ITT Exelis takeover debate emerges post spin-off

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Dealmakers interviewed by dealReporter have different views on whether ITT Exelis (NYSE:XLS) will attract takeout interest soon after being spun out of ITT (NYSE:ITT).

The unit, a defense and information solutions business, starts trading today. In January ITT announced it would execute a tax-free spin-off to shareholders of both its defense and water-related divisions, leaving the remainder of the company to trade as an industrial company.

One of the industry sources said it is “very likely” that Raytheon (NYSE:RTN) may take a run at ITT Exelis soon after being spun out, commenting that “if it goes, it goes quick.” This source cautioned, however, that a potential approach could also go nowhere.

It could not be learned if ITT Exelis would be receptive to an offer. A spokesperson for ITT Exelis said the company does not comment on rumors and speculation.

Raytheon, the Waltham, Massachusetts-based prime defense contractor, reported cash and cash equivalents of USD 2.405bn as of 2 October, according to its most recent 10Q. A company spokesperson said the company does not comment on rumor or speculation.

Another industry source said rumors about Raytheon’s interest in ITT Exelis have been circulating since ITT announced its break-up earlier this year. While this source did not discount the potential that the prime defense contractor makes a move on the ITT unit, he said the chatter could simply be talk recycled on the finalization of the split.

A third industry source said he would be “shocked” if Raytheon made an approach on ITT Exelis. Instead, he said BAE Systems (LON:BA) might be the most logical suitor if it were in a position to execute on a deal of this size, as it would offer the UK-based defense contractor greater exposure to the US. The same source said he believed ITT Exelis management would prefer to go it alone.

On its 3Q11 earnings call, Raytheon CEO William Swanson was asked by an analyst if previous acquisitions in the cyber area had given the company what it needed in the sector, or if it would push harder.

“I’d probably continue to push harder ... this is a threat that travels at the speed of light,” Swanson replied. “It’s one click and the threat morphs and you have to work on it from both ends. And that’s why we continue to do that. And if you look at it, you not only have to look at it from what I’d call, DoD or intelligence point of view, but the commercial world is realizing the exposures that they have.”

Questioned about the potential tax implications of pursuing ITT Exelis so soon after the split, one of the industry sources claimed Raytheon should not have any.

A fourth industry source said any potential suitor interested in taking a run at ITT Exelis within two years after it commences trading could not have discussed with ITT a purchase, deal structure or price of the unit pre-spin. Otherwise, he underscored that the tax leakage of the transaction would be so “huge” it would erode the logic of pursuing a takeover.

In general to ensure the spin-offs are not taxable in the event of a sale, a company must not have agreed to a deal or “substantially negotiated” a deal during the two-year period prior to the date of the spin off, this news service has previously reported.

One of the sources likened a potential ITT Exelis transaction to Google’s (NASDAQ:GOOG) USD 12.5bn takeover of Motorola Mobility (NYSE:MMI). The search company announced the proposed takeover approximately seven months after Motorola Mobility completed its separation from Motorola Solutions (NYSE:MSI) on 4 January.

Some of the industry sources argued that ITT Exelis would be a better target once bidders had more clarity on the contemplated cuts to the Department of Defense budget that are currently being discussed by legislators. But another of the sources countered that the uncertainty surrounding budget cuts could be used as an argument to drive down price expectations by any potential acquirer.

According to the third industry source, ITT Exelis has more Iraq and Afghanistan exposure than several of its peers and its business has seen more softness than some of its competitors. He questioned how a potential acquirer, Raytheon or other, would get its board comfortable conducting due diligence on ITT Exelis given the lack of visibility relating to budgetary cuts. “I don’t believe anybody right now wants to do a [large] defense deal in this environment,” he said.

In the event of a sale, one of the industry sources estimated that ITT Exelis could command between 7x to 8x EBITDA. The company’s year-to-date EBITDA as of 30 June was USD 317m. Its full-year 2010 EBITDA was USD 828m.

The third industry source estimated that it may take six months for ITT Exelis to begin trading at “natural levels.” He predicted that once the stock settles, it may trade at a level below the initial spin-off pricing. This source compared ITT Exelis to Northrop Grumman’s (NYSE:NOC) spin-off of its Huntington Ingalls Industries (NYSE:HII) shipbuilding unit, which closed today at USD 29.50 per share, down 29% from its initial pricing of around USD 40 per share.

Because ITT Exelis’ stock price may slump, the same source said it may be an “un-clever” move for a bidder to enter the fray early. Since 21 October, ITT Exelis has been trading in the When-Issued market at between USD 10.35 and USD 12.11 per share. Today, it closed at USD 11.30 per share.

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