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Cobham targets Ultra Electronics for potential takeover

The private equity-owned defence company is exploring the creation of “a global defence electronics champion”
June 28, 2021
  • Ultra Electronics says that the two companies have only discussed the combination of specific business units, not a full takeover
  • Jefferies analyst Sandy Morris believes that a full merger is “a challenging proposition”

Ultra Electronics’s (ULE) shares shot up by 7 per cent on Friday after it emerged that the company had been approached by fellow aerospace and defence group Cobham for a potential merger.

A statement released by Cobham – which is controlled by private equity firm Advent International – confirmed media speculation, and said that it was exploring the creation of “a global defence electronics champion” through “a number of structures.” This could include a takeover, or a merger in which it receives new shares in the combined group.

But those share price gains were largely erased this morning in response to a strongly worded statement issued by Ultra Electronics on Friday evening, which indicated that it would not welcome a takeover offer with open arms.  

Ultra says that the two companies were only in the “very early stages of exploratory discussions” around a possible combination of certain divisions – its intelligence and communications unit, and Cobham’s electronics business CAES. It says that it was “expressly made clear” that a full takeover was not on the table, and it has now terminated these discussions.

Under Takeover Code rules, Cobham has until close of play on 23 July to make a firm bid or walk away. If it decides to proceed, it may well have to resort to a hostile takeover.

Jefferies analyst Sandy Morris says that the conflicting accounts from the two companies suggest that “the gloves have come off at some point.”

He believes that a full merger between Cobham and Ultra Electronics is “a challenging proposition”, but says that the specific tie-up mentioned by Ultra “might be attractive.” Ultra’s intelligence and communications business includes Herley Industries – an electronic warfare specialist it bought for $265m (£190m) in 2015 – which crosses over with Cobham’s CAES division in the field of radio frequency and microwave technology.

A controversial proposition

Even without the ‘hostile’ element, a consolidation of Cobham and Ultra Electronics wouldn’t be without controversy, not least because it involves the realm of defence and would also equate to a foreign private equity takeover by stealth.

Cobham was purchased by US buyout firm Advent International for £4bn last year. Despite opposition from the founding family, the deal was given the greenlight by then business secretary Andrea Leadsom, who said that national security risks had been mitigated to “an acceptable level.”

“Advent’s acquisition of Cobham was controversial,” says Morris. “The acquisition of Ultra is likely to be even more controversial.”

It could trigger an intervention under the new National Security and Investment Act 2021, and the government would face pressure to at least be seen to be doing something in light of its handling of the Cobham takeover.

Ultra is no stranger to contentious takeovers itself. Back in 2017, it struck an agreement to acquire its joint venture (JV) partner Sparton for $234m. But the deal fell through after the US Department of Justice raised competition concerns, and Sparton was eventually snapped up by private equity firm Cerberus Capital Management. Their JV known as ERAPSCO remains operational and supplies the US navy with ‘sonobuoys’ – electronic sensors that detect enemy submarines.

UK defence companies under attack?

Ultra Electronics isn’t the only defence company to have attracted the interest of private equity this year. Lone Star had been circling Senior (SNR), but recently walked away after its fifth approach at 200p per share was rejected. It was likely looking to pick up a bargain given Senior’s exposure to civil aerospace, a sector that has been hammered by the Covid-19 crisis. Indeed, Senior’s shares have only recently reached their pre-pandemic levels thanks to investor excitement over a possible takeover.

If embattled Senior can hold its ground, Ultra is in an even better position to either fend off a takeover approach or demand a high premium. The shares have bounced back strongly from a profit warning that sent its shares tumbling in 2017, and the company has also powered through the pandemic thanks to robust defence spending by the so-called ‘five eyes’ nations – the US, Canada, UK, Australia and New Zealand. Operating profit rose by 13 per cent in 2020 to £106m, and Ultra entered 2021 with a record £1.1bn order book.

So, even if a Cobham takeover doesn’t materialise, Ultra’s outlook is still positive as it continues to win new orders. Its expertise in electronic warfare and cybersecurity leaves it well positioned for shifting defence spending priorities, and its accelerated ‘Focus; Fix; Grow’ transformation plan should underpin higher margins. Buy at 2,166p.

Last IC View: Buy, 2,086p, 09 Mar 2021