Update: WAB – A Short Once the GE Deal Closes

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SEE LAST PAGE OF THIS REPORT Graham Copley / Anthony Salzillo

FOR IMPORTANT DISCLOSURES 203.901.1629/203.901.1627

gcopley@/asalzillo @ssrllc.com

September 19th, 2018

Update: WAB – A Short Once the GE Deal Closes

  • We are essentially republishing the piece that we wrote when the GE Transport/WAB deal was announced – if you read the first one only some charts have been updated.
  • Despite the tax efficient structure, we think that WAB is likely a good short idea following the announcement of the GE Transport deal.
    • We believe that WAB overpaid for the business, and it is unlikely that the GE business will perform as suggested in 2018 and 2019.
    • WAB is expensive and we see as much as 20-30% downside after the deal closes.
  • With OLN’s purchase of Dow’s Chlorine Products business, also a tax efficient Reverse Morris Trust (RMT) structure, initial projections for the business turned out to be very ambitious – driving negative revisions and earnings misses as well as stock underperformance – Exhibit 1.
    • Here, the timing was bad relative to the chlorine cycle, but OLN failed to deliver on businesses other than chlorine and underperformed other chlorine exposed companies such as Westlake.
  • OLN’s stock peaked after the deal announcement and subsequently underperformed by 45%, falling 47% in absolute terms over the following 12 months. Adjusting for the chlorine cycle and using WLK as a proxy we would estimate that as much as half of the underperformance was a function of the acquisition not delivering as planned.
    • We believe that this risk is an appropriate way to think about risk at WAB today.
  • This still appears to be a good deal for GE
    • We expect some restatements of earnings prior to closing as financial instruments linked to Transports are moved out of GE Capital and into the operating business – this may trigger underperformance at WAB prior to the deal closing.

Exhibit 1

Source: Capital IQ

RMT – Does the deal structure overwhelm whether it is a good deal? The Proxies

Example 1: The Dow Chlorine Products deal was supposed to transform OLN – the stock peaked on the deal announcement and immediately started to decline as the chlorine and caustic markets weakened, but because OLN had doubled its exposure and taken on more debt the stock was hurt more severely. The stock bottomed in early 2016 after the company had guided down from earlier expectations – down almost 50% from its peak.

Outside chlorine, the company has failed to meet earnings goals – epoxies illustrated below in Exhibit 2 – and has spent more on Capex to fix underperforming businesses than originally indicated. In our opinion, Olin overpaid for a business that was presented to the company in the best possible light and subsequently disappointed.

Exhibit 3 shows Olin’s share price relative to Westlake to try and correct for the chlorine cycle impact.

Exhibit 2

Source: Capital IQ and SSR Analysis

Exhibit 3

Source: Capital IQ and SSR Analysis

Example 2: The PPG-Georgia Gulf deal was supposed to transform the newly created Axiall. The company value peaked shortly after the deal was completed, but fell away as estimates declined driven by negative guidance. To illustrate, shortly after the deal closed in early 2013, the company was projected to earn more than $5.00 per share in 2014. Earnings in 2014 were $1.32!! The real collapse in chlorine did not occur until 2015 and a meaningful portion of the Axiall miss was the consequence of plant reliability issues focused on the assets acquired from PPG (subsequently confirmed by the amount of incremental capex that Westlake has spent on the assets since buying Axiall). Like OLN, Georgia Gulf bought a business that was presented in the most positive light and failed to live up to expectations.

Exhibit 4

Source: Capital IQ and SSR Analysis

In both cases everyone was focused on the clever tax efficiency of the deal and the sellers did very well. In the case of OLN you should have sold on the news and in the case of Axiall you should have sold when the deal closed – or at least before the company reported its first combined quarter.

So, Is WAB Buying a Lipsticked Pig? Maybe!

The projections that GE is making (deal announcement presentation) suggest that the transport business, or at least the piece being sold to WAB, is going to have a transformational year in 2018, growing revenue faster than in any of the prior 5 years, and 1400 basis points higher than the 5-year average – Exhibit 5. In Exhibit 6 we note that not all of the business currently listed as Transport is being sold; the piece that is staying appears to have a 50% EBIT margin based on what has been reported and what was included in the deal presentation!

If we look at what GE is predicting for the transport business it will show materially higher revenue growth than consensus is predicting for the whole company – Exhibit 7. Either consensus for GE is too low or this is a business that GE should be keeping as it will provide both revenue and cash flow growth in 2018 and 2019 – something the company needs.

It is possible that the diesel locomotive cycle is turning and it is also possible that GE is doing the deals that are possible – which would explain the possible outlook and why GE is selling, but it is a stretch. Longer-term, as global power prices fall and environmental pressure continues we expect new orders of electric trains to eat away at the GE diesel business.

We also believe that capex estimates might be too low as GE has spent much less on this business in the last several years as a portion of sales than it has generally – Exhibit 8. This was the case in both of the two examples that we showed above – both OLN and Axiall had to ramp up capex versus expectations.

Exhibit 5

Source: Capital IQ and SSR Analysis

Exhibit 6

Source: Capital IQ and SSR Analysis

Exhibit 7

Source: Capital IQ and SSR Analysis

Exhibit 8

Source: Capital IQ and SSR Analysis

WAB is expensive in absolute terms – EV/EBITDA in Exhibit 9 – though less so on a relative basis – Exhibit 10 based on the ROC trend in Exhibit 11. Return on capital is recovering from the railcar downturn in 2015-16 but still below trend. We are concerned that the company has shown a move towards optimism over the last few years – Exhibit 12 – and this changing mindset might have resulted in overpaying for the GE business.

Exhibit 9

Source: Capital IQ and SSR Analysis

Exhibit 10

Source: Capital IQ and SSR Analysis

Exhibit 11

Source: Capital IQ and SSR Analysis

Exhibit 12

Source: Capital IQ and SSR Analysis

©2018, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Sources: Capital IQ, Bloomberg, Government Publications.

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