by Tony D’Altorio, Investment U Research
Wednesday, November 24, 2010
Caterpillar (NYSE: CAT) is the biggest maker of earth-moving equipment by revenue. And it just got bigger, thanks to its largest purchase in three decades… and the mining industry’s largest in five years.
The company recently announced its acquisition of Bucyrus International (Nasdaq: BUCY), a major manufacturer of mining equipment. It will pay $7.6 billion or $92 per share, while assuming $1 billion of debt.
This follows CAT’s announcement in June of a $700 million, three-year expansion into the mining equipment market. That included starting production of a full range of mining shovels for the first time.
And overall, Caterpillar’s new course – and purchase – looks like a gold mine.
Caterpillar’s Fresh Focus: The Bucyrus Deal
Caterpillar has a fresh focus under its new CEO, Doug Oberhelman.
Even before taking over less than five months ago, he had already changed the business. As head of the rail services division, Oberhelman led CAT’s $820 million purchase of Electro-Motive Diesel, one of the U.S.’s biggest rail locomotive manufacturers.
And just last month, he paid $784 million to buy German engine maker MWM. Now, all eyes are turned to his latest achievement: the Bucyrus deal.
The industry sees it as a sensible, long-term bet on commodity prices and emerging market growth. But the purchase also shows how Oberhelman is transforming Caterpillar from a stodgy, old manufacturer into a lean and nimble giant.
Caterpillar usually doesn’t go on buying sprees, so the Bucyrus deal surprised the market. Notes Adam Fleck of Morningstar: “The new chief executive had given notice of his interest in M&A activity but people had expected more bolt-ons, and this is a pretty big deal. It basically doubles the size of their mining business.”
Yet Oberhelman certainly gave it warning of his intentions. Upon taking over, he spoke of mining equipment as an important sector to expand into.
It was, he said, a “sweet spot” in an attractive sector that fit CAT’s business model.
The Thinking Behind the Bucyrus Deal
The deal for Bucyrus came together in just 60 days or so. Yet Caterpillar has long watched the global economy, finally determining that emerging economies and commodities markets trends are here to stay.
Investment bank Jeffries & Co. says capital expenditure in the mining sector will increase by at least 15% next year. Rio Tinto ADR (NYSE: RIO) alone proves that.
The mining giant is raising capital spending from $1.8 billion in the first half of 2010 to $13 billion from then through December 2011. That’s yet one more sign of booming commodities activity as emerging market demand weighs on mining output.
Bucyrus shows Caterpillar’s confidence that coal isn’t going anywhere, despite pollution concerns. It knows the commodity is still the cheapest and most abundant fossil fuel the emerging world has to power their rapid expansion.
CAT also knows that it can use Bucyrus’s strong presence and reputation with coal mining companies in China. Speaking of the growing market there, Bucyrus CEO Tim Sullivan said, “There’s more of a movement to accept western suppliers, in the coal sector in particular, in China.”
Bringing Together Two Complimentary Companies
The purchase brings together two complimentary companies.
Caterpillar can now offer the widest range of mining equipment of any global manufacturer. And it can take a bigger share of the $30 billion market, competing more effectively with Joy Global (Nasdaq: JOYG) and Japan’s Komatsu ADR (PINK: KMTUY).
Touting the merged company as a superstore for mining customers, CAT will sell Bucyrus products through its extensive global dealer network. Oberhelman says he can now provide “one-stop shopping,” for global miners like Rio Tinto and BHP Billiton ADR (NYSE: BHP).
With the current two-track global economy, he gets the importance of emerging markets:
“When I entered the business world, three-fourths of the world was closed – China, Russia, Vietnam, India, most of Africa. In 2010, the entire world is wide open, the developing world is growing twice as fast as the developed world and there’s still arguably several billion people out there that will modernize and progress.”
The one fly in the ointment is the price tag to all this gain. Caterpillar is paying 11 times next year’s earnings… before interest, tax, depreciation and amortization.
To justify that, Bucyrus has to generate about 14% annual sales growth over the next five years. But based on its historical sales growth, that doesn’t seem unreasonable.
It’s hardly a bargain in the end. But Caterpillar still paid a reasonable price as it tries to widen its hold on the global mining equipment industry.