the TransCore business is in line with Roper’s move away from working-capital-intensive project-related businesses to more predictable, high-margin, recurring revenue businesses. For ST Engineering though, the transaction should help open doors to a much bigger and well-developed US market for its smart mobility and smart city solutions.

Who is TransCore?

• TransCore has been around for more than 80 years in the US, specialising in developing transportation solutions for government agencies and private firms. TransCore is well reputed as a market leader in the Electronic Toll Collection (ETC) market in the US. It operates in three key business areas:
  1. Tolling – collecting and processing more than US$7bn in annual toll revenues worldwide (note that TransCore’s revenues are not linked to toll collections)
     • 11 of 15 largest toll agencies in the US utilise Transcore toll collection systems
     • Operates 10 back-office customer service centres
     • Maintenance Monitoring Center tracks system performance 24/7
  2. Intelligent Transportation Systems (ITS) – designs and deploys advanced traffic management systems
     • Currently manages more than 30,000 intersections worldwide
     • Supporting the deployment of the US$OT’s Connected Vehicle Deployment Pilot Project in New York City
  3. RFID – Transcore is a pioneer in RFID systems and developed the industry’s first transportation applications at Los Alamos Labs in the 1980s.
     • Currently supports tolling facilities, airports, hospitals, parking garages, border patrols, trucking fleets and rail industry
     • Designed, developed, and shipped more than 100 million RFID tags and over 101,000 readers

In addition, TransCore is developing the first ever congestion pricing program in the US.

• TransCore is in the process of deploying an industry-leading congestion pricing system in Lower Manhattan’s Central Business District (CBD) to facilitate improved traffic flow, more predictable travel time, reduced carbon emissions, and the recurring revenue necessary to improve public transportation infrastructure in the region. Key features include:
  • Overhead digital technology to provide licence plate recognition and image-based vehicle detection.
  • Specifically engineered hardware to hide from plain sight and blend into the landscape.
  • Flexible solution to support diverse business rules, such as discounts, exemptions, and others.

Why the acquisition?

• This will accelerate ST Engineering’s Smart City growth and position it as a market leader in Smart Mobility. The Smart City space has been an important strategic focus area for ST Engineering, and the company has been on the lookout for strategic acquisitions to boost its organic imprints. Management believes that TransCore is a strong strategic fit and its road transportation solutions will complement and enhance ST Engineering’s existing suite of Smart Mobility rail and road solutions.
  • Access to new markets: The North America electronic toll collection (ETC) and ITS markets, in which TransCore has leadership positions, are expected to grow from US$2.5bn in 2021 to more than US$4bn in 2030
  • Access to technology: TransCore’s deep capabilities include a range of patents and IP rights in electronic toll collection, congestion pricing and ITS solutions
  • Fits with sustainability agenda: TransCore’s end-to-end transportation solutions are designed to reduce traffic congestion and lower vehicle emissions, which align with ST Engineering’s commitment to help cities deal with the impact of urbanisation and climate change
  • Cross-selling opportunities: Business combination allows for cross-selling of ST Engineering’s current transportation solutions such as smart road junctions, transportation operation centres and road traffic optimisation systems to North America, while TransCore’s electronic toll collection and congestion pricing solutions could be offered to customers in the Southeast Asia region where ST Engineering has a strong presence.

Growth prospects are reasonably bright.

• TransCore has a strong order backlog of US$1.2bn (~S$1.6bn, roughly 10% of ST Engineering’s own order backlog), which will be realised over the next 2-3 years. The backlog implies a healthy book-to-bill ratio of over 2x, compared to FY20 revenues of around US$565m. A substantial part of the orderbook comes from the ~US$500m New York congestion pricing project.
• While the project has seen some delays recently, it should be moving ahead, and once completed, could pave the way for more congestion pricing projects in the other key urban areas in the US, including cities like Chicago, Los Angeles, San Francisco, Portland and Seattle.
• In addition, according to forecasts from strategy consulting firm PTOLEMUS, the core ETC and ITS markets in US are expected to grow at a 4-6% CAGR over the next decade and over in Southeast Asia, the ETC and ITS markets in the region are expected to grow at a rapid CAGR of 14-15% to US$1.2bn by 2030.

We think that the acquisition price is fair.

• ST Engineering will be paying US$2.68bn in cash for the transaction, which it expects to finance using debt markets. The purchase price implies an EV/EBITDA multiple of 16.2x based on FY20 numbers, after accounting for tax benefits. This appears reasonable with industry metrics (both trading multiples and recent acquisition multiples). If we were to exclude PV of tax benefits, the EV/EBITDA multiple would be 18.7x, based on FY20 EBITDA of US$143m for TransCore.
• Furthermore, TransCore’s EBITDA margin of 25% compares favourably with ST Engineering’s own historical core EBITDA margin range of 13-14%. We believe that the business should be able to churn strong cash flows given that 54% of its revenue is recurring/re-occurring in nature, driven by the operations and maintenance of tolling and intelligent transportation systems. High customer retention with a contract renewal rate of 95%, is testament to TransCore’s stellar branding and service capabilities.

Should add to earnings significantly from FY23 onwards.

• The acquisition is expected to be completed in 1QFY22, and hence we assume a 9-month contribution in FY22 and full-year contributions from FY23 onwards. Just to add some perspective, according to proforma estimates, the acquisition would have led to an increase of S$65m in net profits for FY20 for ST Engineering, from S$522m to S$587m, an increase of 12.5%. For 1H21 numbers, TransCore’s PBT of US$54m (~S$72m) is 21% of ST Engineering’s Group PBT of S$340m for 1H21.
• However, management has guided that the acquisition is expected to be earnings accretive only from the second year onwards post-acquisition, due to the presence of one-off transaction costs and integration costs in the beginning. However, the acquisition will be cash flow positive from the first year itself.
• After accounting for all one-off costs and interest expenses from the acquisition debt, and the fact that FY22 will see only a 9-month contribution, we estimate the impact on FY22 earnings to be slightly dilutive, while in FY23, the acquisition should drive earnings accretion of at least 11-12%. The amount of accretion will depend on the pricing of debt issued to fund the acquisition and hence, could be higher if funding costs are lower than what we have assumed.

ST Engineering has the balance sheet to digest this and still continue paying dividends.

• As the acquisition is expected to be 100% debt-funded (through the issue of US$ medium-term notes in future), net gearing (net debt/equity) will rise substantially to around 1.6x post-acquisition from around 0.4-0.5x pre-acquisition, but management has shared that they are committed to maintaining dividends and will be able to do so as TransCore’s cash flow generation is strong.
• While ST Engineering’s credit rating could be downgraded, as the company would likely breach S&P’s downside trigger ( > 2.0x debt to EBITDA) post the acquisition, we believe this would likely have limited impact on its cost of funding.
• Management also highlighted that there is still scope for further acquisitions and will continue to evaluate opportunities as they come. This is sound, in our view, as ST Engineering should continue capitalising on its competitive cost of debt funding to drive growth.

Expect strong growth in FY23 earnings; maintain BUY rating on ST Engineering with higher target price of S$4.55.

• For FY22, we revise up ST Engineering's revenue forecasts by 7% to factor in the acquisition, but trim earnings by around 3% as the acquisition is not immediately accretive. We also introduce FY23 forecasts, with projected revenue growth of 7% and earnings growth of 23%.
• The strong earnings growth in FY23 is a combination of the earnings accretion kicking in from TransCore (after most of the one-off costs have been recognised in FY22 and with the benefit of a full-year contribution), as well as recovery in the Commercial Aerospace segment, with flight activity projected to return closer to pre-COVID levels by 2023.
• Our target price for ST Engineering, which factors in both near-term earnings growth, dividends and long-term growth in cash flows (DCF), is revised up to S$4.55 as we factor in the long-term growth from the acquisition, despite the muted impact on earnings in FY21/22. Maintain BUY.
• See
  • ST Engineering's Share Price,
  • ST Engineering's Target Price,
  • ST Engineering's Analyst Reports,
  • ST Engineering's Dividend History,
  • ST Engineering's Announcements,
  • ST Engineering's Latest News.
• ST Engineering's share price has had an indifferent run over the last two months owing to concerns over the impact of increase in COVID cases in the region delaying the recovery of international air travel. This presents a good entry point to play the Smart City growth story for ST Engineering, as we await an aviation revival. A secure dividend yield of 4% adds to the appeal.

Suvro SARKAR DBS Group Research | Jason SUM DBS Research | https://www.dbsvickers.com/ 2021-10-04

SGX Stock Analyst Report BUY MAINTAIN BUY 4.55 UP 4.200