AeroVironment: BlueHalo Acquisition Is Huge News, But Earnings Contribution Is Unclear

seekingalpha11-20 04:09

AeroVironment's stock has more than doubled since I upgraded it to a buy in July 2023, outperforming the S&P 500.AeroVironment will acquire BlueHalo in a $4.1 billion deal, adding significant revenue....

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In this report, I will be discussing the share price development since I initiated coverage for AeroVironment, the details of the transaction, the estimated addition of BlueHalo to AeroVironment’s earnings, and I will discuss what this means for the stock price target and rating. AeroVironment Stock Price Has More Than Doubled   Report Date Rating AVAV stock performance S&P 500   AeroVironment: Drone Maker Stock Crashes Despite War Tailwind 5/25/2023 Hold 111.5% 42.0%   AeroVironment: An Expanded Multiple Buy 07/07/2023 Buy 101.5% 33.9%   AeroVironment: Consider Buying This Market Outperformer 12/11/2023 Buy 58.0% 27.7%   AeroVironment: Here's Why I'm Downgrading To Hold 03/05/2024 Hold 16.3% 16.1%   Click to enlarge I have been covering AeroVironment stock since May 2023 and initially I assigned a hold rating to AeroVironment as the company was trading at steep multiples. However, in July, I upgraded to buy as I recognized that there were not many companies focused on drones to buy and buying drone makers was what investors were looking for. Since then the stock has more than doubled and easily outperformed the S&P 500. In November, I maintained the buy rating and we also see that the stock continued to outperform with a 58% return and a 28% return for the S&P 500. In March this year, I downgraded the stock to Hold as the stock price had increased significantly and we also see that since then the stock did rise but more in line with the S&P 500. AeroVironment Will Acquire BlueHalo In A $4.1 Billion Deal   AeroVironment The easy starting point to go through the details of the acquisition is the transaction overview from AeroVironment’s presentation. The total enterprise value of BlueHalo is $4.1 billion including $770 million in gross debt and $30 million in cash. So, the company at the time the transaction is expected to be completed in H1 FY2025 will be in a net debt position. The debt will be refinanced by a combination of cash on hand and a new term loan. As part of the deal, the company will issue around 18.5 million shares which means that BlueHalo shareholders will own 39.5% of the company. AeroVironment is currently already in its 2025 financial year, so the transaction likely will be completed by the end of the year.   AeroVironment The business combination will put the annual sales at $1.7 billion. Interestingly, in terms of revenues, BlueHalo seems to be the bigger company with CY2024 estimated north of $900 million compared to FY2025 estimated sales for AeroVironment of $830.1 million. The combination is expected to result in annual savings of $20 million over time. What I found somewhat disheartening is that we normally see that more details on the EBITDA of the company to define any premium paid on the acquisition. The only indication we have is that BlueHalo marketed itself as a company with $150 million in EBITDA in 2022. What the company brings to the table is a mix of space technologies, counter UAS or C-UAS, Electronic Warfare & Ciber and advanced innovations. So, it's definitely enriching AeroVironment’s portfolio.   AeroVironment The company has a CAGR of 18% on sales and a backlog of more than $2.5 billion and opportunities valued more than $29 billion in an addressable market that is valued north of $50 billion. I wouldn’t say that BlueHalo will win all the bids it has put in, but looking at the numbers we can see that by all means this is a very big acquisition for AeroVironment. Our Expectations For BlueHalo On EBITDA   The Aerospace ForumMy estimates on revenues are not based on the 18% growth rate in revenues since 2026 but on a 5% growth rate, which, I believe, is more appropriate given the >$900 million revenue figure that AeroVironment provided. Furthermore, the EBITDA margins are assumed to be around 20% in line with BlueHalo marketing itself as a $150 million EBITDA company back in 2022. AeroVironment Stock Remains A Hold To determine multi-year price targets The Aerospace Forum has developed a stock screener which uses a combination of analyst consensus on EBITDA, cash flows and the most recent balance sheet data. Each quarter, we revisit those assumptions, and the stock price targets accordingly. In a separate blog, I have detailed our analysis methodology.   The Aerospace ForumThe investment case for AeroVironment has never been an easy one because of the elevated multiples that the company trades at. An acquisition in the way AeroVironment announced it without any EBITDA projections does not do a lot to reduce the risk in the investment. I currently believe that the EV/EBITDA for BlueHalo has been around 20.9x based on the revenue growth projections against an EBITDA margin of 20%. The risk here is that if those margins have come down, I could be overstating the EBITDA and FCF additions that BlueHalo provides and that's an obvious risk. Either way, I do expect that through 2027, the combined company can generate $700 million in EBITDA and $180 million in free cash flow. That brings the price target for 2026 to $180.72, down from $189.67 that I estimated earlier with a price target of $211.50 for FY27. So currently the stock is about 6% overvalued, but it does offer upside for FY27 earnings. So, AeroVironment is definitely not unattractive, but it's also not a screaming buy. Conclusion: AeroVironment Grows Its Defense Capabilities  While the acquisition of BlueHalo does not cause wide swings in the stock price target, I do think it helps AeroVironment into transforming itself into an aerospace and defense company with a broader product portfolio. BlueHalo has several end markets of which space is one, and I do believe that space offers some opportunities, as I discussed in the Investing Expert Podcast on Seeking Alpha recently. For the time being, there could be some downward pressure on the stock price for the simple reason that the acquisition is financed by issuing stock and AeroVironment does not offer a lot of useful information to determine how big the contribution of BlueHalo will be to EBITDA and free cash flow and how big the premium is when considering the enterprise value to EBITDA. 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