Thales S.A. (HO) Earnings Call Transcript & Summary

And your next question comes from the line of Ben Heelan from Bank of America.

I wanted to kind of come back on a similar question to George, and talk a little bit about kind of M&A pipeline. And when you think about potentially strengthening the business through M&A medium term, could you remind us which areas of the business are you particularly focused on? Are there some divisions that you're focused on more than potentially others? And then I guess maybe one for Pascal. How do you see kind of target leverage for the Thales business and post the Transport disposal?

Okay. I'll start on M&A pipeline, and then probably leave to Pascal the second part of your question. Ben, so we have, I would say, always tight targets we look at year-after-year. So nothing I would say specific in mind, but this is something that is, I would say, always, I would say, active. You know that our main focus, generally speaking, is bolt-on acquisitions. However, from time to time, we can decide or we may propose, I would say some, more important moves, like the one we did with Gemalto now 3 -- or 2 to 3 years ago. Clearly, the balance sheet of the group give us this optionality, the bolt-on acquisition, or if it makes sense on, I would say, more sizable -- most sizable target. Be assured that we keep our, I would say, strict track record in terms of financial discipline. I think our track record speaks for ourselves, but we'll keep it when we decide to move, it's, of course, for, I would say, strategic reasons with a sensible price and clearly, we would not move if it doesn't make sense in -- on an economic standpoint. What areas, I would say, should be of interest? I would say, all areas in which we are involved. Defense, clearly, is the great business, even if in defense, M&A are more difficult or more complex than civil or commercial, I would say, activities. Cybersecurity is, of course, very important, growing and promising business for us and was forced here and there as well as Aerospace. So it's difficult to be specific. We consider the profile of the group that you are on Slide 6 -- 7, sorry, 7 has been clearly a core promising. And of course, if opportunities make sense in one of these different, I would say, vertical, yes, we will have this ability to move quickly, thanks to our strong balance sheet. Pascal, would you like to take the second part of the question?

Yes. Sure. Sure. I mean about -- I mean the targeted level of leverage for Thales, I mean, following these transactions and my view is more in the mid- to long-term about I mean what type of leverage would we consider? I do believe that it's not just a question of a pure leverage from a financial standpoint, net debt EBITDA, but it's really about, I mean, the overall capital structure of Thales and considering that basically what we are targeting is really, I mean, a strong investment rate -- I mean type of investment-grade type of rating. So A-, BBB+. I mean this is really, I mean, the type of rating that we are targeting in the long term for our company. And it really makes sense for us. We shouldn't forget that, I mean, we developed a long-term partnership with key customers in our company, and our clients are really keen to make sure that Thales will be able to accompany them on the very long term. I mean in some cases, we signed very long-term project and programs, in particular, with support and maintenance on horizons that can be 1 2020 year. So it is very important for Thales to have a strong overall capital structure, which, in my view, is reflected in this level of rating. And of course, I mean, rating -- from rating companies, doesn't just take into account the pure financial leverage. Of course, they take into account also other obligations, in particular Thales, I mean, our pension obligations, which, as you know, are sizable. So I mean, this is what I can share with you. It's true that overall -- following this transaction, our overall leverage, not just from a pure financial standpoint, but including pension obligations, will be probably more in line with the A- type of rating than a BBB+ type of rating, which give us also, I mean, some headroom if we want to move on, on meaningful acquisitions, while being able to secure this type of rating. So not only a target in terms of financial leverage, but overall, a capital structure that has to be, in the long term, in line with a strong investment-grade type of rating.

[Operator Instructions] And our next question comes from the line of Harry Breach from Stifel.

Could I please just ask a couple of questions. One, just about the process. Are you able to share with us how many companies were interested in buying the ground transportation business? And how many of those were private equity as opposed to trade buyers? And then sort of separately, it's an interesting point to raise about the changes structurally in the signaling market and scale. I'm just wondering, just on a couple of notes here, firstly, Patrice, how do you feel about your in-flight entertainment and connectivity business at the moment? Are you happy with the scale of that and the changes -- technological changes going through that? And then maybe finally, just when we think about Naval Group, with 35%, you have a blocking minority but not control. How do you think about where you'd like to take your shareholding in Naval Group?

Okay. Thank you. Thank you, Harry. On the process, well, we have, I would say, run quite a standard process in this kind of strategic asset sale. Of course, we have had many, many, I would say, signs of interest due to the quality of the business. It's a very scarce business. In fact, it is the last pure player in signaling. So many companies or, let's say, yes, many companies was -- were, sorry, very interested in this sale process. I'm not sure I want to mention them name by name, Bertrand want to do that. But be sure, it was a real competitive tender, a really competitive process, extremely animated. On the PE side, private equity side, in fact, the structure of the business, in particular with warranty in terms of execution of the contracts, is a kind of a showstopper for them. Pascal, I thought you may develop this point a little bit to make it even more clear for the trend?

Yes, it's true that we have some clear interest from PE in these assets. Now it's also true that, I mean this asset, which is a project-driven asset, has to be able to mobilize a significant amount of bank guarantee, which, of course, creates a bit of additional financial costs, which for private equity companies, has an impact in terms of valuations. I mean this -- which means that -- and it's not mystery. I mean this type of business, with this level of needed bank guarantee, is probably more for strategic investors than for private equity for this specific reasons. Now as Patrice mentioned, I mean we got number of markup interest in our overall disposal process, which, at the end of the day, led us to select Hitachi, which, in our view, combined, I mean, the best of what we're looking for. I mean, first valuation, of course, which was absolutely essential. Second, also, I mean, validity to commit on, I would say, the certainty of the deal and in particular, in terms of financial power. And also, I mean, Hitachi, with our Transport business, I would plan to be that this is a perfect match, resulting in a significant level of synergies for Hitachi. And at the same time, they consider that, from an antitrust standpoint, I mean the potential remedy that, by the way, will be under their own responsibility, the level of remedies that might be required to complete the transactions would be quite limited. So when you put all of that together, I guess it's quite obvious that you end up saying that -- I mean, these assets was probably more to end up in -- within Hitachi. And also, what I've not mentioned are also the fact that Hitachi, which is also a large company, also provides the overall framework for employees to develop in this new company in a positive way with, of course, I mean personal developments that are quite obvious in such a large group like Hitachi Rail, in particular.

Okay. If I move to I think IFE was your next point, if I remember well. So in IFE we are, I would say, -- it's a market which is composed of IFE and connectivity in fact. So we usually speaks about high tech, and not just IFE. IFE, as you know, we are #2 in size worldwide. Of course, this market is highly competitive. Furthermore, the market conditions are not the greatest ones, as you may know, you may imagine. But this is a big factor. It is notwithstanding our own performance. In terms of connectivity, I think we have made in the recent past, the right technological bet or choice by, I would say, being one of the sole player, in fact, there only 2, ViaSat and ourselves, offering Ka-band connectivity. So you could say, well, does it really matter? Yes, it does. In fact, it does really matter. Because KA is the only way Ka-band, Ka-band is the only way to offer real broadband Internet access on board aircrafts and other players like Naval Group and so on and so forth, are clearly in a difficult situation as they have bet on Ku in the past, which is, nowadays, not the right technological choice to meet airlines requirements. So clearly, this is quite promising for guys like us having made the right technological choice recently. Now for sure, again, it is a very challenging market, highly competitive, for sure, and the market conditions are not great. So at the end of the day, yes, this is an interesting business. Now we are truly pragmatic. If at one stage, we would need to move to partner whatsoever, we will look at things, as we have done in the past, in a very pragmatic way and looking for value creation as one of the main driver of our decision-making process, of course. Thus moving to Naval Group now. So Naval Group, it's not, I would say, just a stake in a shipyard, it's much more than that. First, we enjoyed a de facto co-control on Naval Group. And Naval Group brings to Thales a very important go-to-market. Naval Group is a customer, even more partner. And thanks to this, I would say, intimate relationship, we are able to maximize the, I would say, surface of contact, surface of opportunities with Naval Group, be it on the French market or on export markets. But the beauty of this, I would say, set up is the fact that at the same time, we have kept all our freedom to partner with other shipyards. And again, the recent past has demonstrated our ability to be agile, notwithstanding this partnership with Naval Group. When we -- I would say, when we have been selected with Damen on the F-125 big projects for the German Navy, we demonstrate our freedom and agility when we have been selected with Babcock in the U.K. to design, develop and deliver the future frigate for the Royal Navy Type 31. This is another great example of our ability to cope with as many shipyards as possible to maximize the impact, the number of contracts we can win, we can book. So honestly, so far, we are, I would say, satisfied with this position with Naval Group. And we will continue to monitor the situation, of course, being pragmatic. But clearly, this gives us, I would say, satisfaction to be there at the side of Naval Group and being a shareholder of Naval Group.

And your next question comes from the line of Chris Hallam from Goldman Sachs.

So two questions for me. First of all, are you able to provide a breakdown of the rail business in terms of sales and backlog splits between urban and mainline? And how does that match up with Hitachi, Pascal, just thinking about your comments earlier? And then second, on free operating cash flow. You've provided a helpful walk through recently on how to think about the line cash conversion and then the working capital moving parts on top of that. So how does that change for '21 and '22 following this announcement? Apologies if you touched on that earlier, I missed a portion of the call.

You want to do it first, Pascal?

Yes. I mean maybe -- I mean first, good morning, Chris. On the first topic, I mean, and the splits between mainlines and urban. I think that in the past, we provided you with, I mean, this overall level of split. Now how does it match with Hitachi away that's probably a question that should be directed to Hitachi. I mean, just to remind you that our business overall is ground transportation business. We have 4 subsegments, the largest one being mainline, with overall a level of revenue that is overall a bit more than 50% of our business. Then we have a few urban business, which represents around 20% of our business. Then this overall communication supervisions business, which were present also 20%. And the rest, which is more air ticketing fair collection system business, which represents approximately 10%. And to make sure that it was clear. I mean, all those businesses will be sold to Hitachi. So we will not retain any of those 4 business. Now in terms of cash conversions, no, I mean, we have not discussed upon so far in the call, so you have not missed anything, Chris. My view is quite simple. I mean in terms of the overall cash conversion ratio, I mean, the disposal of our Transport shouldn't change the overall cash conversion ratio. So basically, what I shared with you a few weeks ago in terms of, I mean, both the 2021 and more long-term view in terms of cash conversion ratio is pretty much the same. Also, it's important to remind you that from an accounting standpoint, these assets will be dealt as a discontinued operations as from our next release of results. So it will start in Q3 on order intake and sales, and of course, in our financial accounts for 2021. However, of course, I mean, we will provide you -- I mean we'll keep providing you on our 2021 figures. I mean the contributions of our Transportation business and also keep giving you on our 2021 financial accounts. I mean the contributions in terms of order intake, our level of revenue, our contribution to EBIT of this business, despite the fact it will be treated as a discontinued operation. So you will have in this visibility and also the same from a free cash flow standpoint.

Thank you. There are no further questions at this time. I will now hand back to Patrice Caine for closing remarks.

Okay. So as there are no further questions, so together with Pascal, I look forward to seeing you next month at the upcoming roadshows and conferences. Please, of course, do not hesitate to contact Bertrand or Olivier if you have further questions on these announcements or on the investment case. So now take care and have a nice summer break. Thank you very much. Goodbye.