* Deal success not priced in: We think the current price for Zodiac is factoring in a 50/50 chance of a deal with Safran going through, while we continue to believe it is likely that a revised deal can be reached. We upgrade Zodiac to Outperform and change our target price to EUR27.5 per share to align it with our scenario analysis of a potential revised offer.
* Earnings revisions: We have tried to assess the three factors that have triggered Zodiac's 10th profit warning (on March 14). Part of it is probably non-recurring and nearly solved (A350 lavatories). The Seats UK issue is likely to be more persistent. The lack of rebound in the bizjet / helicopter markets requires a rebasing of expectations. As a result, we have cut organic growth in Aircraft Interiors and reduced the operating margin to account for the latest disappointment. We cut 2017/18E operating income by -26% (in line with new guidance) and reduce 2019/20E by -6% (still c.20% above consensus), with a 13.7% operating margin.
* A revised offer appears the most probable outcome: We believe that both companies still want a deal to happen. We think that 1/ Zodiac's controlling shareholders will lower their expectations enough to reflect the
unexpected deterioration of the business and satisfy Safran and 2/ that Safran will seek a price cut and new conditions which will meet Zodiac's shareholders expectations while securing enough guarantees to reassure some of its own shareholders.
* Valuation: Based on the issues discovered on March 14th, our scenario analysis indicates a potential revised offer price of EUR27.5 per share (vs EUR29.47 for the current offer). Our grey sky scenario would take the valuation to EUR18. At the current level, the market is effectively pricing in a 50/50 chance of a deal being found. We find this an attractive risk / reward and we upgrade the stock to Outperform (vs Neutral). We continue to rate Safran Neutral, as its shares are roughly in line with our TP of EUR70.