OSI Systems [OSIS] has agreed to acquire its competitor in the security detection market, American Science and Engineering [ASEI], for $269 million in a cash deal that will significantly expand its product and service portfolio and boost earnings.
The acquisition, which is expected to close by the end of 2016, has been approved by both companies’ boards of directors and is subject to approval by AS&E’s shareholders and government regulators.
“The acquisition of AS&E will be the most significant security acquisition in our company’s history and we believe represents an excellent strategic fit consistent with our expansion strategy,” says Deepak Chopra, chairman and CEO of OSI Systems. “AS&E’s backscatter X-ray technology has long been a leader with the security industry, and its cutting-edge products, extensive service network, and premier customer base are highly complementary to our current operations.”
Chopra says the deal will expand his company’s customer base and strengthens its abilities in technology development and integrated solutions, adding that AS&E’s backscatter technology will also enhance OSI’s position in ports and border security solutions.
Chuck Dougherty, president and CEO of AS&E, says that the sale of his company to OSI Systems will “create a leader in cargo and aviation security screening platforms.” He adds that the combination will also “provide customers and business partners with an enhanced set of competitive products and services.”
The acquisition will provide complementary products to OSI’s Rapiscan Systems security division.
Rapiscan makes Advanced Technology X-ray systems for use at airport checkpoints in the United States to screen carry-on bags as well as scanning systems that screen and image cargo containers. The company also has developed and is selling a next-generation computed tomography-based explosive detection system (EDS) that automatically screens checked bags at airports for explosives.
Another solid revenue stream for Rapiscan the past few years has been its turnkey screening service business that is being used in Mexico, Puerto Rico and Albania. This business model involves deploying the company’s screening technology at ports in these countries and territories to screen cargo on a fee per scan basis. The screening services have helped smooth out what traditionally have been a lumpy revenue stream for Rapiscan and its competitors in the security detection space.
AS&E’s marquis product is its Z Backscatter Van (ZBV), a mobile system that provides X-ray scanning capabilities of vehicles and other objects. ZBVs are deployed worldwide and are also in use by the U.S. government and defense agencies.
Chopra says continued strong demand for the ZBV across a wide range of customers is expected given the current threat environment.
AS&E, which is based in Massachusetts, also sells a variety of cargo scanning systems that are deployed worldwide and a vehicle scanner deployed by U.S. Customs and Border Protection and international customers that allows occupants to remain inside the vehicle during the imaging process, thereby helping to keep traffic and commerce moving.
AS&E’s backscatter technology is also helpful in identifying organic materials and contraband, making it useful in customs and other applications beyond detecting security threats.
A key revenue driver for AS&E is its comprehensive field services business, a stable business which accounts for about half of company sales. AS&E also makes baggage and parcel X-ray systems and, like Rapiscan, the company has developed a personnel scanner but with limited market success. AS&E also has a handheld X-ray scanner.
Chopra says AS&E’s service business is an “attractive” component of the deal, adding that the two companies provide products in many of the same regions, which will enable Rapiscan to have scale in its service offerings.
With U.S. spending on cargo inspection technologies lagging the past few years, unrest in the Middle East, and government spending downturns globally, AS&E has watched its sales tumble in turn. In its most recent fiscal year, sales were $103 million, down from $127 million in FY ’15. In FY ’14 the company had $190 million in sales.
OSI Systems’ Rapiscan division had $440 million in sales in FY ’15, $481 million in FY ’14, and $372 million in FY ’13, demonstrating more resiliency than AS&E in the face of difficult market conditions. Rapiscan’s turnkey screening services business has been a welcome source of predictable, sustained business.
The pending acquisition of AS&E by OSI Systems follows on the heels of another looming deal in the security detection space, which is Britain’s Smiths Group buying the Morpho Detection business of France’s Safran Group. Morpho Detection’s two main products are in the EDS market, where it is a global leader, and explosives trace detection (ETD), where it competes globally with Smiths Group’s Smiths Detection business and with Implant Sciences Corp. [IMSC].
Smiths Detection’s primary products are in Advanced Technology X-ray systems, where it competes globally, including against Rapiscan for airport checkpoint business in the U.S. Smiths Detection also competes against AS&E and Rapiscan globally for cargo container scanning systems and the company also makes a high-speed EDS system that so far has limited sales.
Benchmark Company security analyst Josephine Millward in a client note lauds the pending OSI Systems deal for AS&E, saying it will give the California-based company AS&E’s $154 million in funded backlog and “strengthen” its overall security product offerings.
OSI Systems says the deal is expected to result in $18 million in annual cost savings synergies within two years and is expected to be accretive to its earnings in FY ’17, which begins in July, excluding one-time transaction expenses and integration costs. It also expects the deal to be at least 10 percent accretive to earnings in FY ’18. The cost savings synergies don’t include potential real estate consolidations.
Longer term, Chopra believes the acquisition will accelerate his company’s sales and earnings growth.
In the U.S., the combined company’s key customers will be the Department’s of Defense, Homeland Security, State, the U.S. Postal Service, and a number of state and local governments. Chopra says the deal expands its presence with U.S. customers and bolsters its presence in Africa, the Middle East and Asia where Rapiscan already has customers.
OSI Systems, which also makes healthcare equipment and does contract manufacturing, said the acquisition is expected to result in at least $18 million of annual pre-tax cost savings within the first two years of closing.
Evercore is serving as AS&E’s financial adviser and OSI Systems is being advised by Citigroup and Roth Capital.
OSI Systems is paying $37 per share of AS&E’s stock, which represents a 25 percent premium to the average daily closing price for the past three months. Excluding $82 million in unrestricted cash held by AS&E, the enterprise value of the deal is $187 million.