Virus Didn't Have to Ground This Aviation Deal

(Bloomberg Opinion) -- Who’s willing to bet on the aerospace industry’s quick return from the coronavirus devastation? Not the CEOs of two of its leading suppliers.

Woodward Inc. and Hexcel Corp. mutually agreed to call off their planned merger in light of the current pandemic. More than half of the world’s fleet has been grounded as travel bans and fear of contagion keep fliers at home, forcing the aerospace industry into a fight for its survival. This isn’t the first deal to get scotched because of the coronavirus: Xerox Holdings Corp. called off its $35 billion hostile pursuit of HP Inc. and private equity firm Apollo Global Management Inc. reportedly abandoned talks with TV-station owner Tegna Inc. for an $8.5 billion takeover. But both of those transactions reportedly involved at least some cash, which has become a precious commodity in the age of the coronavirus. The Woodward-Hexcel merger, by contrast, was all-stock, and as such, not dependent on capricious debt markets and an ill-timed overloading of balance sheets.

There were some signs the companies were still being punished for going through with the deal: As of Friday, Hexcel and Woodward had each dropped more than 55% since the merger was announced in mid-January, compared with a decline of about 35% for the SPDR S&P Aerospace & Defense ETF. At those prices, the deal terms valued Hexcel at about $32 a share, or about $3.7 billion including debt, compared with an enterprise value of about $7.5 billion when the merger was first announced.

While Hexcel shares declined Monday on news that the merger was off, Woodward’s stock rallied more than 10%. That gain feels short-sighted. If you liked an aerospace combination that “brings together a broad, unparalleled portfolio of leading-edge technologies” with a “strong balance sheet” in January, you should like it even more in April. The fact that the companies themselves aren’t convinced of this is on the one hand a sign of just how deep and long-lasting the slump in aerospace will be. But it also feels like a missed opportunity. A famous Warren Buffett maxim comes to mind: Be fearful when others are greedy and be greedy when others are fearful.

To be sure, one of the big selling points of the Woodward-Hexcel merger was the ability to significantly ramp up research and development spending to better position the combined company to compete on the next generation of aircraft technology, with an eye toward better fuel efficiency and lower emissions. That has likely fallen further down the list of priorities for aerospace companies right now given the virus cash crunch and a drop in oil prices that’s made it more economical to keep flying older, clunkier models. There is also the question of distraction. Big deals are complicated. For all of Hexcel and Woodward’s previous talk of complementary cultures, there are bound to be integration hiccups, particularly when the virus fallout makes it likely job cuts will be in order. Separately on Monday, Woodward said it was implementing “workforce management” policies including a hiring freeze, layoffs and furloughs, without specifying the number of jobs that would be affected. It will also reduce its dividend, eliminate 2020 bonus payments and trim pay for the CEO, board and top officers. Hexcel also announced plans to evaluate employment levels and reduce spending.

Still, the trend toward more climate-friendly aircraft is likely to be sustained over the longer term and the companies would have gotten more out of these cost-reduction actions if they were spread out across a bigger, combined entity. “Calling off the merger is clearly bad news for both companies, as we think scaling up makes a lot of sense, particularly when it comes to dealing with a crisis,” Vertical Research Partners analyst Rob Stallard wrote in a note. Both Woodward and Hexcel also announced shareholder rights plans meant to guard against unwanted takeover advances in a sign they are worried someone else will have take advantage of their depressed stock prices and have the gumption to pull off a deal that they couldn’t.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

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