Air Products & Chemicals (APD) has offered about $60 per share for rival industrial gas company Airgas (ARG), plus the assumption of about $1.9 billion in debt. The two Pennsylvania based companies have reportedly been in contact since October regarding a possible deal, and two subsequent offers were unanimously rejected by the CEO and Board of the smaller Air Gas. In October, Airgas was trading right around $50 per share and the management team believed the offers of roughly the same amount as today’s offer undervalued the company. APD was disappointed by the lack of flexibility in previous negotiations saying in a letter to Airgas, “In our prior correspondence, we clearly and repeatedly stated our flexibility as to both value and form of consideration, yet you have continued to refuse even to discuss our offers. Your unwillingness to engage has delayed the ability of your shareholders to receive a substantial premium.”
Earlier this month, Airgas issued earnings guidance for fiscal fourth quarter 2010 of $.67 to $.71 cents per share, well below the $.74 that Wall Street had hoped to see. Full year guidance was $2.66 to $2.70 versus analysts’ expectations of $2.77. So, earlier this month the stock dropped more than 10% shortly after the cautious guidance, and of course APD hopes to take advantage of the recent weakness making their offer look more attractive.
Air Products & Chemicals is coming back to the board with an offer of $60 per share, which represents a 38% premium over yesterday’s closing price. However, this bid should be more attractive to ARG because it is an all cash deal rather than the half cash half stock offer from October. The bid was delivered in a letter to Airgas management, and it stated that they would entertain the idea of raising the offer if Airgas could demonstrate “incremental value”. The potential for an increased bid or a competing offer has Airgas trading slightly higher than the offered price on Friday morning. The letter also detailed APD expectations of $250 million in cost savings that the combined entity could see annually. Were the two companies to merge, it would create the largest industrial gas maker in North America by revenue with fiscal 2010 sales expected to top $13 billion.
The two companies seem to be a reasonably good match, with Airgas specializing in packaged gases and Air Products & Chemicals focused primarily on bulk sales. At Ockham, we have both stocks rated as Fairly Valued as the both are trading within their historically normal valuation ranges coming into the day. We had Airgas rated slightly more attractively because of its consistent growth over the past few years, and the market has awarded it slightly less of a premium for a given set of fundamentals. For example, APD trades at 1.96x sales per share while (coming into the day) ARG traded for .88x sales per share. Price-to-cash earnings is a similar story although less extreme as APD commands 9.6x cash earnings per share versus ARG’s cash earnings multiple of 7.6x coming into the day.
Considering Airgas’ more attractive growth and valuation, we can understand why APD has been in hot pursuit of their cross state rival. If the board rebuffs this offer, there is a good chance that Air Products will go straight to the shareholders in hopes of pushing it through. Based on current fundamentals, our methodology suggests that this offer is a fair price and anything more would be stretching.
