Heard Off the Street: Aerospace firms facing a dilemma

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Market pundits have observed that the $2.9 billion that Precision Castparts, which supplies castings and other components to the aerospace industry, is paying for Titanium Metals is equal to the value investors place on all of the stock of Allegheny Technologies.

The compelling comparison aside, the combination will have a profound effect on Allegheny Technologies and another Pittsburgh-based titanium producer, RTI International Metals. Aerospace and defense accounted for about 30 percent of Allegheny Technologies' business and 87 percent of RTI's revenue last year.

The transaction, announced Nov. 9, will give Precision a secure source of raw materials and the integrated supply chain -- from melting titanium to making forged components from the high strength metal -- the aerospace industry demands. Boeing, Airbus and other aerospace companies prefer dealing with one supplier who can do it all instead of buying metal from one company, then negotiating with others to shape the metal into the components they need.

Consequently, their suppliers "want to sell a system or solutions rather than something that costs so many cents a pound," said John Tumazos, an industry analyst from Holmdel, N.J.

Precision already has such an arrangement in the high-performance nickel alloys business -- another market where it competes with Allegheny Technologies -- thanks to its 2006 acquisition of Special Metals.

How much are such arrangements worth? Precision values the possibilities so much that it is willing to acquire the shares of Dallas-based Titanium Metals, also known as Timet, for a 43 percent premium.

"The potential for value creation is vast," Mark Donegan, Precision chairman and CEO, said in the press statement announcing the acquisition.

Investors agreed. While the shares of companies making an acquisition typically fall on the news, Precision's stock jumped 5 percent Monday, the first day of trading after the announcement. They retreated after that but finished Friday at $174.05, up $2.72 for the week. The increase reflects investor confidence that Precision, which has made seven significant acquisitions over the last three years, can deliver on the Timet synergies it is touting.

The Precision-Timet marriage is a larger-scale version of a strategy Allegheny and RTI are pursuing. Both metals producers are moving downstream in order to offer more than just metal to the aerospace industry.

Allegheny paid $897.6 million in May 2011 to acquire Ladish, a Cudahy, Wis., company that forges and casts metal supplied by its new parent into products for aerospace, defense and other industries. And Moon-based RTI spent $182.5 million this year to purchase Remmele Engineering, a New Brighton, Minn., company that makes precision engineered and machined titanium and aluminum parts for the aerospace, medical device and other markets.

To put things in perspective, Precision, which posted net income of $1.2 billion for the fiscal year ended April 1 on sales of $7.2 billion, is buying a company that had 2011 earnings of $117.2 million on sales of $1 billion. Precision accounted for 15 percent of Timet's revenue last year.

Allegheny had 2011 net income of $214.3 million on sales of $5.2 billion while RTI earned $6.6 million on sales of $529.7 million last year.

Davenport & Co. analyst Lloyd O'Carroll believes the transaction will have a significant impact on the titanium and aerospace industries as well as on companies that compete with Precision and Timet. He expects it will be a few years before those changes are apparent.

"It takes time for all companies to adapt to a new situation where [Precision] is potentially a supplier, competitor and customer to many other companies all at once," he wrote in a note to investors Monday.

Allegheny, RTI and other companies in the market "will likely tread carefully to avoid damaging commercial relationships with Precision, but will look for their own strategic moves," he wrote.

Allegheny, which is a supplier to Precision as well as a competitor through its Ladish unit, could seek more contracts like the one that it has with General Electric, which mandates that suppliers buy their metals from Allegheny, Mr. O'Carroll wrote. He said the major impact on RTI could come from what happens to the titanium scrap market.

Each stage of production generates scrap metal that provides a source of material for making more titanium and sells for a high enough price to boost the profit margins of the company that controls it. RTI could be hurt if Precision controls a greater portion of scrap following the acquisition, control that could increase RTI's raw materials costs, Mr. O'Carroll wrote.

The fact that Precision is paying $2.9 billion for a company that produces about the same amount of titanium as Allegheny but generates a fifth of Alleghenies' revenue illustrates a dilemma Allegheny faces: investors discount the value of its shares because of its Allegheny Ludlum stainless steel business.

"They know they have a bunch of businesses that are not well understood in the market," Mr. Tumazos said. "Aerospace investors treat the steel company like a liability."

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Len Boselovic: lboselovic@post-gazette.com or 412-263-1941.


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