You are on page 1of 49

Buying Zodiac Aerospace is bad for Safran

and bad for Safran shareholders


February 2017

TCI Client Services Team


Irteam@tcifund.com Private & confidential
US +1 212 468 1050 Intended solely for recipient
UK +44 20 7121 9413
Safran

Summary

Buying Zodiac Aerospace is a bad deal for Safran

Safran is massively overpaying for Zodiac

Safran is a high quality business and its stock is significantly undervalued

The merger with Zodiac will be hugely value destructive

The shareholder vote on the merger should take place before the takeover

Corporate governance at Safran is flawed and will be even worse after the merger

Safran shareholders should vote against the merger to secure strong corporate governance

A share buyback is better for Safran and better for its shareholders

Safran stock is worth 100 without Zodiac

The proposed deal structure disenfranchises Safran shareholders

-2-
Safran

Why buying Zodiac is a bad deal

No strategic rationale Dilution of Safrans high quality Propulsion business

Questionable synergies Accretion dependent on a highly uncertain and


optimistic turnaround of Zodiacs business

Safran is massively overpaying Very low return on capital

Safran has a terrible history of executing and Results in a very high level of debt
integrating takeovers

Safran will be exposed to Zodiacs Safrans public shareholders will be diluted


contingent liabilities for late and defective Capital: 75% 68%
seat and cabin deliveries Votes: 62% 52%
Board seats: 40% 30%

Zodiacs founding families, the Peugeot family, Fonds Strategique and the French State will sign a shareholders
agreement that, together with employees, will give them effective control of Safran

-3-
Safran

Safrans rationale for buying Zodiac is flawed

1. Entering some new areas in aerospace: diversification into a poor business weakens Safran

2. Strategic growth: the deal dilutes Safrans growth rate

3. Financial discipline: Safran is massively overpaying and giving away cheap Safran stock

4. Synergies: these are questionable due to limited product overlap

5. "Create a global aerospace leader: this is good for the French state but not for public shareholders

A ll quotes are from Safran c onferenc e c all 1 9 th J an 2 0 17

-4-
Safran

Zodiac is overvalued even on normalised earnings: fair value = 20

2016 Actual Normalised

Revenue 5.2bn 5.4bn

Reported margin 5%

Normalised margin: allowing for some recovery in Interiors


Previous peak margin adjusted down due to:
Higher complexity of business mix 10%
Increased competition from new entrants e.g. Recaro
More pricing pressure due to shift to Supplier Furnished Equipment

EBIT 260m 540m

EPS 0.50 1.30

Implied multiples at takeout price of 29.50: PE 59x EV/EBIT 18x PE 23x

Fair value PE multiple 15x Zodiac fair value 20

Sourc e: T CI analysis

-5-
Safran

Accretion guidance is highly optimistic

EPS accretion is dependent on a highly uncertain


and optimistic turnaround of Zodiacs Interiors Zodiac's Interiors margin required
business for double digit accretion
15% >12%
Double digit accretion requires
the margin at Zodiacs Interiors
A margin recovery from -1% to over 12% is not business to recover from -1% in
credible because Safran has: 10%
2017 to more than 12% in 2019

Done little due diligence in this area


No experience making seats and cabins
5%
A terrible track record in integrating acquisitions

0%
There is huge execution risk
-1 %
-5%
2012 2013 2014 2015 2016 2017 2018 2019

Sourc e: T CI analysis, as sumes 5 1% tender acceptance, margin rec overy includes s ynergies

-6-
Safran

The Return on Investment of the deal is very low

The takeover destroys value

Current margin Recovery margin TCI Best case

Zodiac Takeout Value 9.7bn 9.7bn 9.7bn

EBIT margin 5% 10% 14%

Zodiac EBIT 320m 540m 760m

NOPAT 230m 390m 540m

Return on Investment 2% 4% 6%

Sourc e: T CI analysis, Zodiac margin inc ludes synergies

-7-
Safran

Zodiac is facing serious financial difficulties

Ten profit warnings in two years

No sign of a recovery in its Interiors business

Very close to breaking its debt covenants

Change in the business model to Supplier Furnished Equipment (SFE) will significantly increase pricing pressure

Increasing competition from new entrants (e.g. Recaro)

The deal is a bail out of Zodiac to create a national champion

-8-
Safran

Buying Zodiac dilutes the quality of Safrans business

Safran Pro forma Safran/Zodiac

Safran has a far superior business. Dilution of high quality Propulsion business.
Defence 4% Defence 5%
Zodiac
Interiors 15%
Equipment 26%
Propulsion 46%
% of Zodiac 2019 (E)
profits Aero Systems 9% revenues
2015

Propulsion 70%

Equipment 25%

The Propulsion business has: Zodiacs business is more fragmented with:


Huge barriers to entry Low barriers to entry
A global monopoly/duopoly position More and increasing pricing pressure from Boeing and
Significant pricing power Airbus as the business moves towards Supplier Furnished
Equipment (SFE)
Very profitable and predictable 25-year cashflows

Sourc e: T CI analysis

-9-
Safran

Safran is hugely undervalued

Safrans reported earnings do not reflect its true earnings power (due to current hedge rate of $1.24/)

Safran 2016 (E)

Revenue 17,500m

Reported EBIT (Safran hedged @ $1.24/) 2,500m

Reported EPS 3.90

EBIT adjustment for FX @ 1.10/ 700m

Real underlying EBIT 3,200m

Real underlying EPS 5.10

Safran EV/EBIT 9x

Safran PE 12x

Reported E PS is pre-Security sale. 1 c move in the $ = 5 0 m


Sourc e: T CI analysis

-10-
Safran

Safrans financial position will be significantly weaker after merging with Zodiac

Net cash position post sale of Security Net debt after Zodiac deal
Guidance: 2.5x debt/EBITDA

2bn net cash


2 2

1 1

0 0

-1 -1

-2 -2
bn

bn
-3 -3

-4 -4

-5 -5

-6 -6

-7 -7
7bn net debt
-8 -8

Sourc e: T CI analysis

-11-
Safran

Public shareholders capital and voting rights will be significantly diluted

Current Safran shareholding structure Safran/Zodiac shareholding structure

French state 14% French state 13%

Employees 11% Employees 10%

Zodiac reference
shareholders 10%
Public 75% Public 67%

Current Safran voting rights Safran/Zodiac voting rights

French state 22% French state 20%

Employees 16% Employees 13%


Public 62%
Public 53%
Zodiac reference
shareholders 14%

Sourc e: T CI analysis

-12-
Safran

Public shareholders board representation will be diluted

The principal shareholders are dividing the board seats of the merged company amongst each other

Zodiacs reference shareholders will all gain board seats

Public shareholders currently own 75% of the capital but post-merger will have only 30% of the board seats

Current Safran Board Safran/Zodiac potential board

Number of seats % Number of seats %

Chairman & CEO 2 12 2 10

French state 3 18 4 20

Employees 5 29 4 20

Independent 7 41 6 30

Zodiac Reference Shareholders 4 20

17 20

Source: TCI analysis


Notes: Employees includes Club Sagem representative.
Safran/Zodiac board assumes employees and independent representatives lose one board seat each.
P18 of merger presentation: the board would comprise 20 members, including representatives of Zodiac Aerospaces reference shareholders
http://www.latribune.fr/entreprises-finance/industrie/aeronautique-defense/fusion-safran-zodiac-l-etat-gagne-un-administrateur-de-plus-au-conseil-de-safran-633649.html

-13-
Safran

Safran
Corporate governance at Safran is flawed

Double voting means the French state and employees control almost 40% of the votes

The Florange Law has produced a governance structure that lacks proper accountability and responsibility

French state 14%


French state 22%

Employees 11%

Capital Voting
structure rights

Employees 16%
Public 75%
Public 62%

Sourc e: T CI analysis

-14-
Safran

Corporate governance will be even worse after the merger

The merger is a cynical attempt by the principal shareholders to take control of the company

The deal will dilute the capital, votes and board seats of public shareholders

Public shareholders will be vulnerable to further abuse if the merger goes ahead

The valuation of the stock will suffer

Safran now Safran/Zodiac

Public share of capital 75% 67%

Public share of votes 62% 53%

Independent board seats # 7 of 17 6 of 20

Independent board seats % 40% 30%

Sourc e: T CI analysis

-15-
Safran

The Safran/Zodiac board will look similar to the board of Volkswagen

TCI, a long term shareholder of Volkswagen (VW), has been actively trying to improve the corporate governance at
VW (see the website www.TCIVWengagement.com)

Huge problems arise from poor governance

Poor governance breeds arrogance and complacency

Safran/Zodiac board Volkswagen Board

French State 4 Lower Saxony 2

Employees/unions 4 Employees/unions 10

Zodiac Family 2 Piech Family 2

Peugeot Family 1 Porsche Family 2

Fonds Strategique 1 Qatar 2

Independent 6 Independent 1

Sourc e: T CI analysis

-16-
Safran

If institutional shareholders vote against the deal it can be stopped

Safran shareholder structure % capital % votes

French state & employees 25 38

Public shareholders 75 62

o/w Institutional shareholders 61 50


o/w US/UK 41 34
o/w French 10 8
o/w other 10 8

o/w index funds 5 4

o/w individual shareholders 5 4

o/w unidentified 5 4

Only 33.4% of votes are needed to stop the merger

Sourc e: T CI analysis

-17-
Safran

TCI has been a shareholder of Safran for five years

Safran share price


70

60

50

Stock price increase


40 Feb 2012Dec 2016: 170%

30

20
Feb 2012
TCI initiates position at 25

10
2012 2013 2014 2015 2016 2017

TCI currently owns over 4% of Safran

-18-
Safran

TCI has a very positive track record of interaction with Safran

In October 2012, TCI sent a public letter to


Safrans CEO and CFO

In the letter TCI proposed that Safran should:


1. Review its capital allocation policy
2. Sell its stake in Ingenico

Subsequently Safran:
1. Sold its Security business for a good price
2. Sold its stake in Ingenico. The final 5%
stake was sold for 110 vs. the current Ingenico
share price of 78

The interaction had positive outcomes for Safran

-19-
Safran

TCI reiterates its proposals from October 2012

In the October 2012 letter TCI also proposed that Safran:

1. Should not make a bid for Zodiac, a company of lower overall quality than Safran. This deal has
questionable strategic rationale and limited synergic benefits. We oppose any new attempt to
take over Zodiac.making engines is a far superior business to making seats.

2. Increase the dividend payout ratio to 50% of profits. Safran has strong cashflow characteristics so this is
easily affordable. There would still be more than enough retained capital for reinvestment and R&D.

3. Not use the companys shares for any future transaction as long as they remain at such a depressed
valuation. At current prices buying back the companys shares would be, by far, the best
investment that Safran could make.

These recommendations still apply today

-20-
Safran

The market is sceptical about the takeover of Zodiac

Safran share price


70

65

Safran stock -10% since


deal announced reflects
60 massive value dilution and
huge execution risk

55
Jul 16 Aug 16 Sep 16 Oct 16 Nov 16 Dec 16 Jan 17

Sourc e: Bloomberg

-21-
Safran

The AMF should intervene

TCI has written to the AMF asking them to intervene:

The proposed deal structure disenfranchises Safran shareholders

Safran shareholders are effectively being deprived of their voting rights

Zodiac public shareholders are not being given the proper information they require before making a decision
(they could receive cash, Safran shares or they could end up owning a hugely devalued minority stake in
Zodiac)

Zodiac reference shareholders are being given a preferential deal to avoid paying tax

It is in the interests of all shareholders that the vote on the merger happens before the takeover

TCIs correspondence with the AMF can be found at www.aStrongerSafran.com

The rights of the public shareholders are being violated

-22-
Safran

Alternative strategy

Zodiac is an inferior business and Safran is paying a massive multiple

Giving away undervalued Safran stock for expensive Zodiac stock is hugely value destructive for Safran

High leverage will weaken Safran

Safran shareholders should vote against the merger

Instead, Safran should do a 3bn share buyback

-23-
Safran

Comparison of the two alternative strategies

Buying Zodiac 3 billion share buyback

EPS accretion dependent on a highly uncertain and Double digit EPS accretion guaranteed.
optimistic turnaround of Zodiacs Interiors business.

Zodiac's Interiors margin required


for double digit accretion
15% >12%
Double digit accretion requires
the margin at Zodiacs Interiors
business to recover from -1% in
2017 to more than 12% in 2019
10%

5%

0%

-1 %
-5%
2012 2013 2014 2015 2016 2017 2018 2019

Sourc e: T CI analysis, as sumes 5 1% tender acceptance, margin rec overy includes s ynergies

-24-
Safran

Comparison of the two alternative strategies

Buying Zodiac 3 billion share buyback

Results in a very high level of debt: Safran would have zero debt
Leverage guidance = 2.5x EV/EBITDA 2bn in cash plus over 1bn of FCF pa
Debt = 7bn

Vulnerable dividend due to high leverage Secure dividend

Lower FCF conversion due to high levels of capex FCF/Net income conversion would be approx. 100%
at Zodiac

Future cashflow will be used to pay down debt Future cashflow could be used for:
1. More R&D
Dividend payout ratio capped at 40% 2. Investing in new products
3. Higher dividends; the payout ratio could be
raised to 50-60%

Sourc e: T CI analysis

-25-
Safran

Comparison of the two alternative strategies

Buying Zodiac 3 billion share buyback

Exposure to contingent liabilities Zero exposure to Zodiacs troubled seats and cabins
business and potential associated liabilities
Zodiac is exposed to unquantifiable penalties for
late deliveries and future claims for potentially
defective seats and cabins

There is significant risk that Zodiac faces huge


costs in the future to fix recently delivered
faulty products.

Once the deal closes Safran will be liable for


these payments

This will consume cash that Safran could have


used to invest for the future and in R&D

Sourc e: T CI analysis

-26-
Safran

Comparison of the two alternative strategies

Buying Zodiac 3 billion share buyback

The takeover will be massively value destructive A share buyback would be massively value enhancing
It only covers Safrans cost of capital under highly Safran stock is hugely undervalued (12x adjusted
optimistic scenarios earnings)

Safran has a terrible history of executing and Zero deal risk


integrating takeovers

Dilution of key business metrics: Superior business model maintained:


Lower growth rate High growth rate
Lower return on capital High return on capital
Higher capital requirements Low capital requirements

Sourc e: T CI analysis

-27-
Safran

Summary

Buying Zodiac 3 billion share buyback

Buying Zodiac will significantly dilute the quality of Safran would remain focused on the high quality
Safrans business Aerospace Propulsion business

A Safran/Zodiac combination would have: Safran would have:


Lower growth A much higher growth rate
A lower return on capital A higher return on capital
A high level of debt Zero debt
A vulnerable dividend due to high leverage A secure dividend
Sub-100% FCF conversion due to high levels of capex The potential for higher dividends
required at Zodiac 100% FCF conversion

Safran is massively overpaying for Zodiac Safran stock is very cheap

Zodiacs fair value is 20

The takeover will be hugely value destructive The buyback would be massively value enhancing

Sourc e: T CI analysis

-28-
Safran

Safran stock is worth 100 with a share buyback

Buying Zodiac 3bn share buyback


Current Safran Lower quality business High quality business
share price High leverage No leverage
15x PE 20x PE

100

56%
upside
75
17%
64 upside

Sourc e: T CI analysis

-29-
Safran

Conclusion

Safran is massively overpaying for Zodiac

The merger vote should take place before the takeover

Corporate governance at Safran is flawed and will be even worse after the merger

Shareholders should vote against the merger (only 33.4% of the votes needed to block it)

Safrans stock price is significantly undervalued so a share buyback would be hugely value accretive

Safran stock is worth 100 without Zodiac

TCI will be voting against the merger and proposing a 3bn share buyback

-30-
Appendix
Safrans stand-alone growth prospects are very strong

TCI Client Services Team


Irteam@tcifund.com Private & confidential
US +1 212 468 1050 Intended solely for recipient
UK +44 20 7121 9413
Safran

Safran

The aerospace engine
business is the best
CEO
business in the world.

-32-
Safran

Safrans Propulsion business has over 80% share of the narrow body market

CFM 100% market share


monopoly specification CFM 60% market share
10,000 duopoly specification

8,000
Engines in fleet

6,000
CFM

4,000

2,000

0
Boeing 737 Family Airbus A320 Family

CFM IAE

Sourc e: A scend

-33-
Safran

Growing CFM installed base

CFM fleet in service to grow by 4%+ annually over CFM fleet in service
the next decade 40,000

25,000 CFM56 engines in operation today

By 2025, 11,000+ engines expected to be


30,000
added to the fleet in service

Number of engines
20,000

10,000

2018(E)
2021(E)
1982
1985

2000
2003

2024(E)
1988
1991
1994
1997

2006
2009
2012
2015
CFM56 LEAP

Sourc e: T CI analysis

-34-
Safran

Aftermarket profits will grow strongly

CFM deliveries
All of these engines not making profits yet
1,800

1,600

1,400
Number of engines

1,200

1,000

800

600

400

200

0
1989

1990

1994

1998

1999

2003

2007

2008

2012
1988

1991

1992

1993

1995

1996

1997

2000

2001

2002

2004

2005

2006

2009

2010

2011

2013

2014

2015
pre-1988

Sourc e: A scend, T CI analysis

-35-
Safran

Shop visit outlook

Maximum shop visit activity on CFM56 Worldwide CFM fleet shop visits
around 2025 4,000

CFM56 Gen 2 shop visit activity will grow by


50%+ over the next ten years
3,000

Number of visits
2,000

1,000

2022(E)

2023(E)

2024(E)

2025(E)
2016(E)

2017(E)

2018(E)

2019(E)

2020(E)

2021(E)
2012

2013

2014

2015
CFM56 LEAP

Sourc e: T CI analysis

-36-
Safran

A huge wave of engines will need servicing in the next 15 years

CFM56 engine deliveries and maintenance shop visits


2,000

1,800 Engines Engines Engines Engines


on 4th on 3rd on 2nd on 1st
1,600 visit visit visit visit
Number of deliveries

1,400

1,200

1,000

800

600

400

200

2019(E)
2016(E)
2017(E)
2018(E)

2020(E)
1985

1988

1992

1995

1998

2002

2005

2008

2012

2015
1986
1987

1989
1990
1991

1993
1994

1996
1997

1999
2000
2001

2003
2004

2006
2007

2009
2010
2011

2013
2014
Sourc e: A scend, Bernstein analysis

-37-
Safran

Expected CFM56 spare parts growth

Aftermarket revenues will peak 70% above 2015 level

2x 3x
2007

2016

2019

2028
2010

2013

2022

2025
Sourc e: Safran SA

-38-
Safran

LEAP dominating new engine orders and commitments

LEAP (Safran)

A320neo 1,571 aircraft (55% market share)


CFM LEAP
737 MAX 3,129 aircraft (100% market share) 74%
737 MAX
Comac C919 517 aircraft (100% market share)

5,217 aircraft
C919

GTF (Pratt & Whitney) C Series

MC-21
A320neo 1,264 aircraft (45% market share)

CSeries 403 aircraft A320neo A320neo

MC-21 176 aircraft PW1000G


26%
1,843 aircraft

Sourc e: Safran SA

-39-
Safran

Propulsion EBIT margin will bottom in 2017

25%

23%

21%

19%

17%

15%

13%

11%

9%

7%

5%
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Sourc e: T CI analysis

-40-
Safran

Equipment division: Leading positions in braking and landing markets

Wheels and brakes Landing gear & systems

#1 worldwide #1 worldwide
for carbon brakes for civil aircraft

Sales Sales
99% aftermarket share 43% aftermarket
Generally dual sourced 57% OE

Revenue based on fee per landing Generally single sourced

Carbon brakes replacing steel brakes OE sales to Airframers

Aftermarket sales to operators and MROs

Sourc e: Safran SA

-41-
Safran

Equipment division: Strong growth expected

Wheels and carbon brakes Landing gear & systems

Number of commercial aircraft fleet Commercial market (OE + aftermarket)


equipped with carbon brakes

200

150

Base 100 Base 100


2025(E)

2025(E)
2014

2014
Sourc e: Safran SA

-42-
Safran

Margins at other divisions forecast to grow 1% p.a. for the next 5 years

Aircraft equipment Defence

15% 15%

10% 10%

5% 5%

0% 0%
2016(E)

2017(E)

2018(E)

2019(E)

2020(E)

2016(E)

2017(E)

2018(E)

2019(E)

2020(E)
2015

2015

Sourc e: Safran SA

-43-
Safran

3 years of flat EBIT, before growth resumes in 2018

4,000

3,500

3,000

2,500
m

2,000

1,500

1,000

500

0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Sourc e: T CI analysis, pre s ale of s ecurity

-44-
Safran

CAPEX peak in 2016

1,000

800

600
m

400

200

2019(E)

2020(E)
2016(E)

2017(E)

2018(E)
2015

Sourc e: Safran SA

-45-
Safran

Research and development spending peaked in 2014

2,000 2,100m

1,500 1,356m
m

1,000

500 495m

0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016(E) 2017(E) 2018(E) 2019(E) 2020(E)

Capitalised R&D Total self-funded R&D Total R&D effort

Decrease of development spending as programs enter into service

Sourc e: Safran SA

-46-
Safran

Strong dividend growth

Dividend per share

1.38

1.20
1.12

0.96

0.62

0.50

0.38

2009 2010 2011 2012 2013 2014 2015

Sourc e: Safran SA

-47-
Safran

The French government stake has been falling

35%

30%
30%
27%

25%
French government stake

22%

20% 18%

15%
15% 14%

10%

5%

0%

Mar-15
Mar-13
Jan-13

Nov-13

Nov-15

Nov-16
Sale proceeds ($m) 600 1,200 1,200 800 350
Price () 35 46 63 69 63

Sourc e: Bloomberg

-48-
Disclaimer

This document is being issued by TCI Fund Management Limited and the information contained herein may not be reproduced, distributed or published by any
recipient for any purpose without the prior consent of TCI Fund Management Limited. By accepting these materials, you hereby acknowledge and agree to all of the
terms and conditions in this disclaimer and disclosure statement. This document is not classified as a financial promotion.

TC I Fund Management Limited is authorised and regulated by the Financial Conduct Authority of the United Kingdom.The information and opinions contained in this
document are for background purposes only, do not purport to be full or complete and do not constitute investment advice. This document does not constitute or form
part of any offer to issue or sell, or any solicitation of an offer to subscribe or purchase any investment nor shall it or the fact of its distribution form the basis of, or be
relied on in connection with, any contract therefore.

C ertain information contained herein may constitute forward-looking statements. Due to various uncertainties and actual events, including those discussed herein,
recipients should not rely on such forward-looking statements. Any target objectives are goals only, are not projections or predictions, and are presented solely for
your information. No reliance may be placed for any purpose on the information and opinions contained in this document or their accuracy or completeness. No
representation, warranty or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained in this document by
any of TC I Fund Management Limited, its directors, affiliates or employees and no liability is accepted by such persons for the accuracy or completeness of any such
information or opinions.

TC I Fund Management Limited, 7 C lifford Street, London, W1S 2FT, UK

-49-