Invensys looks an easy target

The willingness of German engineering giant Siemens to pay over £1.7bn for Invensys Rail stunned the City. It was equivalent to the group’s market capitalisation prior to the deal and considerably more than anyone had expected – analysts at investment bank UBS valued it at just £1bn.

Shareholders will get £625m, or 76.7p in cash per share. More important, paying £400m upfront and putting £225m into a trust sorts out problems with legacy pension funds, long acknowledged as a serious barrier to a takeover. It will leave Invensys with £548m of net cash and a logical focus on supplying industrial software and control equipment to power stations, factories and oil refineries.

This is IOM, the sexy, high-margin part of Invensys, which generates almost three quarters of the slimmed group's sales and profits. Strong demand for simulation programmes used to automate and sharpen up performance grew software sales by 16 per cent during the first half and control and safety systems flew off the shelves, too. Even demand for control equipment was steady, despite a slowdown in China, and enquiries are picking up. Crucially, emerging markets will chip in more than a third of sales and over half the order book. An end to annual pension payments of over £40m and restructuring costs of £25m a year will boost cash flow, too.

That should be enough to interest rivals. "We suspect it may be only be a matter of time before Invensys is acquired once the sale to Siemens is completed - likely around May 2013," says Andrew Carter, an analyst at broker RBC Capital. And it's clear why. In June, Invensys acknowledged that US big-hitter Emerson Electric had come knocking. Others were interested, too, management said, but the situation has changed. Invensys is a thorn in Emerson’s side and the disposal of rail should be enough to re-ignite US interest.

There'll be competition. Honeywell, Switzerland's ABB and General Electric will want a look. And don't rule out Siemens or private equity interest. All could easily afford what's left of Invensys and would love its impressive client list of oil majors, power generators and pharmaceutical giants. But it won't come cheap.

City analysts reckon a buyer would have to find over £3bn, or 400p per share, double the company's June valuation and way above the current market price. Using a multiple of 9.8 times forecasts for 2013-14's operating profit and 25 per cent takeover premium, analysts at Nomura think the operations management division alone could be worth £2.2bn and the controls unit - on 8.2 times earnings - another £552m.

RBC is more conservative, valuing IOM at just £1.5bn, or 10 times estimates of current year cash profits. But it thinks the software business, which will chip in less than 20 per cent of the division's sales, could be worth £900m on its own, and pricing the controls unit at just £400m looks cautious, as the recovering US housing market should drive demand for domestic appliances. Besides, when the gloves are off in a bid battle, strange things can happen.

Even without a deal, analysts at investment bank Barclays Capital think their estimates may prove too cautious (see table). Factoring in the loss of rail earnings in 2013-14 and stripping out both the special dividend and 67p of cash leaves Invensys shares trading on just 11 times forward earnings. That compares with Emerson on a forward PE ratio of over 12 times and software peers nearer 20. Add in earnings-enhancing acquisitions and a big deal or two and the shares could be worth 450p, Barclays says.

True, disposal of the rail division still requires approval from shareholders, the UK pensions regulator and competition authorities, but there’s nothing to worry about. Following that, it looks like a question of when not whether the bid emerges.