The Alcoa-RTI Deal: 3 Things Shareholders Should Know

Image source: Alcoa.

Alcoa (AA), once called the Aluminum Company of America, has a long history of leading the U.S. aluminum industry. Yet over time, Alcoa has accepted that demand for lightweight materials other than aluminum has climbed substantially, and it has made strategic moves to bolster its presence in the production of these other materials.

In particular, titanium has been a key component for use in the aerospace industry, and Alcoa's bid to purchase RTI International Metals (NYSE: RTI) furthers its strategic efforts to serve its customers in the aircraft- and components-manufacturing business. Now that RTI International shareholders have voted to approve the deal by an overwhelming margin, the two companies expect the merger to close on July 23. Let's take a closer look at the Alcoa-RTI deal with an eye toward what it will mean for Alcoa's long-term results going forward.

1. The importance of aerospace for Alcoa makes the RTI buyout extremely valuable.
RTI International's prominence in the titanium market builds up what Alcoa has identified as a key driver for its future performance in the aerospace industry. As Alcoa CEO Klaus Kleinfeld said when the company first announced the deal, "RTI expands our aerospace portfolio market reach and positions us to capture future growth to deliver compelling value." RTI CEO Dawne Hickton added that "innovation and scale are critical to winning in both the titanium and aerospace industries today, which is why this transaction is such a natural strategic fit for both RTI and Alcoa."

Alcoa has gotten a lot of its recent growth from the value-add side of its business, providing customized products and components to customers rather than simply providing the raw materials for those customers to manufacture specialized products themselves. Both RTI and Alcoa have reputations for being innovators in the areas of process technology and materials science, and as Alcoa grows the non-aluminum side of its business, taking on RTI's intellectual property and innovations in titanium should help it gain speed more efficiently and quickly. Moreover, even though RTI does most of its business in aerospace and defense, it also has exposure to the energy and medical-device markets, which fit well with some of Alcoa's own prospects in those and other fields.

2. The impact of the Alcoa-RTI deal on revenue will be substantial.
The completion of the Alcoa-RTI merger will have an immediate and large impact on Alcoa's revenue, especially in the aerospace sector. Alcoa has said that RTI would boost its pro forma 2014 revenue from the aerospace sector by 13% to $5.6 billion, and would increase aerospace's share of revenue from Alcoa's value-add businesses to 37%.

Yet Alcoa has higher hopes for RTI's future. Having brought in $794 million in sales last year, RTI's contribution to Alcoa could exceed $1.2 billion by 2019. Moreover, Alcoa expects a substantial boost in operating margins over the next several years, with the hope of hitting the 25% mark in margins of earnings before income tax, depreciation, and amortization within the next four years. With its current EBITDA margin below 15%, the rise in profitability should help Alcoa's fundamentals, especially if Alcoa's projections for 5% to 6% annual growth in the global aerospace market overall.

3. The mechanics of the transaction will leave RTI shareholders with exposure to Alcoa's future.
Under the terms of the deal, RTI International shareholders will receive 2.8315 shares of Alcoa stock for every RTI share they own. With RTI reporting about 30.8 million outstanding shares as of its most recent quarterly report, the roughly 87 million new Alcoa shares that RTI shareholders will receive will represent a collective stake in the former aluminum specialist of just over 7%.

Already, RTI shareholders have seen some of the negatives of exposure to Alcoa's broader business. After a huge jump when the merger was announced, RTI stock has moved almost in lockstep with Alcoa's share price, and the two companies have both suffered an almost 25% decline in stock price as continuing challenges in the global aluminum market have put further pressure on Alcoa's business prospects. With all of their gains since the merger announcement now essentially gone, RTI shareholders will have to decide whether they should hang on to their Alcoa shares after the deal closes.

Alcoa still plays a key role in the aluminum industry, but it has made great efforts to diversify its business to include other materials as well. The Alcoa-RTI deal should go a long way toward that goal, but hasn't solved all of its problems, as market conditions remain difficult. The company's efforts to recast itself as a broader-based metals supplier are starting to pay off, though, and in time, Alcoa could see its share price rise as a result.