Keep on truckin’

24 October 2011 By Antony Currie, Rob Cox

Carl Icahn fancies himself as something of an investment banker. The billionaire investor regularly, and rather loudly, tells companies he owns stakes in to do deals. Some of his ideas can be loopy, like Lions Gate leveraging up to buy Hollywood studio MGM out of bankruptcy. But his latest notion – a merger of American truck makers Navistar and Oshkosh – is worthy of some consideration.

Icahn has an interest in seeing any combination benefit both sets of owners – he owns 9.8 percent of Navistar and 9.5 percent of Oshkosh. But crunching the two groups together could create value. That explains why both shares have jumped since Icahn revealed his aspirations last week.

Consider the industrial logic: a merger would create a more powerful player in a shrinking defense industry, better cope with a downturn in supplying cash-strapped states and municipalities, improve the two companies’ pricing power, and allow them to consolidate their engine and finance units.

Now look at the arithmetic. The companies have a combined annual cost base of $17.3 billion and gross operating income over the past 12 months of $3.7 billion – an 18 percent gross margin. Boosting margins in line with the 22 percent at Man Group in Germany would allow a merged Navistar-Oshkosh to slice off around $950 million of costs – a relatively modest 5 percent of current expenses.

It provides the wherewithal for Navistar, the larger of the two, to pay a bumper control premium. Usually the buyer needs a cracking good reason for paying a premium greater than the capitalized value of any synergies – and ideally should preserve some of those for itself. In this instance, once taxed and capitalized, the present value to shareholders would be around $6.5 billion – more than the current market value of the two truckers. Say Navistar offered $36 a share, a normalized sum-of-the-parts valuation JPMorgan has put on Oshkosh. At 80 percent above where it currently trades, that looks wacky. Yet it would account for just over a fifth of capitalized synergies, leaving billions of cost-cutting value left for both sets of shareholders to enjoy. Icahn’s M&A picks may jackknife occasionally, but this one looks roadworthy.


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