Shares in Cobham have reversed gains of nearly 5% this morning to trade almost 2% lower, adding to yesterday’s 4.6% decline, as investors digest the company’s sale of two businesses for $455m/£325m following a portfolio review.

Yes the deal is in cash. Yes the company will use the proceeds (along with existing cash) to pay down another £440m in debt (already more than halved to £460m at H117, or 1.5x net debt/EBITDA, thanks to May’s 2-for-5 rights issue), at a time when financial conditions are gradually tightening and borrowing is set to become more expensive. Yes the deal may simplify the group by removing from its biggest division businesses in which it has no competitive advantage, allowing it to focus on defence, aero and space. However, the figures don’t stack up.

Cobham Communication and Connectivity (CCC) is the group’s biggest division, representing 36% of FY 2016 group revenues (£690m of £1943m) and 27% of group operating profits (£60m of £225m), implying a divisional underlying operating margin of 8.6% in 2016 (7.5% H1-17) which is already lower than the group’s 11.6% in 2016 (9% H1-17).  And with the test and measurement businesses in question (AvComm and Wireless) accounting for around 25% of the division’s revenues (£170m of £690m) and 42% of its underlying profits (£25m of £60m), this begs the question why management is selling two businesses with a higher aggregate 14.7% margin. The sale may well be only “slightly dilutive” for the group’s margin (a few bps), but may well take its biggest division below 7%.

Furthermore, this morning’s statement talks rather optimistically about improving market conditions and profitability for the businesses being sold thanks to 5G rollout, which resulted in a competitive auction. A financial and operational turnaround is in progress, and big decisions required. Business simplification and lowering debt is good, so long as margins don’t suffer too much.

Mike van Dulken, Head of Resarch, 2 Feb 2018