25 Acquisitions

2007 Acquisitions

On 29 June 2007, the Group completed the acquisition of the Teleflex Aerospace Manufacturing Group (TAMG) of Teleflex Inc, in a mixed trade and asset and legal entity deal, for a fair value consideration of £68 million. The businesses acquired provide manufacturing and engineering services from operations in the US, Mexico, France and the UK.

The acquisition has been accounted for by the purchase method of accounting. Fair values on the acquisition remain provisional as the review of acquired operations and assets remains ongoing.

Valuation of non-operating intangibles—methodology

The fair value exercise carried out in conjunction with a third party expert on the acquisition of TAMG considered the existence of the following recognisable intangibles attributable to the business: in-process research & development (IPRD), non-compete covenants, marketing agreements, distributor relationships, trade names, leasehold interests, software, proprietary technology and customer relationships/contracts.

No significant IPRD or marketing agreements were identified and accordingly no fair value was ascribed. TAMG transacts most of its business directly with aerospace prime engine manufacturers, any revenue applicable to distributors is included within the customer relationship calculation. No trade names were acquired in the transaction.

As part of the transaction the vendor covenanted not to compete on the products and processes of the business acquired for a period of three years. Although the vendor still operates in the aerospace business it has retained no activities of a similar nature to those it disposed of. The costs of recreating the specific technology and processes it disposed of would be significant. A fair value of £1 million was identified for the covenant not to compete.

TAMG is a recognised market leader in the manufacture of complex engine components for the aerospace industry, thus giving the Group further positions on a range of established engine programmes. The business has a range of both cold section products that are complementary to the Group’s existing engine case and fan blade activities and hot section core activities in blisks, compressor airfoils and guide vanes. TAMG has manufacturing and technological expertise in electrochemical machining (ECM), forging, multi axis milling and conventional milling. These capabilities are based on developed ECM proprietary technology and milling know-how. The proprietary technology and know-how has been valued using a relief from royalty methodology. The cash flow forecasts supporting this valuation reflect the future sales to be generated in conjunction with the technology. The fair value attributed to proprietary technology represents the theoretical costs avoided by TAMG from not having to pay a licence fee for the technology. The royalty rate used in the valuation was 3.0% for ECM and 2.0% for milling, which was based on a review of licence agreements for comparable technologies in similar industrial segments. An after tax discount rate of 12.0% was applied to the forecast cash flows, a rate that reflects the higher inherent risk of intangible cash flows compared to the weighted average cost of capital of the TAMG acquisition.

The intangible assets inherent in TAMG’s customer relationships/contracts were valued using an excess earnings method. This methodology places a value on the intangible as a function of (a) management’s estimate of the attrition rate on the expected cash flows arising from the contracts and forecast cash flows likely to accrue to TAMG from its customer base; (b) expected cash flows arising from the intangibles; (c) discount rate reflective of the risks inherent in the flows; and (d) an asset charge attributable to operating assets needed to generate the cash flows. The cash flows attributable to customer relationships include an annual attrition rate of 5.0% to reflect expected decay in future revenues. An after tax discount rate of 14.0% was applied to the forecast cash flows.

TAMG’s primary operations and centre of management are based in the US. The valuation of all intangibles reflects the tax benefit of amortisation, which in the context of TAMG has meant a benefit assessed with reference to US tax laws. According to US tax law an intangible may be rateably amortised over 15 years regardless of its actual useful life, as such, there is a tax benefit to an acquirer and hence values attributable to the intangible assets have been recognised. This value amounts to £3 million across all the intangibles recognised.

The fair value of customer relationships/contracts recognised was £13 million and the fair value of ECM and milling know-how was £7 million.

Fair value adjustments on tangible fixed assets represent a net uplift on plant and equipment to fair values following an external third party appraisal. The uplift primarily represents the restoration of asset values fully depreciated by TAMG. TAMG operates from owned and leased facilities. At leased facilities the rentals are reflective of current market values and hence no fair value is attributable to TAMG’s interest in these leases. Inventories acquired were assessed for scrap and obsolete items before being fair valued. Inventories acquired have been fair valued at current replacement cost for raw materials and selling price, adjusted for costs of disposal and a selling margin, for finished goods and work-in-progress. The value of the fair value inventory uplift was £1 million, the adjustment for scrap and obsolete items was £2 million. Provisions includes amounts in respect of onerous contracts. Three contracts with two customers have been identified where the unavoidable costs of meeting the obligations under long term agreements exceeds the economic inflow they generate. In assessing these contracts dedicated fixed assets have been impaired upon acquisition. Two of the contracts identified are at an early stage and reflect the impact of contractually committed price downs. Unavoidable costs include direct labour and material and a reasonable proportion of manufacturing overhead. Also included are the unavoidable costs of purchasing fixed assets dedicated to these contracts and required as future volumes increase.

The goodwill arising on the acquisition of TAMG is attributable to the anticipated future operating synergies from the combination with the Group’s existing US Engine Products business, the value of the embedded workforce, the value of a significant manufacturer in the US engine component market and the ownership and control of a leading business in an industry with substantial barriers to entry.

TAMG contributed £38 million to sales and £4 million to the Group’s trading profit for the period between the date of acquisition and the balance sheet date. If the acquisition of TAMG had been completed on the first day of the financial year, Group sales for the year would have increased by £72 million and Group trading profit would have increased by £6 million. TAMG was acquired debt and cash free.

In the post-acquisition period TAMG contributed £4 million to cash generated from operations and absorbed £1 million in investing activities.

Prior year acquisitions

Finalisation of fair value adjustments in respect of the 2006 acquisitions of Stellex Aerostructures, Rockford Powertrain and Liuzhou Steel Rim Factory (Liuzhou) were made in the year. As required under IFRS 3, amendments to provisional fair values have been shown as a prior period restatement. As a consequence, and only in respect of Liuzhou, intangible fixed assets have been restated to recognise non-operating intangible assets arising on business combinations of £1 million with an equal reduction in the value of goodwill.