I always thought of TRW Inc as an ogre company, the one that snoops into my private financial affairs and sells that information to whomever will pay. It is one of the three leading credit-reporting agencies in the US, and one that is regularly hauled up in front of Congress to talk about whether it is guilty of invading the privacy of Americans.
Little did I realise – like plenty of other Americans, I suspect – that credit-reporting is only a small part of TRW’s business, accounting for less than 6 per cent of the total. More than 90 per cent of the rest comes from sales to the aerospace and automotive industries.
In 1995 TRW’s credit-reporting and sales of other information products were a mere $540 mn, against total revenues of about $10 bn. And these information services certainly have not been a high-growth business. Apart from credit reporting, they include ‘targeted marketing,’ in which TRW uses its demographic lists to help sellers pinpoint potential buyers, and highly tailored real estate information to make comparable property analysis. Another division that comes under the information services umbrella is transaction-processing systems (TPS), which helps huge clients with their processing needs, such as banks’ check-cashing activities.
Last year the information business unit’s sales were flat and its profits were down 10 per cent. No wonder then that TRW wanted to sell it. After all, who would want to keep a unit with falling profitability, little prospect of significant growth and a public relations headache?
On the other hand, who would want to buy it? For years, TRW chairman Joseph T Gorman had been saying publicly that TRW would sell the unit if it could find a ‘strategic buyer’ willing to pay an attractive price. Not surprisingly, takers were hard to find.
But the unit finally was sold in early February this year, and at an apparently attractive price. Under the agreement TRW will receive $1.01 bn in cash, plus convertible preferred stock with a face value of $90 mn in a new company that will acquire the information services division. The stock holding will give TRW a 16 per cent stake in the new company.
The sale was possible because of a highly creative approach that met Gorman’s wish for a strategic buyer half-way. The purchasers, who were found by TRW’s investment bank, Bear Stearns & Company, are two Boston-based private equity firms, Bain Capital Inc and Thomas H Lee Co. The firms also invited some private investors to participate in the deal.
The plan is to spin the TRW information unit off into a new company, enhance the products it already offers, and acquire other entrepreneurial companies whose products complement and strengthen the existing product line. If all goes well, Bain and Lee will eventually take the new ompany public.
So the upshot of the deal for TRW was that it got a decent price for what had been an unwanted stepchild. Based on the unit’s reported earnings of $86.8 mn in 1995, the cash portion alone represents 12 times earnings. And, of course, TRW still will have the $90 mn in stock (mostly preferred but with a small amount of ordinary shares), which could be worth significantly more (or less) in the end.
But the arithmetic is a bit more complicated than that. The transaction-processing systems business was the cause of the information unit’s fall in earnings last year, according to Tom Myers, TRW’s IR officer, and that business is not part of the deal. Instead, TRW is shifting TPS to its systems integration unit.
It’s not clear whether TPS made any money last year, or whether it lost any. Myers describes demand for TPS services as ‘chunky,’ saying that contracts come and go in ‘big pieces.’ But if TPS did lose money in 1995, then the information unit made more than the reported $86.8 mn and the Bain/Lee cash payment was in fact less than 12 times earnings.
Internal accounting is always tricky in any case, and buyers and sellers both have to make their own judgments. ‘The vagaries of segment accounting in public companies sometimes is not the easiest thing to understand, and therefore our belief is that the company grew year on year, and profits grew year on year,’ says Mark Nunnelly, managing director of Bain Capital. For his firm and for co-buyer Lee, the convertible preferred stock portion of the deal was crucial, because it ensured that TRW would continue to work closely with the new company. Since they are novices in the business, having access to TRW’s expertise is important for the new owners; so is their right under the terms of the deal to go on using the TRW name for two years.
And, for its part, TRW has both the incentive and the opportunity to contribute to the success of the new company under the deal, which gives it not only a 16 per cent stake but also a seat on the company.
Bain, which manages a little more than $1.2 bn – half from wealthy individuals and half from college endowment funds – is a veteran in this kind of transaction. Among its more successful deals was its acquisition of the Gartner Group. Gartner sells research reports about the computer industry and provides live telephone support and on-site consulting. Bain paid $70-$80 mn to buy Gartner from private investors in 1990, spruced up its product line – in part by acquiring other firms – and sold it in 1993 for something around $500 mn and $600 mn, according to Nunnelly.
‘We’ve used this strategy in a lot of our investments and it’s highly likely it will work with TRW’s information business,’ he says. He expects to enhance the unit’s value by expanding internationally and by strengthening its clients’ ability to use and analyse the unit’s information base.
The market certainly reacted positively to the deal. It was announced by TRW on Friday, February 9, although word of it had begun leaking out the previous Tuesday (February 6). The CNBC cable television network carried a story saying that TRW would announce the sale of its information services unit for about $1 bn.
The day before, Monday, the stock closed at $84.625. On Tuesday it closed at $87.50, up 3.4 per cent. TRW was inundated with questions about the reports, some of which Myers said were not totally accurate. ‘But we did not have an agreement so there was nothing to say, except that: ‘We routinely do not comment on speculations of the market,’ Myers relates.
The formal announcement was duly made on Friday, February 9 about 3.30 in the afternoon. Trading in the stock was halted just before the announcement was made, and didn’t begin again until after the market’s opening the following Monday (February 12). At that point, the stock soared to $90.375, up 6.7 per cent.
This enthusiastic response may have been largely a vote of confidence in the transaction itself, but there was another deal-related factor that impacted TRW’s share price. That was the announcement that the $600-650 mn after-tax proceeds would be used to buy back stock. Earlier, the board had authorised the repurchase of up to 10 mn shares, or about 15 per cent of the total outstanding equity.
‘It’s not a phantom buy-back as many companies do, where they announce the buy-back but don’t actually do it,’ Myers said. ‘We have already been in the market this week {the week after the deal} buying back shares.’ Myers noted that TRW actually plans to spend more than the cash it netted on the deal to buy back its shares. He said that under the board’s buy-back authorisation, it would cost the company $850 mn to acquire the 10 mn shares at $85 a share, or $900 mn at $90 a share.
But the press release was not entirely clear on the issue. While it stated that ‘the proceeds will be used to buy back company stock,’ it went on to add in the same paragraph, ‘TRW will continue to explore investment opportunities in high-growth segments of the company’s automotive and space and defence businesses.’
Asked about this apparent discrepancy, Myers said, ‘Of course, if we did make a major acquisition, or some other combination that would require cash or financing, we would certainly reconsider how aggressive we’d be on the buy-back programme.’
The only negative comment about the deal came from Moody’s Investors Services, which took the view that TRW was losing a piece of its business with a ‘predictable cashflow,’ in contrast to the group’s main product lines, which depend on the highly cyclical automotive and aerospace industries. Moody’s also said that share repurchase programmes tend to be renewed, leading to little or no capital formation.
Myers says that in TRW’s case, the cyclicality of the auto business is offset by gains in content per vehicle. In terms of the services TRW provides to the defence industry, Myers says, ‘We are beginning the up cycle.’ And Moody’s, despite its criticism, confirmed TRW’s credit ratings, as did Standard & Poor’s.
Just about everyone else seemed upbeat about the deal, too. The sale ‘is a positive event,’ Reuters reported Roulston Research Corporation analyst Mark Johnson as saying. ‘It makes TRW more focused on core operations,’ he said.
Three days after the announcement of the transaction, on February 12, two sell-side firms chimed in their approvals. Goldman Sachs promoted TRW to its recommended list, from market perform; and Wolfgang Demisch, an analyst at Bankers Trust Company, reaffirmed its ‘outperform’ rating, predicting that TRW stock would soar to more than $100 a share.
