City welcomes Tomkins' $1bn Gates buy

The City yesterday welcomed news from the buns-to-guns conglomerate Tomkins that it has found a sensible use for its fast-growing cash pile. The proposed $1bn (pounds 685m) acquisition of Gates Rubber made analysts doubly happy because it appeared to be taking the group back to its engineering roots. The shares rose 7p to 269p.

The change in sentiment towards Tomkins follows three years during which the shares have stagnated as investors failed to appreciate the commercial logic of the group's last big acquisition of Ranks Hovis McDougall. That move was damned for taking the group into the volatile world of bread price wars and for flooding the market with shares.

Gates Rubber, which makes power transmission belts and hoses for the automotive industry, is a family-owned Denver business with turnover of about $1.5bn expected this year. Tomkins beat off offers from two other bidders to secure the deal which is expected to be completed in the first quarter of next year.

Although details are still sketchy, the market welcomed the fact that the deal will be funded by the issue of convertible shares to Gates rather than another rights issue. The pounds 900m RHM acquisition was paid for with a one-for-two rights issue, hard on the heels of a pounds 325m cash call the previous year to fund the purchase of Philips Industries of the US.

Geoff Allum of Henderson Crosthwaite said the deal was just the sort of acquisition Tomkins should be making. "It's darned good news. It looks a very positive deal for Tomkins on the information so far available," he said. Zafar Khan at Societe Generale Strauss Turnbull agreed: "It's a sensible deal and one that the market will warm to."

Full details will not be available until contracts are finalised later this month, but analysts thought the deal would not dilute earnings in its first year in Tomkins. Based on the assumption that Tomkins will pay close to the speculated price of $1bn and assume $240m of Gates's debt, it will have to squeeze a 9.5 per cent margin out of sales of $1.6bn to remain earnings-neutral. Brokers believed that was achievable, with Gates's 13 plants employing 14,000 workers offering substantial scope for savings.

The hope in the City is that the acquisition of Gates will mark a turning point for Tomkins, which has consistently produced excellent results but failed to persuade investors of its merits. Despite turning in an 18 per cent rise in profits for the year to April with a similar rise in the dividend payout to shareholders, the shares have remained under the cosh, rated less highly even than its peers in the out-of-favour diversified industrials sector.

Over the long run Tomkins' performance has been even more impressive. Earnings per share have risen every year since 1984, notching up a compound growth rate of 34 per cent, compared with the average of UK quoted companies of just 7.5 per cent. Dividends have risen 29 per cent a year on average over the past 12 years.