What: Shares of both Cintas (NASDAQ:CTAS) and G&K Services (NASDAQ:GK) surged on Tuesday after the two companies signed a merger agreement. Under the terms of the deal, Cintas will acquire G&K Services for $97.50 per share, which is a 19% premium to yesterday's closing price. Investors loved the agreement and sent both stocks up sharply in early morning trading:
So what: The merger transaction values G&K Services at $2.2 billion, including the assumption of debt. However, while Cintas is paying a pretty hefty premium to acquire the company, it believes the deal will be accretive to earnings per share in the second full year after the transaction closes. Further, Cintas anticipates realizing $130 million to $140 million of annual synergies by the fourth full year after closing. In addition to that, Cintas believes that the merger with G&K Services will provide it with additional processing capacity, which will enable it to improve customer service.
Both companies are coming off of strong years, with each reporting their fiscal year-end results recently. In late July, Cintas reported that its fiscal 2016 revenue was up 9.6% to $4.9 billion, which was above the high end of its guidance range. Earnings, likewise, were above the high end of its guidance range, coming in at $4.09 per share, which was well above last year's total of $3.46 per share. Further, Cintas offered an optimistic outlook for fiscal 2017, with its revenue expected to grow by 5% to 6.5%, while earnings were projected to increase by 6.4% to 8.8%.
Meanwhile, G&K Services reported record fiscal 2016 earnings this morning. Overall, earnings rose 22.4% to $3.61 per share to go along with a 42% increase in cash flow from operations, which set a record at $134 million. Meanwhile, revenue was up 4.3% to $978 million. While the company is clearly doing well on its own, it couldn't refuse Cintas' offer price, which was 20% above its all-time closing high and at a rather lofty 14 times EBITDA multiple.
Now what: Cintas is paying a premium price for a premium business. Because of that, the G&K transaction won't be immediately accretive to earnings. That said, it has the potential to deliver robust cost savings over the next few years, which is what has investors excited about the deal.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends Cintas. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.