(FinancialPress) — Cemtrex (NASDAQ:CETX) Chief Executive, Saagar Govil, has never been one of limited vision. Once a small, OTC-listed company, Govil has guided Cemtrex through major acquisitions, an uplist to the Nasdaq exchange, and a substantial increase in sales and profits. Now, Govil is at it again, setting his sights on acquiring Key Tronic (KTCC), a peer more than twice the size of Cemtrex by market cap, through an exchange offer where each share of KTCC would be swapped for a share of CETX.
Cemtrex sees considerable value in a merger of the two electronics manufacturing services (EMS) companies, for which Key Tronic would be expected to operate as a subsidiary of Cemtrex. Cemtrex built a formidable overseas presence in the EMS space through the 2013 acquisition of the Germany-based ROB Group and the acquisition last year of fellow German EMS company, Periscope, effectively positioning Cemtrex as a Top 15 EMS company in the German market.
The business model has resulted in the Cemtrex EMS unit currently having a record backlog of $38 million.
Operating for more than 45 years with facilities in the U.S., Mexico, and China, Key Tronic has a broad spectrum of manufacturing specialties, including PCB assembly, plastic molding, precision metal stamping, full product assembly, and more, with products covering the whole complexity gamut for customers worldwide.
Cemtrex believes that combining the scale and skills of Key Tronic with its company would deliver an improved return for KTCC shareholders immediately as a combined force in the $270 billion global EMS market.
Furthermore, the company says that there is a “once-in-a-generation market opportunity in a variety of electronics markets” due to the evolution of cutting edge technologies that are reshaping the world as we know it, such as the Internet of Things (IoT), wearables, autonomous vehicles, autonomous manufacturing, and advanced robotics in healthcare, to name a few applications. CTEX views this as a $500 billion market opportunity across the next ten years, one that a merged company would be better positioned to capitalize on as they develop.
Cemtrex has put its money where its mouth is when it comes to assessing the evolving opportunity. In mid-August, the company brought in Joe Novelli as Vice President of a new subsidiary called, “Cemtrex Advanced Technologies Inc.” for the purpose of developing and commercializing IoT technology and wearables. Novelli previously spent more than two decades in executive positions at Sony developing and marketing new products.
A Look Under the Hood
As of the markets’ close on Thursday, Spokane Valley, Washington-based Key Tronic had a market capitalization of $73.81 million, versus $31.16 million for Cemtrex. Key Tronic publicly responded to the situation Thursday evening, saying it was unaware of any offer prior to Cemtrex filing documents with the SEC and issuing a press release on the matter. The company said it had no discussions with Cemtrex or affiliates and, while not directly offering an opinion, noted the 53.7% difference in current share prices.
Cemtrex doesn’t see the market capitalization, a simple calculation of share price multiplied by the number of outstanding shares for a company, as the key metric to consider. Rather, Farmingdale, NY-based Cemtrex thinks it is more appropriate to consider profits during the latest fiscal years.
In Cemtrex’s fiscal 2016 (ended Sept. 30, 2016), the company posted net income of $5.0 million, or 58 cents per share. The profits were derived from revenue of $93.7 million.
Key Tronic, during its fiscal 2017 year, ended July 1, 2017, reported net income of $5.6 million, or 51 cents per share, on revenue of $467.8 million.
Noting the “not substantially higher” net income of Key Tronic and the fact that CETX delivered higher earnings per share despite a much lower revenue total, Cemtrex offered that “the difference in the stock prices of the two companies should not be the primary basis for assessing each company’s inherent value.”
Based upon profits over the last twelve months, the price-to-earnings ratio, another commonly used valuation tool, for CETX is 6.6:1, less than half of that of KTCC at 13.5:1.
CETX management says that Key Tronics has underperformed “significantly,” noting an average return on equity – the amount of net income returned as a percentage of stockholder equity – for Cemtrex in excess of 75% over the last five years, versus 9.7% for Key Tronic.
In addition to aligning for the future, there are accretive effects to a collective company, according to Cemtrex. It estimates $5 million – $7 million more in annual profits for Key Tronic as a subsidiary of Cemtrex as an effect of management and cost savings associated with being a public company. Eliminating any overlap and low-value cost centers, while benefiting from operational synergies, should also immediately translate to increased revenue and improved profit margins.
The Bottom Line
While somewhat uncommon, it’s not unheard of for a smaller company to consider or pursue the acquisition of a larger firm. There’s no mistaking that Key Tronic is larger (nearly 5,000 employees vs. about 600, revenue of $467 million vs. $94 million), but Cemtrex lays out different evaluation metrics and has yet to let a company being bigger serve as a deterrent. While any potential deal is still in the posturing stage – as mentioned, Key Tronic says it hasn’t even spoken to Cemtrex – it will be interesting to see how this one plays out because there is something to be said about the magnitude of what a combined company would look like.
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