What's Behind Circor's Rally, Any Room Left?

M&A (mergers and acquisitions) activity has slowed across the table, as central investment banks like Citigroup NYSE: C and Goldman Sachs NYSE: GS have also seen their fees decline due to a lack of deal activity. In addition, as interest rates took on their high cycle when the United States FED saw it fit to hike to combat the rampant inflation levels in the nation, acquisition and buyout financing became harder to come by.

Private and public business valuations have contracted due to lackluster deal volumes. This dynamic ultimately concludes in an environment where, as capital and deals are harder to spot, acquirers must find the best of the best.

Knowing the need to find the highest quality of acquisition targets, investors can get an idea of just how much value KKR & Co NYSE: KKR saw in Circor International NYSE: CIR as the latter entered into a definitive agreement to be acquired by KKR. This deal values Circor at $1.6 billion. The terms of the agreement, which were laid out in a press release within Circor's investor relations site, stipulate that CIR shareholders will receive a one-time cash payment of $49.0 per share owned.

The P.E. Effect 

Private Equity is a branch of investing that focuses on buying a majority stake in a business and sometimes even buying out the entire Equity of the underlying. In this case, KKR has had a successful multi-decade record of acquiring companies optimized operationally and financially to increase their valuations substantially.

This is one of the reasons behind Circor's 50% rally experienced during Monday's trading session, as KKR - after due diligence - has determined that the stock is worth closer to $49, compared to its previous price of $31.63 on Friday's close.

Investors can ask questions after seeing the current price quote below the agreed-upon deal price. Buyout and acquisition deals, despite being signed upon and approved by respective director boards, still do have the potential to 'fall through' and not take place after the fact. The 2.5% discount to the buyout price reflects the current doubt from investors and markets, a proxy for the perceived probability of the deal not closing. 

Historically, deals fall apart due to a couple of simple reasons. The most common is a blockage in the financing, where the debt incurred by the acquirer sees a term change or is completely pulled. For KKR, this possibility may be out of the picture, as the company's financials would reflect a $12.8 billion balance in its cash & equivalents items. Having more than enough cash to cover the entire buy price and any amount of debt - if any - incurred to purchase Circor. 

The second-most common cause of deals falling apart is a higher power. Government and commissions can sometimes blockade a merger or acquisition deal; to avoid anti-trust issues and monopolizing forces, entities like the Federal Trade Commission (FTC) may intervene or delay any such contract. As this specific buyout is expected to close by the fourth quarter of 2023, the risks lie in the hands of the shareholders and respective government entities. 

Course of Action

Circor's analyst ratings suggest a median price target of $32.33 per share, with a top-side target of $40, placing both under the generous offer made by KKR. The deal could still fall apart if the majority of shareholders vote against the acquisition. However, management has recommended that shareholders vote for this deal. Considering the price targets analysts assign, shareholders should favor the significantly higher premium this deal offers.

Circor has been on a successful recovery road, as its first quarter 2023 results were more than satisfactory. Sporting double-digit growth rates across revenue and net profits, investors landed on the perfect timing storm to attract a significant buyer like KKR. As management took due time to deliver on its value proposition to shareholders, it would have taken more time to deliver on book value growth.

Today, investors can fast-forward through these trials and tribulations and accept a 6.0x multiple on book value, significantly eroding any uncertainty the future could have brought.

For those investors who see the logic behind the deal closing and would be okay with holding the stock for the long run until similar valuations are realized organically, today's price would represent a near risk-free bargain up until the deal closing in the fourth quarter. The stock would automatically go to $49 by the deal close, representing a relative gain on top of whatever price was paid for the stock previously. Thus the only risk lies in the possibility of the deal not closing.