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In the summer of 2021 I offered some thoughts on shares of MKS Instruments (NASDAQ:MKSI) after it announced the acquisition of Atotech after it dropped out of the bidding race for Coherent.
Seen as a largely similar deal by myself, albeit at rich(er) multiples, investors reacted with reserves, as the debt incurred and the market booming made the deal even more expensive, with the benefit of hindsight. Right now the deal has closed and while debt is still huge, it seems manageable, although MKS is not out of the woods just yet.
A Recap
MKS Instruments focuses on precise control, generation and control and integrated solutions for complex technologies. These skill sets and services are used in semiconductor, life science, research and industrial technology, creating diversified exposure to long term growth trends.
The company generated sales at a rate of $2.4 billion per annum in 2020, while posting earnings at around $8 per share. With shares trading at $190 at the start of 2021, the multiple came in at 22-23 times earnings, a reasonable valuation given the times of the day and the positioning of the firm.
Shares fell to $147 in February, even as underlying momentum was strong, yet investors feared the involvement of the company in the bidding race for Coherent. MKS offered $6 billion in cash for the business, while the company commanded a valuation just surpassing that offer price at the time, leaving investors rightfully cautious.
That said, with earnings power trending at $9 per share, and shares trading around $150, the valuation looks compelling given the reasons discussed already. In fact, I took a smaller position in the hope of the company bailing out on the bidding war. This is exactly what happened in April, albeit that the company hiked the offer for Coherent by ten dollar per share in the meantime.
With shares rallying to $190 in April on the back of the company dropping out of the bidding race, and solid results posted in the meantime, I took the easy and quick profits, cutting my involvement with MKS.
In the meantime, the company announced a CAD $343 million deal for Photon Control, but the big news came in July as the company announced a $5.1 billion deal to acquire German-based Atotech, with the enterprise valuation coming in as high as $6.5 billion. With some of the deal paid for in stock, but most in cash and stock, the company would operate with a pro forma net debt load of $4.5 billion, equal to a 4.0 times leverage ratio.
Atotech would contribute about $1.4 billion in sales and $440 million in EBITDA. MKS itself generated some $2.8 billion in sales and $800 million in EBITDA, as the combination would generate $4.2 billion in sales and $1.24 billion in EBITDA, with the last metric potentially benefiting on top of this from $50 million in anticipated synergies.
Shares fell from $178 to $170 upon the announcement as investors were cautious, as the Atotech deal is very substantial, rich and feels rushed, being announced just a couple of months after the company dropped out of the Coherent deal.
With earnings seen around $12 per share the multiples looked very reasonable at 14 times earnings, yet leverage was high, and investors were fearing the situation in case fat margins would revert to perhaps more normal levels.
Valuation Reset
Trading at $170 upon the deal announcement for Atotech, shares of MKS fell to $150 over the summer, yet started the year 2022 at $180 per share. What followed was a brutal decline through 2022, with shares trading at $65 as recent as November, now having recovered to $97 per share at the moment of writing.
Early in 2022, the company posted its 2022 results which were still entirely driven by MKS, with the purchase of Atotech still pending. Revenues rose to $2.95 billion, with full year adjusted earnings posted at $11.38 per share and GAAP earnings reported at $9.90 per share.
Some weakness was seen in the first quarter results. While revenues of $742 million were up year-over-year, they were down $22 million on a sequential basis, with adjusted earnings down thirty-one cents to $2.71 per share. More so, the company guided for further falls in revenues and earnings in the second quarter, but fortunately, the company closed on financing for the Atotech deal already.
In the end, second quarter revenues rose to $765 million which was quite strong albeit that adjusted earnings fell a bit to $2.59 per share. More so, the company expected similar results in the third quarter. In August of last year, the company finally closed on the Atotech deal, more than a year since the announcement. In November, the company posted third quarter results which included a partial contribution from the Atotech deal.
Revenues came in at $954 million with adjusted earnings posted at $2.74 per share. Net debt stood at $4.3 billion, for a 3.3 times leverage ratio, down quite a bit since the deal announcement as the company used the year to deleverage the balance sheet a bit in anticipation of the deal closing. Pro forma third quarter revenues of $1.14 billion were up a percent on the year before.
I was left somewhat puzzled with the outlook for the fourth quarter, a period in which revenues are seen around a billion with adjusted earnings seen at just $1.34 per share. The reason for that seems to be a renewed leg lower in the revenues in the fourth quarter, hitting earnings in a disproportional manner, in part because dilution will still increase in the fourth quarter following the Atotech deal.
What Now?
Leverage is still high but has come down quite a bit as MKS is serious about reducing leverage. The issue is that an $11 per share earnings run rate through the third quarter makes that shares look like a screaming buy below $100 per share. Of course, there is the issue of debt, but also the issue of the very soft guidance for the fourth quarter, notably with regard to the earnings outlook.
The company is still not out of the woods, as is evident in the softer fourth quarter outlook, but leverage appears manageable as the company smartly saved its earnings over the past year, after making a too expensive deal of course. If the company can stabilize here and growth returns, the stock is dirt cheap, with shares quite easily trading above $150 again, but for that we need a different market mantra.
Leverage is a bit concerning, but I have the feeling that the company can manage this, yet after a big near 50% run from the lows in recent months, I see no advantage in getting involved with shares at this point in time.
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