In these days of heightened sensitivities in the Ministry of Defence, a mischievous sort might suggest that the hapless civil servants in Whitehall take a look at yesterday’s £610 million sale of an industrial component manufacturer by Rolls-Royce on the grounds of national security.
Rolls has disposed of a diesel engine fuel injection system business called L’Orange to Woodward, a US company. The technology innovation of L’Orange, based in Germany, is on the engines that Rolls makes under the MTU and Bergen brands for the railway, off-highway automotive and shipping industries. But perhaps crucially for Gavin Williamson, the defence secretary, L’Orange’s kit will be part of the MTU engines made by Rolls that will be on the nation’s new Type 26 frigates.
Taking the recent rule of thumb that as GKN makes some subsidiary parts for Rolls-Royce engines and BAE Systems Eurofighter Typhoons then its takeover by Melrose should be called in on national security grounds, then so should Rolls’ L’Orange deal be in for some ministerial interference.
Of course it won’t, because L’Orange is as relevant to a national security alert as GKN’s aerospace components.
The analogy between L’Orange and GKN on manufacturing grounds is not far-fetched, though. L’Orange is being sold because it is effectively a tier 1 supplier — those component manufacturers at the top of the supply chain, like GKN, which deliver goods to the original equipment manufacturers (OEMs) or main contractors such as Rolls or BAE, where the real national security issues sit. Rolls is gradually cleaning up its portfolio of businesses as it seeks to re-position itself as the king of British engineering and adjust a crown that has been sitting uneasily. The wider picture is that Rolls wants to look like it is focused on the three things it does well: making jet engines for Airbus and Boeing; engines for British or overseas military vehicles, planes or ships; and engines for trains, commercial shipping and big mining or construction vehicles.
In the metaphors that its chief executive Warren East likes, Rolls has been through a storm at sea. Stuff was broken but, as the ship stabilises, there are bits and pieces the vessel doesn’t need and which can be disposed of.
L’Orange is a profitable, cash-generative business making margins of about 25 per cent on annual revenues of £200 million. But while it makes key components, Rolls is happy that those parts can be delivered by a supplier. More to the point, it raises cash immediately for a company whose cash generation has not been good, leading the credit rating agencies to fail to afford the company the A rating that it desires.
Rolls-Royce needs to start generating cash because investment is needed on the diesel engines power systems side of its business; train, ship and heavy automotive manufacturers are demanding more electrification. It Rolls doesn’t invest, it will be left making engines that its customers do not want.
That Rolls is still with us after the revelations of systemic fraud is testament to shareholders that want it to win and the simple fact that in among the screw-ups is a champion industrial technology innovator waiting to shine. On the immediate plus side, it has £35 billion of Derby-built Trent XWB engines to be delivered from now through the next decade for the Airbus A350.
Most sensible brokers say that Rolls’ shares should be well north of £10, which puts it on a tasty rating compared with its 2017 earnings of 40p a share. Those earnings, though, are the depressed returns of a company in recovery.
ADVICE Buy
WHY An attractive rating and a leadership that is determined to restore its pre-eminent reputation
Entertainment One
Entertainment One has been pigging out on acquisitions for years, so few eyebrows were raised yesterday when the television distribution and production company announced yet another deal, this time for Whizz Kid Entertainment, a British production company.
The Toronto-based owner of the Peppa Pig cartoon franchise paid £6.9 million for a 70 per cent stake in Whizz Kid, which produces non-scripted programmes, such as Lip Sync Battle for Channel 5. The Canadian company previously has worked on an American adaptation of Whizz Kid’s Ex on the Beach, a reality series on MTV.
It is Entertainment One’s first foray into Britain, providing it with a “a strong footing in one of the most creative markets in the world”. It was founded in 1973 as Records on Wheels, a retail music distributor. Since then it has expanded into home entertainment distribution, film and television acquisition and production. The London-listed company has built up a rights library that contains more than 80,000 hours of film and television content, as well as about 40,000 music tracks.
In recent years, it has pivoted away from independent film acquisitions, where margins have been squeezed as DVD sales decline, and ploughed its resources into producing its own content. It put out over 172 releases in the 2017 financial year, but plans to reduce this figure and to produce the majority of its releases.
A desire to reshape its film and television business by taking “greater control over the content” is not without its critics. An expensive refinancing deal in 2015 wiped £300 million from its market value, while Entertainment One also felt the heat from shareholders in September when they revolted over executive pay.
The energy with which its strategy change is being pursued reflects genuine concerns about imbalances across the company’s divisions. Sales at its family unit grew by 50 per cent in the year to March 31, as Peppa Pig’s roll out across Asia lifted the overall performance. However, its film and television businesses have been flagging. Consumer tastes are fickle and Peppa Pig won’t bring in the bacon for ever. It makes sense to redress those imbalances.
ADVICE Hold
WHY It’s sticking to the script by building its production arm
