Industrial conglomerate 3M (click ticker for report: ) announced its intentions to acquire ceramics and components maker Ceradyne (CRDN) for $35.00 per share in cash, or the equivalent of $860 million ($670 million net of cash, cash equivalents, short-term investments, and debt). On a multiple basis, the deal is somewhat expensive, with 3M paying 35x consensus 2012 earnings and 26x 2013 consensus earnings.
Additionally, we’re not sure how bright Ceradyne’s future looks. With respect to its energy exposure, the firm focuses on solar energy and nuclear power plants—both of which are facing some tremendous headwinds. Cheap natural gas and coal, as well as massive industry supply caused by Chinese manufacturers has created a tremendous supply/demand imbalance. As a result, industry fundamentals have deteriorated precipitously and US solar manufacturers, like Ceradyne and First Solar (FSLR), have struggled to remain profitable. Nuclear energy faces massive safety and fear issues following the Japanese meltdown in 2011. Though both energy sources have fewer carbon emissions than others, we aren’t very confident about the sustainability of either industry’s long-term fundamentals at this juncture. Still, the firm does have a very nice PetroCeram business, which is used to prevent sand from entering oil pipelines. We like this product line, as we don’t see demand for improved drilling productivity falling anytime soon.
Defense, on the other hand, remains a sizable wild card. Historically, the US government has been hesitant to cut defense spending as it retains its reputation as the world enforcer. However, it’s no secret that the government budget is stretched. Ceradyne has a few contracts with the Department of Defense, but production could remain weak, especially for products like missiles (Cereadyne makes the radomes). However, demand for the firm’s armor and helmets should remain strong. The wild card here is whether or not the tension brewing in the Middle East results in a significant conflict that would drive demand higher. But paying 26x times next year’s earnings for this option value seems a bit rich, in our view.
Ceradyne also has a strong industrial products business, which might be the only business line that coincides with 3M’s existing product lines. But even here, we fail to see any meaningful synergies, with the exception of SG&A expenses. Though the company’s organic business increased year-over-year in 2011, Ceradyne itself has grown mostly via mergers and acquisitions rather than via internal expansion. We worry that acquiring an acquirer may not be the best use of shareholder’s capital. Still, we’re confident 3M will be able to seamlessly integrate the acquisition, given its various existing lines of business.
Regardless, we doubt this acquisition will have any material impact on 3M’s earnings. It expects to add $0.01 net of acquisition costs this year, and it only adds incremental revenue of $500 million, which isn’t much for a company that we believe, will post over $30 billion in revenue this year. Shares of 3M remain fairly valued at this time, so we’re not interested in adding the conglomerate to the portfolio of our Best Ideas Newsletter at this time.