Investing.com -- Citi Research upgraded elevator maker Kone to "buy" from "neutral" with a €63 price target, saying the shares' fall since February means they price in only a very low probability of its proposed Thyssenkrupp Elevator acquisition.
The target was cut from €65 because Citi lowered its long-term growth assumption to 3.0% from 3.5% and raised its discount rate to 7.8% to reflect higher bond yields.
Kone shares closed at €51.72 on Oct. 6. Citi expects a 21.8% share price return and a 25.6% total return including dividends.
Citi values Kone at about €55 a share if the deal falls through, which includes an assumed €1.5 billion break fee.
That is broadly in line with the current price. If the deal goes ahead, it values the combined company at about €68 a share. Its target assumes a 60% chance of the deal completing. Citi called the upside from the deal "essentially a 'free option'" at the current price.
Kone shares trade at about 15.5 times expected 2027 earnings before interest, tax and amortisation, on an enterprise-value basis, against an average of about 18.7 times since 2016. Citi said this reflects fears about rising costs outpacing prices, but it sees only modest downside to consensus 2027 estimates.
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Citi said Kone's estimate of €700 million in annual savings within three years of completion looks credible, even after assumed sales of some businesses. Its own estimates add up to €710 million.
The largest part is service, at €250-300 million. Citi said the combined company would have the world's largest fleet of elevators under maintenance, at 3.2 million units, which could let it grow without hiring technicians as aggressively.
Citi said this could lift the combined service margin above 25%. It also expects double-digit earnings-per-share growth from the deal by the third year and a Kone operating margin of about 17%.
Kone agreed to buy TKE, which is owned by Advent and Cinven, for an enterprise value of €29.4 billion. That includes about €20.2 billion for the shares, paid as €5 billion in cash and about €15.2 billion in new Kone shares. Kone would also refinance about €9.2 billion of net debt.
The deal is under review in major jurisdictions, with the European Union still at the "pre-filing" stage. Kone has said it expects a 12 to 18 month process. Citi said 18 months is more likely a minimum, which would put completion in autumn 2027 or later.
Citi's base case is that Kone must sell businesses with about €1.6 billion of European revenue, likely including one major factory, to create a new fourth competitor. As Reuters reported on Oct. 1, Kone is expected to launch a sale process for the assets in November.
Citi said it does not assume any U.S. sales. If Kone had to sell half its legacy U.S. business, Citi estimated synergies would fall to about €450 million and earnings-per-share growth would shrink to single digits. Citi said it sees such a requirement as the more plausible reason Kone might walk away from the deal.
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