General Dynamics Not Backing Down in Bid for CSRA

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Over the weekend, aerospace and defense giant General Dynamics Corp. (NYSE: GD) announced that it intends to proceed with its tender offer to acquire all outstanding shares of defense contractor and IT company CSRA Inc. (NYSE: CSRA) for $40.75 per share in cash.

General Dynamics announced its intention to acquire CSRA in February, but the latest announcement comes in response to a CACI International Inc. (NYSE: CACI) unsolicited offer proposing to acquire CSRA for $44.00 per share in cash and stock. The proposed merger “would unite two businesses with long-term customer relationships, complementary capabilities and substantial presence in high-growth markets,” according to CACI. And it “would further capitalize on this opportunity for growth, amplifying both CACI’s and CSRA’s position in key market areas and improving the value proposition and customer footprint.”

General Dynamics offered the following reasons why its bid for CSRA is the superior one:

  • We believe the nominal price of CACI’s offer to CSRA overstates the real value to the CSRA shareholders and understates the risk attendant to it.
  • CACI’s offer is comprised of $15.00 per share of cash, less than 35 percent of the purported value.
  • Over 65 percent of CACI’s proposed consideration consists of a fixed exchange ratio of CACI stock, which is subject to daily market fluctuations and an estimated four-month delay at a minimum before its real value can be ascertained with certainty.
  • CACI’s nominal $44.00 per share offer depends upon the all-time closing high share price of CACI’s volatile common stock.
  • We believe that CACI’s proposal would burden the resulting entity with approximately $6.8 billion of debt, which would result in leverage of approximately 5.7x debt to EBITDA, one of the highest in the Government Technology Services sector.
  • CACI’s proposed offer would appear to be approximately 25 percent dilutive to CACI’s GAAP earnings on a pro forma basis pre-synergies and also dilutive to CACI’s GAAP earnings on a pro forma basis even assuming the elevated level of CACI’s estimated cost synergies.
  • CACI’s estimated synergies are, we believe, aggressive at best.
  • With CSRA shareholders owning 55 percent of the combined company, CSRA will bear the burden of 55 percent of the termination fee payable to General Dynamics as well as 55 percent of the transaction expenses, which we estimate for CSRA alone at a total potential after-tax cost of approximately $0.66 per share for each CSRA share. Assuming CACI’s transaction expenses approximate CSRA’s, the estimated total potential after-tax cost could be approximately $0.82 per share for each CSRA share.
  • Based on CACI’s statement that it could close the acquisition of CSRA by July 31, 2018, the time value of money for an investor between early April and the closing of a CACI/CSRA combination would represent a significant opportunity cost.
  • Using the average trading price of CACI’s stock over the past 30 trading days and taking into account the 55 percent of the transaction expenses and termination fee to be borne by the CSRA shareholders and the time value of money opportunity cost due to the significant delay in the closing of a proposed CACI transaction, we estimate the value of CACI’s unsolicited offer to be less than the General Dynamics offer.
  • On this basis, we believe the CACI offer is inferior to our cash offer of $40.75 per share even prior to factoring in the significant market risk associated with a CACI transaction closing many months in the future with a fixed exchange ratio.

Merrill Lynch recently named General Dynamics one of its top alpha generation ideas for the rest of 2018. The stock is also on the Merrill Lynch US 1 list of high-conviction picks. Alpha generating stocks make good sense for long-term growth accounts that can buy good ideas and put them away for a reasonably long time.

A few other analysts have chimed in on General Dynamics recently:

  • Cowen reiterated an Outperform rating and has a $253 price target.
  • Morgan Stanley has an Underweight rating and a $225 price target.
  • RBC has an Outperform rating and a $267 price target.
  • Credit Suisse has an Outperform rating too and boosted its price target to $262.
  • Argus has a Buy rating with a $250 price target.

Shares of General Dynamics were last seen at $222.74, in a 52-week trading range of $183.72 to $230.00. The stock was inactive in Monday’s premarket.

CSRA shares were up 2.7% to $41.74 in premarket trading, a new 52-week high if it holds. The 52-week low is $27.38.

CACI ended trading last week at $157.45 a share, and it also was quiet in the premarket.

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