Good day, ladies and gentlemen, and welcome to Parker-Hannifin Corp conference call and webcast to discuss the agreement to acquire LORD Corporation. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this conference may be recorded. I would now like to turn this conference over to Cathy Suever, CFO. You may begin.
Thank you, Sonia. Good morning, and welcome to everyone on the call. We appreciate your participation today as we discuss this morning's announcement that we have reached an agreement to acquire LORD Corporation. Joining me today are Chairman and Chief Executive Officer, Tom Williams, and President and Chief Operating Officer, Lee Banks. Today's presentation slides, together with the audio webcast replay, will be accessible on the company's investor information website at phstock.com. On slide two, you will find the company's safe harbor disclosure statement addressing forward-looking statements. I would also encourage you to review the language in our press release and SEC filings today for other required legal disclosures. Today's call agenda appears on slide three. We will give you an overview of the transaction and its strategic fit. We will introduce you to LORD Corporation and review the synergies. We will then open the call to questions.
At this time, I will hand it over to Tom.
Thank you, Cathy, and good morning, everybody. It's an exciting day for Parker, an exciting day for LORD Corporation. I want to welcome all of our shareholders and analysts, Parker team members around the world, and a real special welcome to all the LORD team members that are listening in. We are really looking forward to working with everybody at LORD. LORD is a great company, one that we've admired for a long time, and we're proud to have you part of the Parker family. You've heard me talk about two overarching drivers for Parker. The first is for us to be a top quartile performer amongst our diversified industrial peers. The second is to be a great generator and deployer of cash. This acquisition achieves both of those drivers.
LORD is a top quartile performer when you look at it from a growth standpoint, margins, and cash generation. From a capital deployment, you've heard me talk about being the consolidator of choice within motion control. In particular, we wanted to invest in filtration, engineered materials, aerospace, instrumentation. Just a little over two years ago, we invested in filtration with the CLARCOR acquisition, and today we're making a significant investment in our engineered materials space with the LORD Corporation acquisition. As a result, when you look at that, what we've done over the last several years, our filtration engineered materials technology platform will now be the largest in Parker, and it will drive significant growth margins and resilience for us going forward. If you jump to slide four, we'll talk about the transaction summary.
We're going to acquire 100% of LORD Corporation, a leader in material science and vibration control technologies. I'm going to give you a lot of application pictures and take you through those to help bring that comment to life. LORD being a private company, we thought we'd spend a little bit more time on this call describing what LORD does and what makes them such a great company. Calendar year 2019 estimate on sales is $1.1 billion, and their estimate EBITDA margin is 23%, and they're tracking to that with their first quarter performance. Transaction consideration on $3.675 billion cash purchase price. You can see the multiples there, 15.1x on Adjusted EBITDA. When you look at the synergies, 9.9x. These synergies, similar to how we did CLARCOR, are cost synergies only, and I'll discuss that later. Financial impact, EPS accretion in the first 12 months.
EBITDA margin and sales growth rates are accretive. They're growing at a higher rate than we are and have better margins. High single-digit ROIC in year five with continued expansion thereafter. The cost synergies that I mentioned, $125 million. Revenue synergies, obviously, we will go after them, but they are upside to our model here. This is going to be funded with debt. We expect it to close within four to six months. Why buy LORD? This is the page, slide five, on the strategic fit and financial benefits. This is a space we wanted to invest in. This is a strategic portfolio acquisition where we are significantly expanding our engineered materials business. As I mentioned, filtration engineered materials together will now be the largest technology platform that we have in the company. They make different but complementary products, and they go into industries we understand.
That, for me, is always the sweet spot in doing a deal. Does it expand your technologies and go into spaces that you understand that creates a high degree of execution certainty? They have a really rich history of innovation and product reliability. When I take you through the examples, I think it will come to life just how critical their solutions are to their customers. Strong global brands, and when you look at their customer list, it's a blue-chip customer list, very similar to ours, with decade-long relationships with these customers. Really strengthens material science. We'll give you a lineup of our technologies and LORD technologies, and you'll see how powerful the combination is. We take advantage of a number of mega trends here.
The electrification of virtually everything and the thermal management and adhesion technologies they bring to that, as well as their nice aerospace market exposure, which will drive growth for us. You're going to see in the numbers they are clearly accretive to our organic growth rates. EBITDA margins, they are a mid-teens CFOA business and will be accretive to our EPS going forward as well. On slide six, just to give you the actual numbers here, looking at sales CAGR and margins, this is a top quartile company, and we want to be a top quartile company, so we're buying top quartile companies. You look at a sales CAGR here, we're at 4%. This is a 2016 to 2019 sales CAGR. They're at 7.6%. When you look at EBITDA margins, you can see they're about over 400 basis points higher EBITDA margins than we are.
Very exciting for the company to be adding a quality company like LORD. On slide seven, kind of really starts, I'm going to take you through the background culturally and then also technically and application wise. The leader in material science and vibration control technologies. After I show you all these pictures, I think it'll come to life as to what that means. They are on mission critical products, meaning that these applications are on demand a high level of reliability and performance, which is really a big deal to their customers. That criticality has built a level of trust that has really enabled a lot of stickiness between them and their customers. They are clearly a trusted partner.
Virtually everything that they ship has some kind of intellectual property wrapped around it, either a patent or a trade secret formulation or process, which is exactly what we want. On the right-hand side of this page, you look at the pie charts. The first one just kind of shows you that their key markets, they're very balanced. Basically 1/3 industrial, 1/3 aerospace and defense, and 1/3 automotive. You look at the geographies. The advantage for us is they have a higher concentration in Asia than we do, and that will grow our Asia presence, which is something we've always wanted to do. On slide eight, this is really unique. This kind of comes to the list that you can't make these things up when you look at how uncanny the cultural alignment is between the two companies.
I would first start with the bullet we have underneath similar values and history, top quartile focus. We talk a lot about being top quartile. We measure ourselves about being top quartile. Lord does the same thing. We're bringing on a company that understands that same kind of zeal for being at the top of the list when it comes to how you're performing. If I just go through kind of bullet by bullet, comparing the two companies, you can see we're both about 100 years old, and we both have a father-son founding family that was very influential to the start of the company. For us, it was Art Parker and obviously his son, Pat Parker, and then for Lord, it was Hugh Lord and his son, Tom Lord. We both, geography wise, were centered around Lake Erie.
Cleveland, Ohio, for us, and Erie, Pennsylvania, still a very important part of LORD. We were both on the Spirit of St. Louis flight, the Charles Lindbergh flight across Atlantic, which is the picture at the bottom of this page. If you were Charles Lindbergh, a couple important things when he was in that plane. First, you want to make sure you have enough fuel to get across the Atlantic. Having fittings that didn't leak, which is what we provided, Parker, was really important. Then it's kind of important to be able to read your gauges, and the gauges were shaking like crazy. LORD provided the vibration controls, which is still kind of the founding part of the company that provided Lindbergh the ability to read the gauges.
We first got introduced to LORD about 10 years ago, this was through our engaged people process and really benchmarking each other on high performance teams. This is a big part of why we are so excited about the cultural symmetry, because of how we treat people and our engagement of people and how we want people involved in decision making, and people are owners of the company, and owners of their value streams. Then remarkably, the strategy of the companies look very similar. We call ours the WIN Strategy, LORD calls theirs LORD Summits. If you look at them side by side, they have the same four major ingredients, engaged people, customer experience, profitable growth, and financial performance. Whenever you do a deal, regardless of size, cultural alignment is really important. This one scores a lot of points when it comes to cultural alignment.
If you turn this to slide nine, I'm going to spend a few minutes on this page because this really kind of starts to bring the technologies to light. Just to orientate you to how this page is organized, I'm going to cover these three major columns, key technologies, the selected products, then really what makes them different. I'll cover the blue boxes on the right last. Let's start first with rubber to substrate bonding. I have a slide on this. I'll go through some more detail, but when I say substrate, this would be bonding rubber, or really for that matter, any kind of elastomeric product to glass, to ceramic, to plastic, to metal. Their key brand here is the Chemlok brand. If you think about facial tissues, they are the Kleenex equivalent of adhesives around the world.
They are in virtually every vehicle in the world with proprietary trade secret type of formulations. Second category of technology is thermal management. Think about all the electronics around the world. Heat management and heat dissipation is a big part of the success of any piece of equipment when you have a lot of electronics. Their brand is called CoolTherm. Again, they have a range of chemistries. Of the million electric vehicles that are out there, LORD is on all of them with their thermal management solutions. Third category is structural adhesives, this is really for assembly and repair into automotive or industrial applications. I'll give you a feel for that, again, a broad range of chemistries. The last two are back to how the company started. I told you about that vibration control example on the Lindbergh flight.
These two at the bottom are what we would call noise, vibration, and harshness technologies. You'll hear the acronym NVH used a lot. The first one, the electromechanical systems, is on the active vibration control. It's really the combination of actuation and fluids to counter the vibration forces, and I'll give you an example of that later on to kind of bring that to life. The last one is passive vibration control, which is using elastomeric technologies, laminate bearings, mounts, et cetera, to isolate stress, isolate vibration in the application. In sum, if you take all these five technologies, the blue boxes on the right, they are providing critical solutions. The applications they are on have a high cost of failure.
When I show you the pictures of where the products are, you'll recognize how this is a high cost of failure, hence why you want a trusted partner to go in there. Their cost to value ratio is significant, meaning that they are bringing tremendous value for the cost the customer pays for this technology. They've got decade-long relationships, hence why customers trust them so much in doing this. If you go to slide 10, we lined up all the capabilities of what Parker brings, what LORD brings, of course what the combination's going to look like. Again, I would just emphasize they're different, but they're complementary. The first three is what LORD really brings to the table. Their adhesion and coating science, their vibration, isolation, passive and active dampening.
Cockpit controls, we're a little stronger on that, but they have some nice lever technology that will add to us. Thermal management, both probably equally strong in this. However, LORD has a much stronger, significant presence on electric vehicles and their electrification technologies. The last four is really what Parker's brought to the game with our existing engineered materials technology. When you look at this, when you look at the combined column, you have a very compelling lineup that's going to customers to create a very powerful value proposition for them. On slide 11, this is where we take a look at it from an industry standpoint. These are all industries that we understand. A key part about this page, I always like deals or bringing complementary technologies into spaces that we understand.
We understand the channels, we understand the OEMs, that degree of risk is not there. The takeaway box on the bottom is really important. There's a reason why they're growing faster than the market. They're growing faster than the market because they are exposed to mega trends and technologies that are growing faster than industrial production growth, like aerospace, light weighting, which I'll explain what that means, and electrification. Not just electrification of automobiles, but electrification of everything, and the thermal management and adhesion technologies that would go into that. That's why they're growing faster than the market, and that's why when we bring them part of Parker, they'll help us grow faster than the market. Let's start with, on slide 12, that first technology that I talked about earlier, the leading rubber-to-substrate applications. They have a wide spectrum of adhesives and coatings.
Adhesives, meaning that you're bonding any particular type of elastomer to glass, ceramics, plastic, metal, et cetera, and coatings, which are really enhancing the performance capabilities of that rubber or elastomer. Again, they are the trusted brand name in the market, that Kleenex equivalent, either with the Chemlok or the Chemosil brand. They have a solution for every process, meaning however the OEM, whatever their application environment is, whether they have a solvent or water-based application, spray, dip, or brush, whether this is a low temp or a high temp application, they have the different chemistries to do that. They cover more than just rubber. They have various elastomers that they can adhere to, and they got a solution for every environment.
Regardless of how stressful your environment is as a customer, whether your temperature issues, your salt spray corrosion challenges that you might have, the resistant tests, or the bond strengths that you have to achieve on your adhesion properties, they've got the chemistry to get that done. Some pictures that I think you're not going to be able to understand each one of these boxes, but at least you'll understand kind of where they're going. Just to orientate you in these pages, because they're somewhat all organized the same way. On the right-hand side will be examples of their technologies, color-coded, you can find that box as to where it is on the application. On here, there's 4 different types of products. The first three, again, focus on that noise, vibration, and harshness .
For a helicopter application, you're really trying to reduce the vibration in the helicopter fuselages that's generated by the main rotor as the helicopter is running. The bearings and dampers, mounts and isolators, vibration and torque monitoring are all part of that noise, vibration, and harshness technologies. The cockpit controls will be the levers that I mentioned earlier for the throttle, the flaps and slats, brake control, and the steering controls. They are clearly recognized as a pioneer in the aerospace and defense industry. If I switch it to 14, these are the same products that you saw before, but just on a fixed wing application. Maybe if I just make a couple comments about some of these.
If you take the mounts and isolators, that colored box, really what they're doing here is they're isolating vibration from the avionics, which as you can imagine, is an important thing. They're isolating vibration from the various equipment across the aircraft as well as the interiors for you and I to ride an aircraft and have a nice ride. Look at the picture around the engine mount. On the engine mount, they've got a variety of elastomeric solutions, Fluidlastic isolator technology. All these are trying to balance out vibration forces that are around the engine mount itself. Again, decade-long relationship here. Mission critical application. You can see how important these applications are. A lot of cases, without their technologies, the aircraft or the helicopter doesn't function the way it needs to function.
creates that kind of customer stickiness and that strong collaborative spirit that they've had with customers for a long time. Moving to an industrial picture for you on slide 15. This is obviously a cutaway of a wheel loader, and there's two technologies that we wanted to highlight here, the MR dampers, I'll explain that in a second, and the elastomer mounts. MR stands for magnetically responsive fluids. And what these are, these are unique fluids that instantly change viscosity in response to a magnetic field. In your car, some of you may have in your car a button that you can press that would change you from a sport ride to a comfort ride.
When you're doing that, you are activating a magnetic field around these fluids, and they have this special sauce inside these fluids, that's what makes it special, to change that viscosity and change the ride that you're going to experience. Doing the same thing here in an industrial application for the seat, for the cab, and the primary suspensions of this wheel loader. The elastomer mounts, you see them around the engine, the various equipment that's in the wheel loader, the cab itself. These mounts help attach critical equipment to the frame of the vehicle, as well as minimizing noise and vibration. Again, a wide spectrum of material science and bonding experience, all again creating high value and low risk for the customer. Slide 16, I want to move to this concept of light weighting.
light weighting is the phenomena of what's happening in the industry, both in automotive and in industrial applications, where adhesives, structural adhesives, are replacing mechanical fasteners. If you think about the advantages of that, when you replace a mechanical fastener, you're reducing weight, you're automatically improving fuel efficiency, you're improving the aesthetics, because you don't need to look at all the fasteners. You have better corrosion protection because you just have less metal, less opportunities to create corrosion opportunities. The new materials that are going into automobile construction or other industrial applications, which are pictures on the right-hand side, such as composites, aluminum, polymers, all require the use of these structural adhesives. On the bottom, you can see the various brand names. They have a wide spectrum of adhesives that go into body assembly, industrial assembly, drive corrosion protection.
Their real claim to fame is that reliability and that dimensional stability that they bring to the application. On slide 17, going into the electrification, which this example is of an automobile, but you could have put any vehicle in here, electrification of mobile equipment, electrification of heavy-duty transportation. I'm going to just walk you around the various cutaways here. Remember that the technologies that they're bringing in here is thermal management, adhesives, and coatings. Take a look at that charger box that you see there. What they're bringing is encapsulants and gap fillers. All this is a heat management equation. Do you have the technologies to manage heat flow in that application to improve the performance of electronics? On the inverter, that's the power electronics of the automobile, so you want thermal stability there. They provide the thermal management for that.
There's a lot more motors on an automobile without a combustible engine on there, so they provide the adhesives for the motor casings. That little copper circle you'll see underneath the motor is a winding for the motor. They're providing thermal management epoxies and silicone encapsulants that go into that winding, again, for thermal management. The battery itself has got adhesives for the top and bottom lid, and then gap fillers in there for thermal management. Again, key solutions that are absolutely needed for the success of electrification, whether it's on an automobile or some kind of industrial mobile piece of equipment. How does this all add up for total Parker? Slide 18. We used FY 2018 numbers, because those are finished numbers, to do these pie graphs. The main purpose I wanted to show you on this slide is that middle section, sales application by technology platform.
You can find underneath our current state filtration and engineered materials at 29% of the company. It grows to 34% of the company with this acquisition. Again, making our filtration and engineered materials technology platform the largest in the company. Asia Pacific grows because they have a little stronger concentration. The significance to portfolio is we're adding more content that is growing faster than market, with better margins and better resilience capabilities across the business cycle. Go to slide 19, talk about synergies. These are pre-tax, run rate synergies, and again, I would emphasize, these are cost synergies only. We did not justify the deal based on any revenue synergies. Revenue synergies are going to be addressed, but they will be upside to what we're telling you here. $125 million.
You can see the areas of synergies that we're going to go after on the right-hand side. We have a high degree of confidence in achieving this. The diligence that we did with the LORD team was significant. We had a chance to see a significant number of their facilities. We saw enough facilities to equal approximately 80% of their revenue, so that gives us a lot of confidence here. Our experience with CLARCOR on the track record of delivering those synergies, again, gives us confidence. We will approach this the same way we did before with a dedicated integration team and a dedicated leader. I would just tell you that there's less risk here because there's very few, underline the word few, plant closures as part of the synergy plan. On slide 20 is really the summary, the value proposition for our shareholders.
First, an EPS accretive within the first 12 months. An attractive ROIC, high single digits in year five, and we'll continue to expand upon it. Really attractive EBITDA margins at 23%, and tracking to that year to date for LORD. Remember that we're at 18.5%, so this is significantly higher than where we're at. When we combine both companies and we forecast the next five years, we're looking to grow total Parker's EBITDA by another 300 basis points by year five. Very compelling EBITDA expansion over the next five years. The synergy opportunity is significant but achievable, $125 million, with, in my view, less risk of execution because of a very few plant closure plan to make that happen.
This is a top quartile performer that we're bringing to the team with great technologies, material science, and innovation, and growing on those fast applications that I mentioned, aerospace, lightweighting, electrification. Hopefully those applications I gave you give you a feel for the power of LORD. We really think this is a compelling capital allocation, great deployment that's going to drive long-term shareholder value creation. We can do this all while keeping our dividend payout at that 30%-35%. We fully intend to keep increasing our dividends as we continue to grow the net income of this combined enterprise. You'll see us continue to grow dividends. Just in closing, before I open up to Q&A, this is an exciting day for both companies, and we're looking forward to LORD joining the team. Sonia, with that, I'll let you open up the Q&A.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from Joe Ritchie of Goldman Sachs. Your line is now open.
Thanks. Good morning, Tom and team.
Morning, Joe.
Maybe my first question, Tom, is can you just talk a little bit about the cyclicality of this business, and also the free cash flow profile?
The CFOA, I'm starting with that, is mid-teens, and the free cash flow would be very similar to ours, so it's a very attractive cash flow. When we look at it over the cycle, they grew through the last couple of recessions. They grew through the financial crisis. They grew through the 2015, 2016 recession, and in all these recessions, they held margins. This company, this is why we're so excited about it, has proven that they can grow through these good times and bad times and maintain their margins or expand them, obviously, during good times.
That's interesting. I guess my follow-on is when you think about the synergies of this business, the synergies are relatively high to the revenue component. If I think about well-run business already, EBITDA margins in the low 20s, I know that you've expressed some confidence in being able to achieve the synergies, but maybe dive in a little bit deeper on what gives you that confidence that there is a lot of opportunity.
First, we're going to sit down with the LORD team. These are synergies that we've identified at this point for us, but we clearly are going to sit down with them to go through the synergies in more detail. Because what we learned with the CLARCOR acquisition is involve the team together so that together you come up with a compelling synergy package. Obviously, at this point, we have to do it ourselves to help identify the deal. There are big opportunities when you look at WIN Strategy type of synergies. If you look at the basics of WIN Strategy, which are still the foundation of WIN Strategy from when it started early 2000s, around value pricing, strategic supply chain, lean. I would say relatively early days, if I compare where we are in a journey to where LORD is in a journey.
I think there's going to be simplification opportunities. That whole concept of simplification is a relatively new concept. Where that will show up, we'll be looking at the SG&A structure of both companies, primarily LORD itself. There's quite a bit of opportunities there. We think there's material synergies on the supply chain standpoint. While they're a very good operator with very good margins, we think there's lean opportunities. I think that would capture the bulk. There's obviously some corporate synergies that you have when you combine some of the corporate functions. It's going to be around a lot of organization design when you look at the value of what this is bringing. Anytime we've had things that had organization design, optimization is the key element to it. Those carry less risk because you're not smashing plants together and moving processes.
Because their technologies are different and complementary, we need those factories. We just think there's an SG&A structure around supporting those factories and the overhead structure outside of those factories that can be streamlined. We want to continue to invest in R&D like they have, because that's an important part of their success, and we'll continue to do that going forward. I feel good about it. When you look at this as a % of revenue, it would be close, a little bit higher than what we did with CLARCOR. We're at $160 million over $1.4 billion, it's around the same neck of the woods. Our team feels very good about this, and I would say the diligence that we did here was much more extensive, we feel much better at this point of the journey than we were at CLARCOR.
Thanks, Tom. I'll get back in queue.
Thanks, Joe.
Thank you. Our next question comes from Jamie Cook of Credit Suisse. Your line is now open.
Hi. Good morning. I guess just two questions. One, Tom, just your thoughts on the multiple for this transaction without synergies. Also even with synergies, four years, you know what I mean, to get the synergy seems like a long period of time, so wondering if there's any conservatism in that. I guess my last question, how you're sort of thinking about the automotive exposure, and I know you said this company grew throughout the cycle, but what they saw on the sort of auto side in OE versus aftermarket. Thanks.
Okay. Jamie, you're going to have to help me, because if I missed something there, but I'll start with the automotive. Regardless of what's happening with production, what is going to help drive their growth rates is the fact that electrification of vehicles and lightweighting of vehicles is at very early stages of implementation into the industry. That will continue to allow them to grow regardless, even if auto production becomes stagnant or declines, the % of automobiles that will become electrified is going to grow, and the % of automobiles that are going to have lightweighting opportunities are going to grow. They have grown through any kind of changes in the automobile production rate schedules because of that. Our total exposure now, when you put Lord as part of the team, will still be less than 7%.
Our strategy in automotive has always been to be in the factories, helping our customers make the vehicles, and to be very selective, in particular with material science technologies, to be on the automobile. This fits exactly what we've always said on that. We were already on the automobile today with our existing sealing and shielding. We're just adding to with this. Now on the multiples. We're buying a top quartile company. Top quartile growth rates, top quartile margins. When you do look at transaction comps for top quartile companies in the space that they're in, this is a top quartile multiple, and that's the headline multiple that we paid at approximately 15. With the synergized multiple, we get this down to a very manageable 9.9x. Now, we're still looking at a three-year type of integration plan here.
The difference here is that we have this stub year where we don't know when this is going to close. Sometime in FY 2020 it's going to close. Hence, that's why this might bleed into it. If it closed earlier in FY 2020, you could pull things earlier. It's still going to be a three-year march to get into the $125 million run rate. I'm not worried about that at all, and you all shouldn't be worried about that either. It's still a three-year integration plan. Jamie, did I miss something that you had?
No, you answered everything. I appreciate the color. Thank you.
Okay. All right.
Thank you. Our next question comes from Tim Thein of Citigroup. Your line is now open.
Hi. Thank you. Good morning. The first question is just on synergies. Historically, when you've done deals, you've been able to realize a good portion of the synergy capture from improving the pricing and optimizing the channel mix in terms of putting more sales through the Parker distribution base. I'm guessing that's different here. Maybe you can just talk a little bit about, specifically more on the channel mix in terms of the OE versus distribution, and does this present an opportunity in terms of leveraging your distributor base?
Hi, Tim. It's Tom. Yes, there is definitely an opportunity from a channel standpoint. In round numbers, they're about 2/3 direct, 1/3 through distribution. Let me just give you some color on their distribution network. It is a distribution network very similar to ours, where it's a focused distribution network where the LORD products are kind of the kingpin of products that goes into there. They're the key lead supplier for that distributor. This is a technical sale similar to ours, a lot of application support. It's that kind of engineering type of sell. They have a global footprint on distributors. When you look at their distributors versus our distributors, very low conflict. This is going to be very helpful as far as easy to manage channel conflict.
We can look at where appropriate, expanding the line card for our distributors and expanding the line card for the LORD distributors, which will obviously at close will all be Parker distributors. We see that as a big upside. We did not model any of that. All the revenue synergies are upside and really a contingency for any kind of execution risk. Now on the pricing side, I think one of the advantages that we have with almost anything that we buy is that we have, I think, one of the better value pricing systems, and you've heard us talk about this for years, about how we look at the value creation that we provide for our customers. We obviously have to be competitive. There's opportunities there as we look at putting our pricing system into LORD's thought process.
That's how I would summarize those two things.
Okay. That's helpful. Cathy, have you articulated a goal in terms of deleveraging? There was a question earlier on free cash flow, maybe just help us in terms of thinking about debt paydown and how the model has that kind of formulated. Thank you.
Sure, Tim. We intend to do all debt for this transaction. We will be borrowing bonds, term loan, and commercial paper. We want to keep it flexible so that we can do early retirement. With their strong cash flow on top of Parker's strong cash flow, we will soon be at a cash flow from operations of $2 billion a year. We have a model that shows we intend to pay down about $2 billion of debt in the first few years after this transaction. With the debt that we will borrow, we are assuming an average interest rate of about 3.6%, again, keep it short term. We will be at less than a 3x multiple at the time of transaction, we forecast that we can get back down to a 2x leverage within a three-year time period.
Tim, it's Tom, I want to just tag on. This is really just kind of a reminder to everybody on the phone. When we did CLARCOR, where Parker was at 14% EBITDA, we generated about $1.7 billion EBITDA. Today, when we put LORD and Parker together, we'll be between 18%-19% EBITDA and $2.9 billion of EBITDA. Our ability to digest deals is a lot more proficient. We can digest things at a much faster rate because our EBITDA margins and our total EBITDA dollars are higher. As I mentioned earlier, we're going to grow EBITDA margins 300 basis points over the next five years. We're going to continue to generate even more EBITDA, which will allow us to digest this.
Thanks a lot.
Thanks.
Thanks, Tim.
Thank you. Our next question comes from Ann Duignan at JPMorgan. Your line is now open.
Hi, good morning.
Good morning, Ann.
A lot of my questions have been answered, maybe just looking at the revenue CAGR, can you just talk a little bit about how sustainable that three-year CAGR is going forward? If there was anything unusual there, any big automotive wins, any big aerospace? Just anything to give us a sense of the go-forward revenue CAGR growth, please.
Ann, it's Tom. What we've modeled, obviously, the three-year CAGR is really strong. We modeled something very similar to what they've been doing the last 15 years. Their 15-year sales CAGR is 5.5%. When we did our DCF, and we did the model for looking at the returns for this company, this acquisition, we modeled it at 5.5%. I always feel good when we do things like that. We didn't put in something that was higher. We didn't use their current growth rates, which they've been doing a really nice job. We've used what they've historically proven to do. I think we have a good chance of beating that, but that was a conservative way to model it.
Okay, I appreciate that. Then a follow-up. Can you talk a little bit about who their competitors are and a little bit about the go-forward strategy from a sales perspective? I know you mentioned distribution, but on the OE side, will they lead the automotive piece? Just a little bit about your thoughts there.
Yeah, okay, Ann. It's Tom again. On competitors, I break them into kind of two. Their technology platforms. The adhesives and coatings would be a lot of names you're familiar with, DowDuPont , 3M, Henkel, H.B. Fuller, and a number of other competitors. On the whole noise, vibration, and harshness is Hutchinson, Freudenberg, Trelleborg, Moog, SKF, and a number of other companies. A very competitive field, but they've got nice positions in that competitive landscape. When we look at the revenue synergies, I talked about distribution. On the OEM list, if you look at their OEMs compared to ours, it's a hand in glove. It's the same list of customers. We have those relationships. Now we can leverage a stronger portfolio, which is what we've always tried to do, bring in a more compelling motion control value proposition to our customer.
We'll clearly be trying to do that. The fact that we, on most of these accounts, will have a larger sales presence in there, we'll be able to leverage that. Another big upside is their aerospace business, their industry exposure with their technologies being roughly 1/3 of their company. We can really help on the aftermarket side because we have a very well-renowned aftermarket organization. Our customer support operations is part of our aerospace group that we can have that team help leverage the aftermarket management and opportunities, taking our existing technologies that they manage today and adding in the lower technology. We see that as a big upside into the aerospace part of things.
Okay, great. Thank you. I appreciate the color. I'll get back in line.
Thanks, Ann.
Thank you. Our next question comes from John Inch of Gordon Haskett. Your line is now open.
Oh, thank you. Good morning, everyone.
Morning, John.
Morning, guys. I realize you present, as in Parker, your COGS and SGA a little bit differently. If you were to look at just pure SG&A to revenues, kind of on an apples to apples basis, how does LORD stand up versus Parker?
You're right. John, it's Tom. Things are counted slightly different, so there's an obvious opportunity. That's why when I described the synergies, there'll be a fair amount that will be in that SG&A arena. The sweet spot here is we obviously want to have the right kind of resources, the right kind of support, the right kind of technology development, the right kind of R&D, et cetera, the right kind of functional overhead structure done at the most efficient fashion. When we look at that comparison, there's an opportunity there.
Right. Tom, would it be fair to say they must be a lot higher? Because you're sort of talking 11%-12% margin improvement, I'm assuming mostly on LORD, where you're actually not touching much of the factory footprint. It's kind of becoming, I'm assuming mostly or very heavily out of SG&A. I know you mentioned supply chain as well, but is that a fair assumption?
No, it's not mostly. I wouldn't characterize it as mostly.
Okay.
When you go through the WIN Strategy synergies, when you look at lean pricing supply chain, you add in SG&A, it's fairly balanced. It's not equally weighted amongst all those. It's not far off. This is not going to get done all through the SG&A channel, but it's an opportunity.
The other question I had is, you and LORD, it's interesting, you have similar heritages. You're both a 100-year-old company. LORD's been growing at 5.5% CAGR for the past 15 years. Why are they a billion-dollar company, but Parker-Hannifin's a $14 billion company? What's held LORD back historically? Have they made big divestitures over time or what's been the holdback? How are you so much larger given your similar overlaps in technology and history and so forth?
Yeah, I think the difference is we've been much more inquisitive in acquiring companies. We've been acquiring companies within this space, and I would say 99% of the growth has been organic.
Got it. Great. Thank you.
Okay, thanks John.
Thank you. Our next question comes from Nicole DeBlase of Deutsche Bank. Your line is now open.
Thanks. Good morning.
Hi, Nicole.
I just want to go through maybe some of the inputs that we need to calculate accretion. When we think about the $125 million of synergies, what's the cadence of that, like year one versus year two versus year three? I assume cost to achieve is probably heavily weighted towards year one, but just not sure about the synergies. If we could also talk about the DNA at LORD. Amortization step up, I assume is excluded from the accretion numbers, tax rate, any other major variables you want to share. Hey, if you guys want to give us what you're coming up with for accretion in year one, that would be helpful too.
Okay. Small, but I'll try all of those, Nicole. We have built our model assuming a close as of October 1, 2019. In starting with the second quarter of our fiscal year 2020, we have modeled it as follows. We have synergies coming in in our fiscal year 2021 of savings of $45 million run rate in fiscal 2021, up to $100 million at the end of fiscal 2022, and reaching the $125 million at the end of 2023. The cost to achieve to get that in our fiscal year 2020, we're assuming $15 million of cost. In fiscal year 2021, we're assuming $40 million of cost, and in 2022, $25 million of cost, totaling $80 million. We tend to be conservative when we estimate amortization, so we probably have a high number, but we've built in $160 million a year in amortization.
We've assumed a tax rate of 23%. We have backed out the amortization in our accretion numbers, with backing it out and looking at a cash basis, we have modeled that in the first 12 months of ownership, we'll have $0.60 of EPS accretion on an adjusted basis.
Thanks, Cathy. That is super helpful. Then maybe just as a follow-up, I know we focus on the auto business a lot, could you guys possibly size today what % of that auto business is EV-driven versus traditional?
Nicole, it's Tom. For LORD today, their EV exposure is about 4% of their autos. That 1/3 of their pie that is automotive, about 4% of that is the EV. Any EV, HEV, as well as any other kind of electrification of other vehicles. That's a big upside. That is relatively early in the days, as that continues to grow, which it all will, the only question is how fast and at what rate, they're going to continue to be able to grow, as a result of that. Big upside.
Got it. Then just thinking about the past few quarters, obviously there's been some challenges with auto production. I know you guys have mentioned that their business has continued to grow through downturns. Could you give us a sense of how their auto business has been performing over the past few quarters in the face of weak global auto production? Then I'll pass it on.
Yeah, Nicole, it's Tom. I want to just clarify, my 4% is the 4% of their total sales, not just that 30% pie. 4% of their $1.1 billion. They've continued to grow. Their first quarter was low teens in growth, total company, and their automotive part of it has continued to grow. Again, remember you've got light weighting and electrification to continue to grow their growth rates. They've not been impacted.
Thank you.
Thank you. Our next question comes from Jeffrey Sprague of Vertical Research, and the line is now open.
Thank you. Good morning, everyone.
Good morning.
Obviously a couple questions around synergies, I think we're still kind of grappling with how to get our head around the magnitude of this number. If I think just about CLARCOR, you did make plant closures a big part of the construct, if you will. I'm wondering if just for context, could you remind us how much of the CLARCOR cost savings came from kind of physical footprint? Can you give us some idea, even if it's just directionally, how your filtration and engineered materials margins stack up versus LORD's margins today?
Let me start with on the margin side, Jeff, it's Tom. Margins are comparable. Our existing engineered materials business has comparable margins to LORD's margins. The reason why I'm a little sensitive on the details is that these impact people. We want all the teams to be involved in creating what the synergy looks like. You'll have to forgive me for not giving you the gory details here, because it's important that we do this collaboratively, we do it in a thoughtful fashion. When you look at the details behind the $125 million, it is fairly balanced. You get a fair amount that is corporate overhead and corporate SG&A. Those are the obvious things that you get when you combine two companies.
We typically always have expected, when you think about lean supply chain and those type of opportunities, to get several points of margin for each one of those initiatives. There's still opportunities from a pricing standpoint here. The SG&A, when you look at direct SG&A, corporate SG&A, R&D, there's a lot of efficiencies there that can happen. Total synergies as a percent are pretty comparable when you look at the total $160 million against a $1.4 billion deal for CLARCOR or a $125 against a $1.1 billion deal. When you do those ratios, they're pretty similar. I would say the only thing that you're kind of switching here, instead of more plant closure savings, you have more SG&A savings. That's probably the only key difference. Everything else is going to be very consistent.
Great. Thanks for that. I'll leave it there.
Okay. Thanks, Jeff.
Thank you. Our next question comes from Nigel Coe of Wolfe Research. Your line is now open.
Thanks, guys. Good morning.
Morning, Nigel.
Congratulations.
Thank you.
Yes, just wanted to take a step back first of all. You've mentioned you've had a 10-year relationship with LORD. Was this an auction? Was it negotiated privately? Just give some context in terms of how you came together and the timing of why LORD decided now as opposed to some other time.
Nigel, it's Tom. This has been really a long relationship because of our relationship on the people side. It's only really a recent phenomenon that their board decided to sell the company. The process was a competitive process. It was a select number of companies. We don't fully know how many, but it was a competitive process, and that ran through really the bulk of the last 90 days, and we were fortunate to come out as the winner here.
I think what LORD looked at is that once reaching $1 billion and their opportunity to continue to take the company to the next level, and the opportunity to take what they have with a bigger company that had more capabilities, system capabilities, broader breadth of technologies, deeper customer relationships, et cetera, that this was an opportunity, a milestone for them when they hit $1 billion to look at potentially doing something different with the company. That was a recent decision by their board, and we were fortunate to be part of that process.
Congratulations, Tom. Just want to dig into the free cash flow, the EBITDA to free cash conversion. I think you mentioned LORD has comparable margins to Parker, so roughly 9%-10%. Seems that they should be a little bit higher than that, so it suggests that the capital intensity is quite high and/or significant work capital investments. I'm just curious, what's driving that relatively low EBITDA conversion ratio, and what opportunities do you see to improve that?
Nigel, it's Tom again. They have about mid-teen CFOA, and their free cash flow, we're going to come in, I'm guessing somewhere around 11% this year. That's a top quartile free cash flow rate. They are a little more capital intensive because of the process technology, the material, the formulation technology that they do. Typically, this is an upside when we've looked at both on working capital and capital intensity, is when we look at any acquisitions as well as any of our own value streams. When we do Lean, we free up about 1/3 of the floor space, and we typically free up capacity as far as CapEx. I think a lot of you remember, if you look at Parker, when we first started Lean, we were around 6% CapEx to sales, and through Lean, drove it down to around 2%.
I don't think we'll get this down to 2%, because inherently they're going to have more process technology. We will be able to free up capital with our technologies. They run around 6% CapEx today, there's an opportunity to take that down. Again, I don't think they're going to get down to our 1.8%-2% that we've been at, but we'll be able to make improvements over time.
Okay, Tom. I'll leave it there. Thank you very much.
Thanks, Nigel.
Thank you. Our next question comes from Jeff Hammond of KeyBanc Capital Markets. Your line is now open.
Hey, good morning.
Morning, Jeff.
Just a quick one here. Can you give us a sense of what the mix is between the adhesives business and the vibration technologies, and if there's any margin profile difference between the two?
It's basically 50/50. The adhesives and coatings business and structural adhesives would be slightly higher margins than the noise, vibration, and harshness . Still both very attractive margins.
Okay. Is the auto margin profile much different than the overall company? Thanks.
It would be equal to or higher than the company average.
Great. Congrats.
Thank you, Jeff.
Thank you. Our next question comes from Josh Pokrzywinski of Morgan Stanley. Your line is now open.
Hi, good morning, guys, and congratulations.
Thanks, Josh.
We've covered a lot of ground already, just a couple cleanups here. I guess first, I'm sorry if I missed it, you said 1/3 distribution for LORD. How does that compare to the comparable business within Parker-Hannifin? I would imagine, probably a little bit higher, it seems like there's kind of naturally a lot of OE exposure here.
Yeah, Josh, it's Tom. You're right. We are probably around 20% distribution. Our engineering materials business is a more direct model. I view this as attractive. The fact that they have a little higher distribution content, being about a third, is a very attractive revenue synergy for us. Why we like this space so much is that it makes good margins, really good margins, both direct and through distribution.
Got it. Can we just take a step back on the R&D intensity here? I think some of the folks in the material science space, my mind comes to 3M first, clearly put a lot of R&D effort into the business. What has been the track record here of innovation or new product development that drives some of those new content wins?
Yeah. Josh, on their R&D, I'm going to use round numbers. They have approximately 8% of sales R&D. It's been a hallmark of the company. Their innovation track record, I would put up against anybody, that's just done a fantastic job. That being said, they probably count a little differently than we count. It's probably not a fair apples to apples looking at their 8% to our 3%, because I think they include some things that we probably would not have included in ours. I think there's an opportunity to still meet the spirit of the investment that we want to do, but probably do it a little more optimally.
Got it. That's helpful. Just one cleanup from me. I want to make sure I understood it right. Cathy, did you say $0.60 of year one accretion? Is that a full number or a run rate number? I think the pre-tax numbers that that works out to seem a bit high relative to my math, but I could be missing something.
Yeah, that is an all-in in the first 12 months. We did adjust out any one-time synergy costs and other one-time transaction fees, et cetera, inventory gross up, and we backed out amortization as well.
Got it. I guess the observation would be, LORD does call it 240, 250-ish of EBITDA, even including depreciation in there. It doesn't leave you with a lot of gap for the higher interest. I get there'll be some synergies, but it seems like there's a bit of a shortfall. We can always take it offline if there's something I'm missing.
Okay.
Thanks.
Thank you. Our next question comes from Andrew Obin of Bank of America. Your line is now open.
Yes, good morning.
Morning, Andrew.
Just a nice thing. Who did you benchmark LORD to when you sort of thought about where the margins end up? Which companies?
They've got a list of companies. I may not be able to find it quickly. They've got a number of adhesive peers and aerospace peers that they looked at when they did their benchmarking, and they were at the top quartile of that peer group. Adhesive peers would be the obvious suspects like 3M. They had other folks that they would have in the aerospace peers, and I can't seem to put my hands on it. You'd have H.B. Fuller, DowDuPont in the adhesive space. The aerospace space would have the normal suspects that you'd have under aerospace, Moog, SKF, et cetera. Even just compared to our peer group, our top quartile for diversified industrials is a 20% EBITDA, and they're at 23% right now in forecasting. Yeah, I'm looking at their peer right now.
They did diversified peers, which would be the people you'd think of, Eaton, Honeywell, ITW, 3M, us, and the adhesive peers that I mentioned. When you look at their growth rates, they're higher. When you look at their margins, they're higher. It's a nice comparison.
Right. I guess the question is, when you're all said and done with restructuring, you're saying that this business is going to be materially higher than 3M, Honeywell, and Moog?
It'll be clearly higher than Moog.
Well, fine. More like 3M, Honeywell. I'm thinking about those guys.
Yeah. When you put in our synergies on this business, you're going to see they will clearly be higher than them. Absolutely.
Got you. The second question, can you just give us a breakdown of automotive business, specifically how much of auto is China? Within China, if you could give us some visibility, how much of it are JVs versus Chinese OEs? Because I think this dynamic between JVs and OEs has been quite important for DowDuPont and 3M. Thank you.
Yeah. Andrew, I may have a hard time giving you quite that granularity. I would just tell you, 25% of their business is Asia Pacific. Probably the majority of that is related to their material science part of their company, the adhesives, the coatings, et cetera. Less tied to the noise, vibration, and harshness . They are clearly taking advantage of what's happening in China related to the movement to electrification, the need to have more electric vehicles, the emission issues that China has. They're not unduly exposed. They've got good balance around the world.
Has their China automotive business been growing because of the EV exposure?
Yeah, absolutely.
Wow. That's impressive. Thank you.
Yeah, go ahead. Thanks.
Okay. Thanks, Andrew.
Thank you. Our next question comes from Andrew Casey of Wells Fargo Securities. Your line is now open.
Thanks a lot.
Morning, Andy.
Good morning, everybody. Just a couple cleanups. First, in addition to the synergies, are you expecting any marginal return on sales benefit against that 5.5% CAGR to really hit the ROIC target? If so, what has their MROS been historically?
Andy, it's Tom. When we modeled this, we did not put in volume lift. We just put the synergies in there. That's, again, a contingency execution risk helping us going forward because obviously we will get some volume lift. Their historical MROS would be kind of in that mid-twenties.
Okay, thanks, Tom. This is a small item, on a couple of slides, you have a footnote at the bottom of the page that indicates a divestiture. Is that going to be completed by standalone LORD or combined entity post-acquisition? If it's post, what sort of impact will that be to the revenue line, that $1.1 billion?
Yeah, it's immaterial to the $1.1 billion, Andy, it's Tom. It's immaterial to that number. The LORD team is initiating that as we speak. It's something they've been looking at before this announcement. It will be virtually done by the time we take over. It is very, very small. It's only about $16 million of revenue. It's not in the $1.1 billion.
Okay. Thank you very much.
Okay. Thanks, Andy.
Thank you. Our next question comes from Joel Tiss of BMO Capital Markets. Your line is now open.
All right. Appreciate you guys staying on. I just had one quick one about 80/20. Is there anything, after this deal is done, as you look through your portfolio and their portfolio, anything that is going to start to come out that could enhance the overall returns and growth of the whole company through PLS and other metrics?
Joel, it's Tom. Clearly, the Parker Lean System, that's a big upside that we'll be working with the team on. As far as simplification and the 80/20 concept, I think that'll be a relatively new concept to the LORD team. I don't necessarily see a lot when we put because both product lines are fairly different. Maybe some opportunities here and there are very small in the thermal management area, but they're pretty much different. I think the opportunity will be applying the same kind of simplification processes that we've done with Legacy Parker to the new team, to the LORD team. You've seen the same kind of margin enhancements we've had when we've applied those technologies. That's part of our synergy plan.
Okay, awesome. Thank you very much.
Okay, thanks, Joel.
Thank you. Ladies and gentlemen, this does conclude our question and answer session. I would now like to turn the call back over to Cathy Suever for any closing remarks.
Okay, thank you, Sonia. I'd like to thank everybody for joining us today. Robin Davenport and Jeff Miller will be available throughout the day to take your calls if you have any further questions. Have a great day.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.