R McInnes, Esq. Chairman Safran S.A. 2, Boulevard du General Martial Valin 75724 PARIS Cedex 15 France 14 February 2017
Dear Mr McInnes TCI Fund has been a shareholder shareholder of Safran for five years. TCI Fund currently owns almost almost 4% of the company. The purpose of this letter is to state our our strong opposition to the takeover of Zodiac Zodiac Aerospace and to demand that Safran shareholders are given a vote on the merger before Safran proceeds with the takeover. We also propose propose an alternative strategy for Safran. We have a lot respect for Safran’s CEO, Mr Petitcolin, and the rest of the executive management team. So far the launch of the LEAP engine has gone well and the Security business has been sold for a good price. This will increase Safran’s focus on the aerospace engine business, a business that Mr Petitcolin once said was the best business business in the world. We agree. It has huge barriers to entry and Safran has a strong market position, significant pricing power and generates very profitable and predictable aftermarket revenues for 25 years. It is therefore inexplicable inexplicable that you would would want to dilute the quality quality of Safran’s business by buying an overpriced, troubled, troubled, Interiors business. Safran is significantly overpaying for Zodiac. The hugely inflated price assumes a full recovery of Zodiac’s margins. After ten profit warnings, warnings, such a recovery is highly uncertain. Furthermore the lack of due due diligence that has been done in this area means there can be no confidence that a turnaround is achievable. In our opinion the fair value of Zodiac is around €20, which is way below the offer of €29.5 and so Safran’s shareholders will suffer massive value destruction. The deal represents a terrible return on investment (ROI) for Safran. Even in a best-case scenario, with Zodiac’s margins recovering recovering from 5% to 14%, the after-tax ROI would be only 6%, a long way below Safran’s cost of capital. At Zodiac’s current level of profitability the ROI R OI of the deal would be just 2%. The deal will also encumber Safran with a huge amount of debt (approximately €7bn, over 2x Debt/EBITDA). This will restrict the company’s ability to invest in R&D and new products, thereby threatening the future success of the company. The CEO of Safran has also acknowledged that there are unknown and unquantifiable liabilities relating to Zodiac’s recent delivery of defective seats and cabins. There are potentially huge late-delivery penalties penalties 7 Clifford Street, London, W1S 2FT
Telephone: +44 (0) 20 7440 2330
TCI Fund Management Limited is a private limited company incorporated and existing under the laws of England and Wales with registered number 08898250 Authorised and regulated by the Financial Conduct Authority
and warranty claims that Zodiac may have have to pay in the future. It is imprudent, if not reckless, for for Safran to assume these liabilities. We demand therefore that the board give Safran shareholders a vote on the merger before Safran initiates the tender offer for Zodiac. The current deal is structured in a way that deliberately disenfranchises disenfranchises Safran shareholders. The board has intentionally intentionally decided to hold the merger vote after a a successful tender offer because effectively it will force Safran shareholders to vote in favour of the merger even if they object to the overall transaction. This is a cynical and outrageous attempt to force Safran shareholders to vote for a merger they may not really want. We have written to the AMF today today asking them to intervene. If the tender offer is successful, Safran will own a majority stake in Zodiac, a publically-listed company which also has a large family influence. influence. This would not be a long-term sustainable sustainable corporate structure. To avoid further value destruction Safran shareholders would be under huge pressure to approve the merger (because Zodiac’s share price would collapse if shareholders voted against the merger). The sequencing has been designed specifically to ambush ambush the public shareholders of Safran in an unethical manner. The fact that the board has agreed to ransom the company and its shareholders in such a way is underhand, unfair, unscrupulous and unbecoming of a company with such a long and impressive history of success. If you think the transaction is compelling you should be prepared to argue your case and let the shareholders have their say. They are the owners of the the business and the providers providers of capital. If the deal is so good, you should be confident it will be approved by a two-thirds majority. While TCI does not support it, other shareholders shareholders may disagree with us. That is fine. Just let the shareholders shareholders have a free, open and fair vote before acquiring the controlling stake in Zodiac. If you refuse to give Safran shareholders a vote on the merger before launching the tender offer, TCI will propose certain agenda items at the forthcoming AGM in June. One of these agenda items items will be to ask shareholders whether they will vote against against the merger at the future EGM. If this item item receives more than 33.4% of the votes this will force force you to withdraw the tender offer for Zodiac. It would not be credible for you to continue with the tender offer knowing that more than 33.4% of the voting rights oppose the merger. If you do proceed with the tender offer, and it is successful, then at the subsequent EGM we will put forward strong arguments arguments why the the merger should still be rejected. We calculate that the value destruction from owning a majority stake in Zodiac would be less than in a full merger of the two companies. Therefore Therefore Zodiac’s reference shareholders should also want certainty that the merger will happen before the tender offer is launched. In the letter to the AMF we have outlined the reasons why the proposed deal structure is unfair to Safran’s and Zodiac’s public public shareholders. The public shareholders of Zodiac are not being given the proper information they require before making a decision – – namely whether the merger with Safran will proceed. Zodiac shareholders could receive cash, Safran Safran shares or they could end up owning a hugely devalued minority stake stake in Zodiac once Safran shareholders have have rejected the merger. This is unfair. unfair. They should know in advance the choice they are making. 7 Clifford Street, London, W1S 2FT
Telephone: +44 (0) 20 7440 2330
TCI Fund Management Limited is a private limited company incorporated and existing under the laws of England and Wales with registered number 08898250 Authorised and regulated by the Financial Conduct Authority
Also, Zodiac’s public shareholders are not being offered the same deal as the reference shareholders. By stating in advance that they will not accept the cash offer, the reference shareholders are shifting the burden of acceptance onto the public shareholders who will be under huge pressure to accept the cash offer. If they do not accept it, the deal will collapse. This makes the the deal one-sided; stacked in favour favour of the insiders who who have negotiated the deal. The controlling Zodiac shareholders have abused their position by making the acceptance of the cash offer by the public shareholders the condition for the merger. This effectively forces forces the public shareholders shareholders to take the cash (and so pay pay tax) rather than elect for Safran shares in a merger. The reference shareholders however have have already stated they will elect to take Safran shares, in order to avoid paying tax. This outrageous, preferential treatment of the insiders should not be permitted by the Fre nch regulator. Furthermore, it is clear the deal structure has been designed specifically to help the Zodiac family shareholders avoid paying tax. It is disgraceful that you and the rest of the Safran board have agreed to such an abusive and unfair deal structure simply to facilitate the blatant tax avoidance strategy of the Zodiac family billionaires. TCI’s detailed detailed analysis of the deal can be found at www.astrongerSafran.com www.astrongerSafran.com.. In summary, buying Zodiac Aerospace is a bad deal for the t he following reasons: 1. There is no strategic rationale; 2. The synergies are questionable due to limited product overlap; 3. Safran is massively overpaying: Zodiac’s fair value is €20; 4. Safran stock is materially undervalued (12x adjusted eps) so exchanging it for overvalued Zodiac stock is hugely value destructive; 5. It results in a very high level le vel of debt (debt = €7 billion, leverage guidance = 2.5x EV/EBITDA); 6. ‘Eps accretion’ is dependent on a highly uncertain and optimistic turnaround of Zodiac’s business; 7. It would dilute the quality of Safran’s business because Zodiac’s business is more fragmented, fragmented, has lower barriers to entry and faces face s more and increasing pricing pressure from Boeing and Airbus; 8. Safran would be exposed to Zodiac’s potentially huge contingent liabilities (i.e. unquantifiable penalties and future warranty claims for defective seats and cabins); 9. Safran has a terrible history of exec uting and integrating takeovers; 10. The return on capital of the deal is very low; well below Safran’s cost of capital; 11. A merged Safran/Zodiac would have a lower growth rate, lower return on capital and lower free cashflow conversion; 12. Safran’s dividend could be vulnerable due to high leverage and Zo diac’s liabilities; 13. Safran’s public shareholders will suffer dilution of capital, votes and board seats. In short, Safran will be significantly weaker if it merges with Zodiac and the high level of debt would severely restrict the amount that Safran would be able to spend on future products, R&D and dividends. A much better strategy would be to use Safran’s cash to initiate a share buyback. While ‘eps accretion’ is a bad metric to evaluate a deal, Safran c ould achieve the same level of targeted accretion by using its cash 7 Clifford Street, London, W1S 2FT
Telephone: +44 (0) 20 7440 2330
TCI Fund Management Limited is a private limited company incorporated and existing under the laws of England and Wales with registered number 08898250 Authorised and regulated by the Financial Conduct Authority
to do an 11% share buyback. There are many compelling reasons why a share share buyback would be much better for Safran and its shareholders: 1. Double digit eps accretion guaranteed; 2. No execution risk; 3. Safran would maintain its superior business quality; 4. FCF/net income conversion would approach 100%; 5. The business would have a much higher growth rate and a higher return on capital; 6. Safran would have zero debt; 7. The dividend would be secure, and the payout ratio could be raised to 60%; 8. Massively value accretive because Safran stock is materially undervalued; 9. The stock would trade on a much higher multiple (20x PE); 10. Safran stock is worth €100 without Zodiac. So to be clear, the Zodiac takeover is a bad deal for Safran and its shareholders. The vote on the merger should happen before the takeover to give Safran’s shareholders their rightful say. The outcome of the vote would also give all Zodiac shareholders cert ainty that the merger will not fail after the takeover. TCI will be voting against the merger and we will continue to make the case for other Safran shareholders to reject the deal and petition the board to cancel t he takeover and initiate a share buyback instead. Yours sincerely
Sir Christopher Hohn Chief Executive and Chief Investment Officer
7 Clifford Street, London, W1S 2FT
Telephone: +44 (0) 20 7440 2330
TCI Fund Management Limited is a private limited company incorporated and existing under the laws of England and Wales with registered number 08898250 Authorised and regulated by the Financial Conduct Authority
