Rexnord’s stock market flotation is the latest in a string of high-profile M&A deals in the water sector. How willing are investors to take on highly leveraged companies?
Rexnord Corporation raised $459 million from a long-promised initial public offering on NYSE in early April, generating strong international demand which helped the stock to rally from $18.00 at launch to around $21.50 as GWI went to press.
The deal is understood to have been five times oversubscribed, with lead underwriters BofA Merrill Lynch, Goldman Sachs and Credit Suisse identifying heavy institutional demand from the US and Europe following a two-week roadshow. The demand overhang allowed the underwriters to exercise their over-allotment option at closing, although some large limit orders at $18 are thought to have obliged the banks to price the deal at the lower end of the indicative range ($18-20).
This, combined with the tight allocation process (two thirds of the institutional placement is understood to have been housed with just ten accounts), allowed the deal to trade up encouragingly in the days following launch, while the fact that the company picked the most active week for US IPOs in around a year to go public added to the tail-wind.
Not everyone liked the story enough to buy in straight away. “Far and away the biggest pushback was the leverage on this company post-IPO, and I think that held the price back a little bit,” commented one observer. When Apollo Management acquired Rexnord in 2006, it loaded the balance sheet up with high-yield debt, and the company has since made little impact in terms of reducing its debt pile.
Although the company successfully refinanced its senior secured credit facilities in March, and expects to retire the $300 million 11.75% high-yield notes using the proceeds from the IPO, total debt stood at more than $2.4 billion as of 31 December 2011, meaning that there is still some way to go on the debt reduction front.
“The institutional community has been reluctant to bail out private equity and delever their over-levered investments for them, and so the IPO route becomes the only route to delever these things,” one USbased banking source commented to GWI. “The buyside would rather see their capital go towards acquisitions and growth capital – not to pay down debt and provide dividends to private equity.”
Despite the debt overhang, Rexnord has a compelling growth story to tell. A series of acquisitions has helped it to grow at a compound annual rate of 14% since fiscal 2004, and its adjusted EBITDA margin is currently nudging 20%.
It entered the water business in 2007 through the acquisition of plumbing fixtures and fittings manufacturer Zurn Industries, subsequently diversifying its client base to include municipal water and wastewater utilities through the purchase of valve manufacturer GA Industries in 2008, slide gate specialist Fontaine in 2009 and industrial valve company VAG Holding in 2011.
The water management business currently accounts for 36% of sales (see chart below), with the remainder coming from process and motion control solutions. Rexnord’s limited exposure to the residential water market has enabled it to ride out the downturn in new housing construction in the US, while benefitting from the retrofit potential of existing buildings to render them more water- and energy-efficient. On the water side, Rexnord’s product portfolio is predominantly specification-driven, which requires close co-operation between the internal sales and marketing and technical teams. In addition, the division relies on over 1,100 independent sales reps to achieve product placement in its end markets.
Rexnord’s success at integrating past acquisitions and its ability to add new platforms to some extent mirrors the rise of Danaher, which entered the water quality business in the late 1990s, and has steadily built the division up both organically and through acquisition.
The man who oversaw Danaher’s entry into the water business, George Sherman (who served as CEO from 1990-2001) is currently non-executive board chairman at Rexnord Corporation, and has a big say in the strategic direction of the group. Sherman’s seat on the board – and his presence at a number of the investor meetings leading up to the IPO – were of no small significance to the investment community. “The Danaher pedigree and the ‘Danaher clone’ business model definitely played well to the Street. I don’t think you can underestimate how valuable that was,” commented one source.
Although Rexnord is undoubtedly making progress in terms of debt reduction, management’s ability to further reduce financial liabilities will be a key point underlying the valuation of the company going forward. On an enterprise value to EBITDA basis, Rexnord looks to have priced at a slight discount to its peer group, although the subsequent performance of the shares has narrowed the gap somewhat.
While the company is expected to continue its growth-through-acquisition strategy – albeit cautiously – it does not ancitipate paying a dividend for the foreseeable future. With many of its peers offering very low dividend yields of under 0.50%, however, this should not be an issue for investors.
What will be more interesting to observe is whether Apollo Management – which still controls 66.5% of Rexnord – looks to further reduce its stake by selling some stock once its 180-day post-IPO lockup period expires. “If Rexnord is still trading in the low-mid $20s six months from now, I think you’re going to see a secondary offering for Apollo to get some proceeds and probably for the company to repay some more debt,” one source observed.