Will This Electric Equipment Stock Shine After This Deal?

Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Just as ABB (NYSE: ABB) reported higher first-quarter profit, partly due to increased sales on account of acquisition of Thomas and Betts last year, the company announced that it has agreed to acquire the U.S. solar company, Power One. The deal marks the entry of the Swiss electrical engineering company into solar power. The acquisition assumes greater significance in light of the acknowledgment by the CEO that there was “continued price pressure on revenues.”

Competitors' forays into solar

ABB competes with Siemens (NYSE: SI) for large infrastructure contracts worldwide. Siemens and ABB’s other competitor, General Electric (NYSE: GE), are conglomerates with diverse operation spread across industries.

Siemens is a powerhouse of electric engineering and electronics. In an effort to take on its biggest competitor, General Electric, in all areas of operations, Siemens entered the solar business by investing in solar startups, or by buying from producers of solar products.

In the process, the company invested in Semprius, which had developed a novel method of producing efficient solar cells and equipment. A few years back, the company had bought an Israel-based company. However, the company’s foray into solar energy proved wasn't fruitful. In October 2012, the company announced that it will exit from the solar business.

General Electric, like Siemens is a diversified technology and financial services company. It already had a big presence in alternative energy sources as a big producer of inverters meant for wind energy before it entered the solar energy space. The company is a leader in thin film solar panel efficiency after its acquired business, PrimeStar Solar, bettered the existing efficiency record for a cell set by First Solar, the market leader that still holds the module efficiency record. General Electric now has a number of solar energy projects underway.

The road ahead for ABB

Out of its own admission, the company said it was “cautiously optimistic” for the year ahead. On the earnings call, Joe Hogan, the CEO, said that while North America was showing signs of recovery, the situation in Europe was highly uncertain. Another major source of worry is the slowdown in China, a crucial market for the company, due to restrained demand in construction and transportation. There were also price pressures due to intense competition in the industrial electrical equipment industry due to overcapacity.

The company was able to save costs to the tune of $260 million in Q1 2013 by improving operations and sourcing initiatives. The cost saving, coupled with the increase in capacity utilization, was the major reason for company’s EBITDA earnings ($1.46 billion) rising faster than revenue.

While the importance of cost savings cannot be denied, ABB’s growth depends on diversification and looking for new growth avenues. The recent acquisition of Power One is apparently a step in the right direction.

The Power One deal

ABB will be paying $6.35 per share in cash for Power One. ABB is paying 57% premium on Power One’s closing price on the day the takeover was announced. Despite the premium, it is a good deal for ABB. Power One is not only a debt free company, but it also has $266 million cash and cash equivalents on its balance sheet.

The deal is to be funded with ABB’s organic funds or internal accruals without involving further issue of debt. As of December 2012, ABB had $8.8 billion in cash and cash equivalents and short-term investments. Besides the financials, the deal has a lot of promise for ABB.

Power One is a leading provider of renewable energy and power solutions. Its products include RE inverters that convert photovoltaic energy into usable grid connected power for use in residential, commercial, and utility-grade solar panels, AC/ DC, and DC/DC converters. Power One reported revenue of $1.02 billion and net income of $55.66 million. 

Solar power

The solar power industry has been through a lot of turmoil in the last few years. However, ABB is betting on its belief that solar power is fast getting closer to competing with conventional energy sources, and the market for solar power is set to grow in the U.S. and emerging markets in Asia and South America. Solar inverters are needed for feeding solar power into large electricity grids.

Solar power products are seen as one of the few growth avenues in an otherwise slow moving electric equipment industry. While cost of conventional energy is rising due to higher oil and gas prices and inflation, cost of solar power systems is falling, making it a competitive alternative.

Summary

The Power One deal provides ABB an opening into the growing photovoltaic market. The projected growth for the solar inverter market is 10% per year until 2021, but I am concerned because solar inverters are among the least profitable businesses in the solar power industry.

Moreover, despite the growth projection, as an investor, I am skeptical of the capacity of solar inverters and the photovoltaic industry for making a big dent in the overall energy scene. ABB’s major business remains conventional energy products and solutions and acquisition of Power One can at best serve as a proverbial drop in the ocean.

At the same time, ABB is a stable company that offers a dividend yield of 3.20% and has a reasonable potential for growth. For investors, I would repeat what the CEO said – I am “cautiously optimistic.” ABB is trading near its 52-week high and appears overvalued with a P/E of 19.07. I would rather wait for a significant correction before I would buy this stock.

 

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This article is written by Suresk Kapoor (B.Com) and edited by Shas Dey, StockRiters' Editor-in-Chief. Neither StockRiters nor any of its Directors or employees have any position in any stock mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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