Will This GE Deal Take Flight?


It's been a good two years since General Electric Vice Chairman John Rice famously promised to invest "$30 billion" into retooling GE into an industrial superpower again. Two years on -- and depending on how you define "industrial" -- the company's probably only halfway through fulfilling on that promise today. And GE's not done shopping yet.

This week, according to The Wall Street Journal, GE's gearing up to make one of its biggest acquisitions yet -- a potential $4 billion deal to capture Italian aerospace company Avio SpA.

Avio is currently majority-owned by European private equity firm Cinven, which bought its stake from Carlyle Group in 2006 for $3.3 billion. Cinven reportedly wanted to IPO Avio itself but found the markets unreceptive. As a result, it's now settling for a cash-out to GE, accepting a middling 21% profit on a deal six years old ... so about 3.5% profit per year.

So Avio hasn't been such a great investment for Cinven. Can GE do better?

Avio: It gives you wings!
To find out, let's start with the valuation. In addition to Cinven, Italy's Finmeccanica also owns part of Avio -- about 15%. Assuming this stake is not already part of the rumored $4 billion purchase price, then acquiring it might cost GE an extra $700 million or so, raising the total valuation on Avio up to $4.7 billion.

Now, Avio is said to have generated as much as $2.6 billion in revenues last year. As a privately held company, it's hard to verify this figure. But if accurate, it suggests GE may have to pay 1.8 times annual sales to own all of Avio. That's slightly more than the 1.6 P/S ratio that GE's own shares currently command -- but is it too much to pay?

I don't think so, and I'll tell you why: Avio grew its aerospace sales by 16% last year. That's a nice growth rate, and especially so when you consider that GE's own revenues actually declined last year. Not to put too fine a point on it, but if GE is worth 1.6 times sales with declining sales, it's not too much of a stretch to see why Avio might be worth a mere two-tenths of a point more when it's growing sales at a double-digit clip.

The more so when you consider that Avio's faster-growing revenues are also more profitable than GE's. According to data taken from Dun & Bradstreet, Avio earned an operating profit margin of about 11.3% in 2011. That's a good 1.6 percentage points better than the 9.7% operating margin that GE is currently earning.

Foolish final thought(s)
So this could turn out to be a very good deal for GE and its shareholders -- and not only for GE. Avio, you see, is already a GE partner and helps the company build engines for Boeing's 777 and 787 jetliners. Now Boeing, as you may recall, had a bit of trouble getting its supply chain in order on the 787 recently. So by taking Avio in-house, GE will be shortening Boeing's supply chain by precisely one link, helping to keep costs under control, and helping to ensure that part arrive on time.

On the other hand, this deal could be bad news for GE rival United Technologies , which also builds engines, and which has also partnered with Avio in the past. By taking its partner in-house, GE will make it just a little bit harder for UTC to do business.

And if GE can do this while goosing its own growth rate a bit, and raking in a little bit more profit on each revenue dollar collected ... so much the better.

For GE, the recent financial crisis struck a blow, but management took advantage of the market's dip to make strategic bets in energy. If you're a GE investor, you need to understand how these bets could drive this company to become the world's infrastructure leader. At the same time, you need to be aware of the threats to GE's portfolio. To help, we're offering comprehensive coverage for investors in a premium report on General Electric, in which our industrials analyst breaks down GE's multiple businesses. You'll find reasons to buy or sell GE, and you'll receive continuing updates as major events unfold during the year. To get started, click here now.

The article Will This GE Deal Take Flight? originally appeared on Fool.com.

Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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