Takeaway: Wabtec’s repurchase seems to reflect anxiety about its sagging share price. Perhaps the Faiveley family is getting antsy about their discount to public holders. For long-term holders who liked the old Wabtec strategy, we do not see how a change in capital allocation is a positive signal.
Choking on Good Burgundy
There are a few odd and noteworthy aspects of the buyback announced today. First, it is utterly uncharacteristic for WAB. Wabtec has had an acquisition driven growth strategy, and the 4Q15 buyback is much larger than the cumulative net buybacks over the last decade. It is a major change in capital allocation, and one may limit post-Faiveley acquisition flexibility.
Second, with the Faiveley deal closing expected at some point in 2016, cash is precious. As we see it, WAB will need to come up with about $1 billion to close, with about $200 million of that currently in escrow. The $365 million spent on the repurchase might have been put to better use, limiting the amount of debt that would be needed to fund the transaction.
Finally, Faiveley’s public holders can elect Euro 100 per share, while the family is stuck taking 75% of their compensation in a fixed 1.125 ratio of WAB equity that has devalued since the deal was announced. The family would be selling shares at – depending where one marks a WAB three-year mandatory convertible preferred of dubious liquidity – a 25% to 30% discount to public holders. Is the Faiveley family finding that a bit hard to swallow, and perhaps pushing for revised terms?
Some Other Questions
- Why change the capital allocation strategy? The share price was at 4Q15 average levels through most of 2014 without a large buyback, so it is unlikely that management was attracted to the exceptional value.
- Is the buyback a signal that business is great, and management wants to demonstrate confidence? That seems a pretty clear, ‘no’. We know that US Freight Rail equipment is going into storage, orders for new equipment are down, and that the international freight market is not robust. Backlogged orders may support activity in early 2016, but we do not believe that Wabtec management is highly optimistic about their market outlook.
- Does WAB just want to add additional leverage, not recognizing that this is likely the peak of the rail capital spending cycle? We hope so. In fairness, Wabtec has probably been underleveraged; that will change with the buyback & Faiveley merger.
- Did the company want a lower share count to improve headline EPS guidance? Perhaps, but the market has not responded well to simplistic financial engineering of late.
- Did the Faiveley family press the company to do something about its sagging share price? That doesn’t seem out of the question. If you were the Faiveley family, would you want to receive less than the public holders?
We may be asking the wrong question, but Wabtec management seemed to want a higher share price in the fourth quarter. For long-term holders who liked the old Wabtec strategy, we do not see how a change in capital allocation strategy is a good signal.