History: In 1968, Thales predecessors Thomson-Brandt and CSF merge to form Thomson-CSF. The company started receiving business from the Middle East and during the oil crises (1973 to 1979) diversified into telephone switchgear, semiconductors and medical imaging. In February 1982, the parent of Thomson SA was nationalized amid weak financial situation, and a portfolio of businesses which was too diversified to be profitable.
During the next decade or so, the company first divested and then sold most of its businesses concentrating on professional and defense electronics. In 1987, the company correctly anticipated the reduction in defense spending in France and started acquiring businesses in an attempt to become more global. By 1996, the non-French subsidiaries contributed 25% of the revenue.
1998 was a watershed year for Thales when Aerospatiale, Alcatel, Dassault, Thomson-CSF and Thomson SA reached an agreement endorsed by the French government whereby i) the professional and defense electronic business of Alcatel, and Dassault are merged with Thomson-CSF, and ii) the satellite business of Alcatel, Aerospatiale and Thomson-CSF are merged to form Alcatel Space — which is owned jointly by Alcatel and Thomson-CSF. Following this agreement, the company remains privately owned with the French government holding 40% and Alcatel/Dassault holding the rest.
In the end of2000, Thomson-CSF was renamed Thales after the acquisition of Racal Electronics PLC, a UK defense electronics group, for £1.3 billion.
In 2006, Thales acquired Alcatel’s space division and its rail signalling business, raising Alcatel’s ownership to 21.66%. In December 2008, Alcatel sold its stake to Dassault Aviation SA for €1.57 billion.
Shareholding: Majority of the company’s equity is bound by shareholder agreements. This includes the partial ownership of the French state (27.08%) and Dassault Aviation (25.96%) - a French private company led by French billionaire Serge Dassault. The French government also holds a golden share which might be used to veto and/or restrict the company against doing something which the government does not approve of. Out of the 46.96% float, Thales owns 1.38% shares and her employees hold another 3.05%.
Management: Not surprisingly the French government as well as Dassault aviation have significant say in the management of the company. After Dassault acquired Alcatel’s stake in 2008, the CEO of many years, Denis Ranque, was replaced by Luc Vigneron.
The same year saw the financial crisis, and the margins of the company suffered. The company had a loss of €202 million. Vigneron started on a plan to turn the company profitable. The plan had a roadmap which lasted until 2014, saving some €1.3 billion. One major piece in his plan was to put in new labor agreements, which was understandably not famous with the powerful labor organizations. They claimed that the CEO was reshuffling managements, in effect trading off the company’s long term for the short term.
The fundamentals of the company paint a different picture. Thales’ has shown modest but steady improvement in its business as well as its financial situation. By the end of 2012, the talks between the labor organizations and the management broke down. Understandably the new socialist French government headed by Hollande sided with the labor unions and Vigneron was marked for removal before the completion of his savings plan. The exact politics behind the scene (between the ministry and the Dassault Aviation) is impossible to guess. But it seems that the French Ministry of Defense got to fire Vigneron, and Dassault was allowed to replace him with their own choice.
Looking at the performance of Vigneron, one cannot help but feel that he was performing quite well for the shareholders and business.
The new CEO Jean-Bernard Levy brings in his own baggage. Levy had been the CEO of Vivendi since 2002. Vivendi’s stock price hit a nine-year low during his tenure, and the rift between him and the chairman of the supervisory board continued to get deeper. Vivendi, a hodge-podge of at least four distinct businesses (video games, music, telecommunications and paid TV) traded at at least a 40% discount to its individual parts. The supervisory board felt that spinning off or selling some of the businesses would help realize the value. Levy, who bought Vodafone out of SFR at €8 billion, was opposed to the idea. Levy quit in June 2012 when it was clear that the board was looking to sell the telecom business against Levy’s judgement.
The individual shareholders seem to come in at a distinct third, after the labor and government, and the private family-owned Dassault Aviation.
It also makes me uncomfortable that Dassault and Thales have common businesses interests.
Business: The company divides its business into two main segments i) Defense & Security, and ii) Aerospace & Transport. The main customer of the defense and security business are governments and public agencies. The aerospace and transport business serves infrastructure operators, avionics, space and transportation systems divisions.
Both these segments have similar margins and are equally large in terms of revenue. The revenue has grown slowly but steadily since the 2009 crisis.
The company has also maintained good cash flows for at least the last eight years.
|Item||(in € mn)|
The company is quite strong financially. It has net debt of €235 million and the interest expense is only €36.8 million, which is quite mild compared to the EBIT of €815.7 million.
The company has learned from its past and has remained quite conservative financially for at least the last 10 years.
Risks: There is revenue risk if the governments put a hold on defence spending. There is also management risk due to the significant shareholding of the Government as well as Dassault Aviation - which is a private family owned enterprise. Their interests may not align with the shareholders.
Valuation: Let us first calculate the EV.
|Market Cap||€6.5 bn|
|Net Debt||€235 mn|
The company has maintained good cash flows. Following is the free cash flow situation for the last eight years.
The FCF hasn’t been very stable though. The average FCF for the last eight years has been €393 million. The EV/FCF ratio stands at 17, which is not very cheap.
We can look at the historical valuation. This is not very good way to value a company, but the history might help us get an idea if the stock is expensive.
Historically too it does not look very promising. The company is not selling for historically low earnings yield and the best time to buy was probably in 2011.
Verdict: Buy after a 30% drop. There is also a significant risk of how the management will behave. Know that the French government and Dassault Aviation might not have the same interests as the shareholders when the times get tough.
Additional disclosure: The data is taken from annual reports, Morningstar and FT. The charts have been made by the Google spreadsheet tool.