Is NIS 12b a realistic valuation for IAI?

Harel Locker Photo: Eyal Izhar

The capital market believes that Israel Aerospace management's figure for valuation in a public offering is over-optimistic.

The proposed public offering of 25% of the shares in Israel Aerospace Industries Ltd. (IAI) (TASE: ARSP.B1) has been mentioned repeatedly in recent weeks. The measure is designed to put billions of shekels into the state treasury.

Why is this now a real possibility? Will the unrealistic value given for IAI confound the optimism being expressed about the offering?

"This time is different, because this time, everyone needs it," a source involved in the process told "Globes." "The IAI offering will help cover part of the state budget deficit. Everyone will profit from it, and everyone has an interest in lending a hand."

The IAI offering is an important goal set by company chairman Harel Locker. The company's management believes that the planned offering will be a condition for achieving the growth plans drawn up in the past two years for the company, including the acquisition of additional companies with potential synergy for IAI.

Tax benefits

According to defense sources, the offering will enable IAI to utilize the Law for the Encouragement of Capital Investment to recover tens of millions of dollars that it very much needs. IAI previously received an estimated $30 million a year as an exporter, but it lost this benefit following a 2010 reform led by the Ministry of Finance and the Ministry of Industry, Trade, and Labor (now the Ministry of Economy and Industry). The reform stipulated that government companies whose activity depended on their relations with the Ministry of Defense would not be eligible for tax benefits, thereby putting IAI in an inferior position in comparison with its rival, Elbit Systems, which is not a government company and is entitled to tax benefits.

Senior sources involved in the offering said that inquiries had shown that even if only 1% of IAI's shares are offered to the public, the Law for the Encouragement of Capital Investments would once more apply to the company.

In addition to the tens of millions of dollars in tax benefits, the offering is expected to generate substantial regulatory benefits for IAI. The company will find it easier to recruit top-level personnel in its fields of activity without being subject to salary restrictions imposed by the Ministry of Finance supervisor of wages and labor agreements.

The eagerness of IAI's heads in promoting the issuance of a minority interest in the company to the public is for the first time matched by enthusiasm in the Government Companies Authority, headed by manager Yaakov Kvint and defense industries head Uri Sheinin, for going ahead with the plan, following a government decision in 2014 in favor of the offering.

The Government Companies Authority's interest in the offering has grown in recent months, providing IAI with backing for continuing steps towards the offering. One of the reasons for the Government Companies Authority's enthusiasm for the offering is the state's need for money. The next government will face budget overruns in the tens of billions of shekels and a demand to add billions of shekels to the defense budget.

IAI teams have been working on the offering for a long time, including its legal and defense aspects. IAI management and the Government Companies Authority want the offering to be presented to the new government as soon as it is formed and sent for approval to the ministerial privatization committee.

Meanwhile, the state is preparing to ask the Attorney General to classify as secret important information in the prospectus being drawn up by the company. The information in question concerns classified defense matters relating to IAI's activity.

At the same time, state legal teams are writing an outline of the state's interests in IAI with the agreement of the Ministry of Defense. In the past, Director of Security of the Defense Establishment (Malmab) Nir Ben-Moshe objected to offering shares in IAI, and Avigdor Liberman, who was minister of defense at the time, ordered that the process be halted.

How much is IAI worth?

The key question concerns the amount of money that the state will receive for the shares in IAI. As far as is known, no regular valuation for IAI has yet been conducted, and no agreements have been contracted with any company in this matter. Defense industry sources said that the offering would be held at a valuation of NIS 12 billion. Other sources believe that IAI's value is NIS 14-15 billion.

IAI has a $4 billion sales turnover in a market in which the average profit margin is 9%. If IAI's profit margin were 9%, it would be worth NIS 20 billion, but the company's current profit margin is much lower than this.

The capital market is much less optimistic about the value of IAI, one of Israel's largest defense companies. The company, which has four main divisions, reported $2 billion (NIS 7 billion) in revenue in the first half of 2019, 11.7% more than in the corresponding period in 2018, and $3.7 billion (NIS 13 billion) in revenue in all of 2018, 4.6% more than in 2017.

For the sake of comparison, defense market competitor Elbit Systems, reported a $3.7 billion turnover, almost the same as IAI. Elbit Systems' current market cap is $7.2 billion (NIS 25.5 billion), which ostensibly should be the point of departure from which IAI's value for the initial offering of shares on the Tel Aviv Stock Exchange (TASE) should be derived.

However, Elbit Systems' profit margin is double that of IAI, showing that it is far more efficient than IAI. Furthermore, Elbit Systems and its management have an excellent reputation in the capital market, which it gained as a result of a long history of success in business. Elbit Systems' current market cap is a record for the company, following a 35% surge in its share price since the beginning of the year. One of the reasons for this increase in value is Elbit Systems' success this year in completing the acquisition of IMI Systems from the state. This acquisition incurs a risk of negative effects in the short term, but also great potential from the synergy between the two companies and the possibility of selling land in central Israel owned by IMI.

Before the acquisition of IMI, Elbit Systems reported a $976 million gross profit, 26% of revenue; a $293 million operating profit, 8% of revenue; and a $207 million net profit attributable to shareholders, 5.6% of revenue; in 2018. IAI, on the other hand, reported a $47 million loss in 2018.

IAI reported a $267 million gross profit, 13.4% of revenue; a $68 million operating profit, 3.4% of revenue, and a $50 million net profit attributable to shareholders, 2.5% of revenue; in the first half of 2019. These profit margins, which are less than half those of IAI, indicate that the valuation at which IAI will be offered on the TASE, if the offering goes through, will be less than half of Elbit Systems' market cap.

It is further recommended to subtract at least 20-30% more from this valuation, due to IAI's current status as a government company subject to a strong and belligerent workers' committee. A valuation of NIS 12 billion for the offering, about half of Elbit Systems' current market cap, therefore appears to be an illusion of IAI's board of directors. When the offering finally takes place, the company valuation is liable to be lower - in the NIS 6-10 billion range.

The workers also want a share

Another important player in the company's plan for an offering is workers' committee chairman Yair Katz. He released a special announcement to IAI's thousands of workers stating that at this stage, no negotiations are taking place between management and the workers on the plan for the offering. Katz wrote, "Any process or idea that can affect our future and employment security in the present and future will not be carried out without the workers' consent."

The Government Companies Authority's idea is to give benefits to IAI workers, so that they can buy 10% of the shares in the offering at a 30% discount. Sources involved in the proceeding in both the state and IAI's management believe that there are precedents for such a mechanism. Nevertheless, the plan has not yet been officially presented to the workers' committee.

Published by Globes, Israel business news - en.globes.co.il - on October 30, 2019

© Copyright of Globes Publisher Itonut (1983) Ltd. 2019

Harel Locker Photo: Eyal Izhar
Harel Locker Photo: Eyal Izhar
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