Tuesday is off to a rocking start with the announcement that Cummins acquired Meritor. In the name of getting info out as quickly as possible, here’s a transcript of the call Cummins and Meritor held with analysts this morning. We’ll have more follow-ups and analysis as we’re able to work through the information and follow this story as it continues to evolve.

Here’s the transcript

Moderator: I will now turn the conference over to Chris Clulow, vice president of investor relations. Chris, you may now begin.

Chris Clulow: Great. Thank you all for joining us today to discuss the acquisition of Meritor by Cummins. Joining me today are Tom Linebarger, CEO and chairman of Cummins, Mark Smith, CFO of Cummins, and Chris Villavarayan, CEO and president of Meritor.

We’ll start the call with some prepared remarks, followed by some time for Q&A with Tom and Mark. Some of our remarks will include forward-looking statements, and I’ll refer you to our disclosure included within our press release and with the slides on cummins.com. First, let me remind you that the acquisition is subject to approval by Meritor shareholders and regulatory approval. Now, let me turn it over to Tom.

Tom Linebarger: Thank you, Chris. And good morning, everybody. We’re really excited to announce and share with you that Cummins and Meritor have reached a definitive agreement for Cummins to acquire Meritor at 36.50 in cash per share of Meritor, for a total transaction value of $3.7 billion, including net debt. Meritor is an industry leader in axles, brakes and electric powertrain capability, and brings complementary strengths to Cummins that will strengthen the portfolio of our core business, and help accelerate the development of zero-carbon solutions within our new power business.

Cummins and Meritor are a great fit, sharing common values and a strong commitment to creating value for shareholders and all stakeholders. We look forward to welcoming Meritor employees to Cummins. Before I dive further into the strategic rationale for this acquisition, let me hand it over to Chris Villavarayan to share his perspectives on why this is a very positive move for Meritor stakeholders.

Chris Villavarayan: Thank you, Tom. I’m happy to be here with you and Mark to announce this transformational event. Today represents a major milestone for Meritor, our shareholders, our employees, and our customers. I’m excited about what this combination offers and what can be achieved together through the expanded offerings of a best-in-class Cummins-Meritor platform.

Let me highlight three areas of compelling value I see delivered by this transaction. First, value for our shareholders. At closing, Meritor shareholders will receive immediate value at a compelling premium to Meritor historical trading prices, and a 48% premium to Meritor trading price as of last Friday, February 18th, 2022.

Second, value for our employees. Our dedicated and diverse team members have been powering Meritor forward for more than 110 years. We could not do what we do every day without the creativity, energy and tireless commitment of our 9,600 global employees. Our team members will become part of a larger enterprise with similar cultures, missions and legacies that will fuel our innovations in core powertrain products and electrification. Our employees’ commitment to excellence helps make this transaction possible. And I know together we will continue to power life forward and help the commercial vehicle industry evolve and transform.

Third, value to our customers. Like Meritor, Cummins, we have always put customers first. Through world class product innovation, delivery and quality across our core axle and break businesses, and our mobility and electric powertrain solutions. In this combination, customers will see the powerful benefit of a broadened portfolio, enhanced technology capabilities, and accelerated investment in e-powertrain development, alongside EV adoption and best-in-class solutions.

Commercial vehicles will continue to transform over the next decade with the benefit of these products, solutions and zero-emissions technology. We could not be more excited about the potential of this combination to deliver compelling value to all stakeholders. Meritor has transformed from a traditional drivetrain manufacturing company into an electric powertrain technology company. And this transaction is the next chapter in our journey. With that, I’ll turn it back to you, Tom.

Tom Linebarger: Thank you, Chris. It’s great to have you with us. And I want to welcome your entire team and employees to Cummins.

Chris Villavarayan: Thank you.

Tom Linebarger: Yeah. So let me just add to Chris’s remarks. Climate change is the existential crisis of our time. And this acquisition accelerates our ability to address it. Our customers need economically viable zero-carbon solutions for commercial vehicle and industrial applications. Our communities and our planet depend on companies like Cummins to invest in and develop these solutions.

Cummins believes that e-axles are a key integration point for battery electric and fuel cell electric powertrain. And we see significant strategic advantage in accelerating investment in e-axles, and integrating Meritor significant capabilities with our new power technologies to deliver winning solutions for customers. Meritor’s core excellent break businesses bring to our components business, products that are powertrain agnostic. By leveraging Cummins’ sales network and global footprint, we expect to raise growth rates in both axles and breaks.

The combination of Cummins and Meritor creates one of the very few global companies that can serve our customers with optimized powertrains across the full range of combustion, electric and fuel cell electric applications. In addition to the strategic benefits, there’s also a very strong financial case for this acquisition. As Mark, we’ll discuss in more detail.

We have built a strong relationship with Meritor over several years. And in working closely with Chris and his leadership team, we have identified clear cost synergies, particularly in SG&A, supply chain and facility optimization.

Just stepping back, decarbonization is a global imperative and a growth opportunity for Cummins and Meritor together. The acquisition of Meritor is a unique opportunity to build out our capabilities in the transition and to provide alternative propulsion in a scalable and financially disciplined manner. Now, let me turn it over to Mark to summarize the key financial elements of this acquisition. Mark.

Mark Smith: Thanks, Tom. Good morning, everyone. Cummins is very focused on delivering strong returns to shareholders. And at the core of our strategy is the disciplined allocation of capital to support investments in the products and capabilities that will deliver future profitable growth, and the commitment to return excess capital to shareholders.

The acquisition of Meritor will bring clear financial benefits to Cummins that are consistent with our strategy as follows. Number one, the acquisition when complete will be immediately accretive to adjusted earnings per share. By year two, we expect to deliver a double-digit return on invested capital. By the end of year three, we expect to generate a run rate of positive pre-tax synergies of $130 million, which will contribute to strong returns and raise Meritor’s EBITDA margins closer to Cummins’ current performance levels. We expect to finance the acquisition through a combination of existing cash balances and debt. Cummins is committed to maintaining a strong credit rating, as this provides access to multiple forms of low-cost financing, which are important in maintaining the flexibility required to operate a global company through economic cycles. We do plan to reduce debt post-completion of the transaction to support our strong credit rating. And this will be achieved through the generation of strong operating cash flows and a slower pace of share repurchases than we executed in 2021. That’s a quick summary of the financial benefits of this transaction and our plans.

Tom Linebarger: Chris, I know that you’re not going to stay on for the Q and A because you’ve got to talk to employees. I really appreciate your team’s support and help. And I look forward to working with them and please welcome them to Cummins on my behalf. Thank you, Chris.

Moderator: Perfect. So now we’ll transition to the Q and A session. Please limit yourself to one question and a related follow-up and we will take questions up until the top of the hour. Thank you. First question is from Ross Gilardi with Bank of America.

Ross Gilardi: Morning guys. Congratulations. Thank you, Ross. Tom, I think this is a good one for you, naturally. But Meritor, I believe just won a nice piece of axle business with Daimler in China. And is that a big portion of your synergy target or does that represent upside? And just any implications on your ability perhaps to take on Daimler’s heavy-duty ICE business in addition to the medium-duty, given the synergies of this transaction. Thanks.

Tom Linebarger: Well, thanks so much. And here’s the way that I would talk about our synergies. We feel like there are three major sources of synergies. One, we think Meritor’s traditional core axle and brake business fits into our components business well. We have strong footprints, both of us, but Cummins is in some places that Meritor isn’t in bigger ways. And we think by bringing Meritor into the places we are that we can grow their core business. And of course our components business becomes more powertrain agnostic over time, providing us a more sustainable source of revenue and profit over a longer period of time. So that’s kind of synergy one.

Synergy two is, as Chris and I both mentioned, we have a very similar culture. We have very similar operations. We believe that we can operate the two companies at substantially lower costs per dollar of revenue than we can operate them separately. Especially because Meritor does have to supply global customers. It’s a relatively small company in that terms. And so we think we can offer significant synergies both on SG&A, supply chain footprint kind of issues. We can make significant headway and we’ve done a lot of work on that already.

And third, we think this synergy is related to investing in new power. Electrification fuel cells are substantial. We think we can be at the table now for pretty much every negotiation about who’s going to supply what in the commercial industrial sector. And that’s a big deal. I mean, this is a fast-moving sector. There are a lot of players in it and we want to make sure that we are able to provide both systems and components that are compelling to customers in that region. So those are the three areas that we’re thinking about the synergies. Of course, there’s a lot of detail underneath each, but that’s how we’ve been thinking through it in this transaction.

Ross Gilardi: Thanks, Tom. Can you comment a little bit more on just Cummins’ ability now out offer a more attractive fully integrated electrified powertrain offering? Just remind us what was Cummins offering on e-axle as part of that with existing offering, and how does this help?

Tom Linebarger: Absolutely. So again, it’s a very fast-evolving field. But you know that in Cummins case we’ve been providing batteries, the overall system controls and integrating systems. In Meritor’s case, they’ve been providing e-axles and then integrating other components into it. So what we add is in addition to the overall system, the brains of the operation and the battery, we now bring the e-axle and traction section to the electric power train. That allows Cummins to think again about whole systems and components much in the same way as we’ve been thinking about it from an engine point of view. We can provide now to OEMs a full range. You want a whole system, you want all the components you want individual components. And the e-axle is just increasingly becoming the place where those components are centered.

So it gives us a place. In an electric powertrain, you kind of lose the engine as a place to hook everything to. The e-axle becomes the new engine block where you start to hook all the components to. So I think it gives us a model to bring our components and systems approach to the market. And also it just significantly advances our technology in that area. And I think the two companies are largely complementary. Almost everything that Meritor has been working on Cummins has not been working on and vice versa. And the two companies are going to combine investments to provide much more economically viable solutions. Thank you.

Moderator: Our next question is from Noah Kaye with Oppenheimer.

Noah Kaye: Thanks. Hey, hey. Thanks so much for that, Tom. And I just want to pick up right there. I’m just curious if you could give us a little bit of the genesis of this. Because as you said, there are a number of players in and around e-axle electrification. I know you’ve obviously been following the space very closely for a long time now and watching it develop. So I guess why Meritor, why now? And did it really start with looking at the e-axle side? Is this is part of a more holistic review process of the portfolio? Just give us a sense of how this came to be and why now, if you can.

Tom Linebarger: It’s a great question, Noah. And it is, as you describe, a more holistic… Look, we have done strategy work in our new power area to say, “What are the key systems and components that we want to invest in versus purchase outside?” And e-axles and tractions kept arising as one of the places that we needed to be in a serious way, given the comments I made earlier to Ross about where we see components being hooked to and connected to in the future.

And then secondly, we’ve been looking for ways to invest in a financially disciplined way in components that build out our entire portfolio and are more engine agnostic. And that we can use our global footprint, our connection to significant customers, et cetera, to enhance their value. So we were doing that on our core business side, we were doing the new power, of course, on the new power side. And the two came together. And then there were very few candidates that fit that bill as, you’d guess. And Meritor is one we’ve been talking about for some time. And again, I would just credit the board of Meritor and the leadership team for recognizing that the future depends on a more significant investment in this new power and they decided that they were going to need to partner up to do that. And I think that’s what really was the genesis of the transaction.

Noah Kaye: Right. And do you think there’s a way to put into terms for us what this did in terms of, or will do, in terms of shortening your speed to market in some of those offerings? Because getting the software and controls right in some of these electrified offerings is incredibly difficult, time-intensive. So what do you think you’ve done in terms of shaving time off of your speed to market?

Tom Linebarger: I think it’s going to allow us to provide customers with more system choices. They can buy components or systems. We can provide customers now with real hardware. Meritor’s already invested in E-Axles and has products running today. So they don’t have to wait for some future offering, we can provide them systems today. And as you know, Cummins has done the same in batteries, where Meritor hasn’t. So we can offer customers now traction systems that are available today that they can start to run and that we can improve upon. And then same with the battery systems. So both companies were seeking out the other solution, and this marriage allows us to provide both or both of them together or separately, which again, just brings us to the table in most conversations in the commercial industrial space for companies that want to think about driving electrification or fuel cell electric vehicle.

Noah Kaye: Well, thanks so much. This is quite the lead-in to the analyst data model, looking forward to it. Well done.

Tom Linebarger: Yeah. Thanks. Appreciate it.

Mark Smith: The next question comes from the line of David Raso with Evercore.

Tom Linebarger: Hi David.

David Raso: With the Jake Brake acquisition, you took a nice step function to provide a solution for 2027 emissions. And now with this Meritor deal, right, a great, just step function in your electrification offering. If my numbers are right, and maybe Mark correct me if I’m wrong, immediately after the deal, the pro forma net debt to trailing EBIDA is still only about 1.2 times. So still plenty of firepower left. So I’m just trying to think, you solved the quick issue with Jake Brake. Obviously a great addition here at Meritor strategically. Do you still see areas, maybe not quite of this size, but areas where there are still holes to fill and opportunities that you can fill in this kind of step function way? And again, do you agree with, or look at net debt to EBIDA on a pro-forma basis? Thank you.

Tom Linebarger: David, I’ll let Mark answer the financial question about, you know, do you have the ratio right? And then I can talk a little bit about holes. Go ahead, Mark.

Mark Smith: Yeah, I’ve got the gross step numbers in my mind here, David. So this transaction will take us above two times gross debt to EBIDA initially, and then we’ll plan through 2024, all things being equal to work that metric down below 1.75 to restore that strong credit rating. That’s what we see in front of us today. Those are the numbers we’re aiming for from a purely financial perspective.

Tom Linebarger: And then let me talk about gross.

David Raso: Is that gross? And is it proforma on the EBIDA?

Tom Linebarger: Yes.

David Raso: Okay. Thank you. Sorry, Tom.

Tom Linebarger: It’s okay. Don’t worry, David. And so I think on the strategic side, we continue to see the evolution on both sides. So in our core business, we are looking for solutions for customers that help them drive carbon footprint down and help them consolidate and to invest in the thing that they want to invest in. So we think there are significant investments to be made given our global footprint in the core business, both powertrain related and powertrain agnostic. And we want to balance that portfolio. As you know, we are continuing to invest in engines because we think they have a long life ahead, especially as we reduce carbon emissions from engines. But also, all these components that we think will be required irrespective of the powertrain. So we’ve got one leg there and then on the new power side, the number of technologies that are coming up and how many might impact the economic viability of the solutions, there’s a lot to be done there and we are still looking at those pieces.

So yes, there are still areas of investment that we are seriously considering trying to invest in. But I would say, back to your question in terms of large-scale things, I think our view is that most of the technology areas are relatively small acquisitions. And then in the core business, we think we can add incrementally in a financially disciplined way. So we are still holding to our idea that we’re going to invest in the new technology spaces and then try to think how to continue to use a very disciplined model to broaden and strengthen our core business over time. That’s kind of the combination. Meritor was a perfect fit for that. And we think we’ll continue to look at other areas, but we’re kind of thinking on kind of an incremental basis today.

David Raso: And lastly, your bigger OEM customers in particular, not saying you could mention you were acquiring Meritor directly, but have you had some broader conversations with your bigger customers to get some affirmation that expanding your content, connecting with the axles and the brakes, is something they would embrace to have one supplier providing that much content?

Tom Linebarger: Well, broadly speaking, I think our customers, you’re right, I did not talk about this transaction directly of course, that would not work. But what I’ve tried to do I think is understand what their requirements are and to make sure that we’re investing in the area that they need us to to give them viable solutions. I think all the customers that I’m talking to want to invest in reduced carbon solutions, but frankly, the cost versus performance trade-off isn’t quite there yet. So they need us to advance that in order to be able sell their trucks onto end-users who just find the whole thing too expensive or too challenging today. I mean, not in small numbers, but in big numbers.

So I think that’s step one. And I think customers will recognize the value of getting our joint investment together. With regard to the core business, my view is that there’s increasing concern about the strength of the supply chain. And I think by Cummins investing here, what customers can count on is that we’ll be there for them when they need us. That we’ll be able to maintain these key components in their supply chain, invest enough to make sure that the cost continues to diminish, the quality continues to rise, and the technology continues to meet the standard that they require. So I think Cummins investing in these areas provides them with more certainty that they’ll have a viable product for years and years to come.

Moderator: The next question is from the line of Jamie Cook with Credit Suisse.

Jamie Cook: Hi, good morning and congrats. I guess two questions. One just, Tom, you’re usually not one to sort of do larger deals. Just thoughts on acquisition versus generally, you sort of go the JV route. And then my second question, as it relates to investment in EV of the combined companies, is this about, I mean, are there savings here? Is spend going to ramp before it goes down? Now just trying to think about that perspective and the impact on margins longer term. Thanks.

Tom Linebarger: Great, Jamie, thank you. So, I think in our strategies, as I answered, I think, earlier to Ross’s question, our strategy here was both how to find ways to grow in our core by adding components that we think we can use with our footprint to grow and to do that in a financially disciplined way. You know that we’ve been talking about that for a long time. Meritor fit that really well. And as you said, we thought about different ways to do it. JVs, different companies to do it. And Acquisition Meritor just seemed like the best way to do it. Even with the premium, the acquisition price and with the synergies allows us to do it in a very financially disciplined way.

Tom Linebarger: We see returns meeting all of our targets. We see earnings being accretive quite quickly. Again, it just looked like an acquisition was going to be the most financially attractive way to do it. I think the new power side added significant impetus to that, the speed with which we need to make these investments and the fact that we need to combine these systems as quickly as possible meant that a joint venture would be complicated. By the way, we have talked with Meritor over the years about different partnership options. So, you were right about that. We did definitely look at a lot of those things. We looked at a bunch of organic options and this was by far the most attractive route. So, that’s why we pursued it.

Tom Linebarger: We will ramp up spending. I want to be clear about that. We think there are significant synergies in this transaction, as I mentioned earlier, where costs can be reduced running these two companies, for sure. In the new power space, we will be increasing investment, not decreasing. So, to your point, we will be investing more. So, it will be indeed that there are synergies between our two companies on capabilities, but one of the promises of this acquisition is that we will be investing more in Meritor’s development of e-axles and traction systems, because we think that’s a significant area of development and the customers need us to.

Mark Smith: And we’ll put that in the context of our business tomorrow during our analyst.

Tom Linebarger: Yeah. So, Mark was just mentioning, Jamie, that tomorrow we’ll show you the overall investment, what that looks like for new power, et cetera. And so at least you can see what … But I guess you asked, is it going to ramp up first before it gets better? And the answer is yes.

Moderator: Our next question comes from Jerry Revich with Goldman Sachs.

Jerry Revich: Hey, Tom, Mark, Chris. Congratulations. Tom, I’m wondering if you can talk about the opportunity for this business in China in greater detail. The e-axle and the traditional axle, how would that fit versus some of your major OEM customers in China? How significant is that opportunity specifically relative to your priority list in terms of building up the manufacturing footprint in China for your local customer base, given the strong connections you have there?

Tom Linebarger: Yeah. We do think there are significant opportunities in China. I think you know, Jerry, that we have substantial partnerships in China. That doesn’t mean automatically they use your components, but it sure helps. You’re talking to a customer that relies on us significantly. And the transmission example is a perfect example of one. It wasn’t that Eaton wasn’t in China, they were, but with Cumin’s customer relationships there, we were able to get significant growth in the Eaton Cummins automated manual transmission because of all those relationships.

We think the same is going to be true in axles, brakes, and e-axles. So, in the core business, as well as the electrification side. I think also in China, what we’re seeing is that the battery side is difficult to penetrate. There’s a lot of investment in batteries in China. On the other hand, the e-axle and traction, other components, we think is a better pathway into the e-drive business in China.

So again, it’s another way for us to penetrate the market. We think we offer significant technology advantages to our Chinese partners there. And this is just a vector, if you will, a way to get there that we think represents a bigger opportunity in the short run than just waiting for the battery market to show up.

Jerry Revich: Got it. And then, Meritor had a $1.5 billion electrification revenue target for 2030. I’m wondering, based on your due diligence and cross-selling opportunities, how comfortable are you folks with that outlook? Any thoughts

Tom Linebarger: Yes. We’ll talk about that in detail tomorrow. I don’t want steal Amy Davis’s thunder. But suffice it to say, that Amy’s view is that Meritor’s target plus Cumin’s target will equal the two combined plus some. So, she feels strongly that the two companies together offer customers more viable solutions quicker, and therefore will offer significant revenue targets.

Tom Linebarger: No doubt that as soon as they each get into each other’s numbers, they’ll want to talk about exactly what each thing is. So, I’ll leave that to them to do. But we think this is a significant revenue growth opportunity for the new power business and really one of the biggest pieces of compelling logic of the acquisition. So let me let Amy take that through rather than jump in front of her here.

Moderator: Thanks very much everyone for joining today.