Alcoa Takes Flight on $2.85 Billion Firth Rixson Buyout

Alcoa (AA) made another big push into the fast-growing aerospace market as it has agreed to buy U.K.-based leading jet engine components maker Firth Rixson from private equity firm Oak Hill Capital Partners in a cash and stock deal worth $2.85 billion. The aluminum giant’s shares screamed higher to touch a new high following the announcement.

The move represents a significant milestone in Alcoa’s portfolio transformation strategy as it gradually shifts its focus on lucrative aerospace and automotive markets. It is in sync with the company’s goal to profitably grow its aerospace franchise and build its value-added businesses.

Alcoa, which continues to grapple with weak aluminum pricing, is increasingly focused on broadening its foothold in the aerospace market as it looks for expansion opportunities beyond its legacy primary aluminum business and diversify into other materials such as those (nickel and titanium-based) used to make aircraft parts. Aluminum prices, which remain weak given the oversupply of the metal in the market, continue to weigh on its bottom line.

Alcoa, which was ousted from the Dow Jones Industrial Average last year partly due to its tepid stock performance, saw its shares shot up as much as 4.3% to reach a new 52-week high of $15.18 yesterday. The stock retraced to end the day at $14.94, gaining around 2.7%. Alcoa’s shares have racked up a healthy 41% gain so far this year, bringing back cheer to investors.

A $2.85 Billion Aerospace Bet

Under the deal terms, Alcoa will buy Firth Rixson for $2.35 billion in cash and $500 million of its stock and an additional $150 million for specific earnings-related milestones. The buyout will be backed by a fully committed bridge facility from Morgan Stanley (MS). Greenhill and Morgan Stanley served as financial advisors to Alcoa on the deal while Citigroup (C) and Lazard (LAZ) acted as financial advisors to Firth Rixson.

The deal has been approved by the boards of both companies and is subject to regulatory clearances and other closing conditions. Alcoa expects to secure the required regulatory approvals and wrap up the transaction by end-2014.

The Rationale

The acquisition of Firth Rixson it a strategic fit for Alcoa as it complements the latter’s goal to strengthen its global aerospace portfolio. Firth Rixson is currently the global number one in seamless rolled jet engine rings that are engineered from nickel-based superalloys and titanium, and is a leading supplier of jet engine forgings. This will boost Alcoa’s foothold in global aerospace engine forgings.

Moreover, Alcoa, through this acquisition, will penetrate into a highly specialized segment of jet engine forgings that need isothermal forging technology. Isothermally forged components are increasingly needed in jet engines that utilize higher turbine temperatures to beef up power output, boost fuel efficiency and cut emissions.

Strong aerospace build rates are expected to triple the demand for large isothermal aerospace engine disks in the next eight years. Firth Rixson, which derived roughly 75% of its sales from the aerospace industry last year, recently entered this market segment through the development of its state-of-the art facility in Savannah, GA.

A Compelling Prospect

The buyout brings in considerable benefits to Alcoa. It reinforces the company’s aerospace business and strongly places it to capture additional growth in this growing market through a broad spectrum of high-growth, value-add jet engine components. The acquisition will expand the market reach of the company’s aerospace portfolio.

Firth Rixson’s sales are expected rise 12% annually through 2019, a rate more than double the global aerospace market. Its revenues have been forecast to increase 60% over the next 3 years to $1.6 billion from $1 billion in 2013. The acquisition will also contribute $350 million EBITDA by 2016.

The acquisition is expected to expand Alcoa’s annual aerospace revenues by 20% to $4.8 billion from $4 billion in 2013 on a pro forma basis and increase the contribution of the high-growth aerospace segment to the company’s value-add revenues to around 35% from 30%.

Alcoa is also expected to realize significant cost synergy from the transaction with cost savings reaching over $100 million by the fifth year. The acquisition is expected to be neutral to its earnings in the first year and accretive afterwards.

Leveraging Strong Momentum in Commercial Jet Space

Alcoa, a Zacks Rank #3 (Hold) stock, makes lightweight metallic solutions for the aerospace industry. It holds leading market positions in aerospace forgings, extrusions, jet engine airfoils and fastening systems made by its downstream business, and aerospace sheet and plate made by its midstream business. The company’s aerospace business was the biggest contributor to its value-add businesses last year, accounting for 57% of overall sales and 80% of segment profits.

Alcoa, in Apr 2014, bumped up its global aerospace growth expectations for 2014 to 8%-9% from 7%-8% factoring in strong demand for both large commercial aircraft and regional jets and sustained growth in the business jet market.

Alcoa recently said that it is investing $25 million to boost capacity at its power and propulsion facility in Hampton, VA, to address increasing demand for next-generation aircraft engine parts. The company, last month, broke ground on its new $100 million aerospace expansion in La Porte, IN, where it will produce nickel-based superalloy jet engine parts for large commercial aircraft, including narrow and wide-body and military airplanes.

With the Firth Rixson takeover, Alcoa will be able to capitalize on strong growth in the commercial aerospace segment. The company envisions the commercial jet sector to grow at a compounded annual rate of 7% through 2019. Given this healthy prospect, Alcoa is undoubtedly moving in the right direction.