Has Industrial Breakup Fever Gone Too Far?
(Bloomberg Opinion) -- As one industrial conglomerate contemplates a breakup, another is doubling down on diversity.
It was a mini merger Monday in the manufacturing world. Parker-Hannifin Corp. announced it’s buying closely held adhesives and coatings maker Lord Corp. for $3.675 billion in a deal that CEO Tom Williams says will “meaningfully transform” the company’s portfolio. Ingersoll-Rand Plc is moving in the opposite direction: it’s reportedly exploring a combination of its industrial unit with Gardner Denver Holdings Inc. The deal would separate a business whose products are as varied as power tools and golf carts from the climate-controls division that makes up the bulk of its sales and profit. Ingersoll-Rand earlier this year agreed to buy Precision Flow Systems for $1.45 billion, a move I interpreted as paving the way to a breakup and an addition to the industrial unit that likely makes the math easier for the Gardner Denver transaction, which is said to be structured as a tax-efficient Reverse Morris Trust.
Over the past few years, we’ve seen a rush of breakups among industrial conglomerates as investors question the logic of binding businesses with disparate markets, profitability and growth prospects together. Generally speaking, I think these splits make sense and I’ve advocated for a fair number of them myself. Companies’ valuations tend to be only as good as their weakest link, and management teams tend to operate better when they’re focused on one business, rather than distractedly trying to manage a mishmash of trends and spending exorbitant amounts of time on conference calls addressing the perceived problem-child units. Also, investors have the ability to pick and choose individual stocks and create the diversity of a conglomerate in their own portfolios. But lately I’ve been thinking more about the trade-offs – namely, that an economic downturn may leave these recently slimmed-down companies looking naked.
Investors love to hate cyclical or odd-fitting units when they drag down otherwise robust results, but those same divisions can also act as a shield when the hot businesses aren’t running so hot. In the case of Ingersoll-Rand, the breakup will leave the company focused almost exclusively on heating, ventilation and air conditioning. That’s not necessarily a bad thing: That business has higher margins than the industrial arm and is growing faster (for now). And Ingersoll-Rand seemingly won’t leave any misfits stranded behind that it has to deal with down the road, avoiding a headache that weighed on Johnson Controls International Plc, Eaton Corp. and Danaher Corp. following their breakups. Lennox International Inc. is an HVAC pure play and its stock held up relatively well during the financial crisis even amid a steep drop-off in its sales. Speculation of consolidation has also been growing ever since United Technologies Corp. announced it would break itself in three and make its Carrier building-controls division a stand-alone company. An Ingersoll-Rand that’s free of its legacy industrial-products operations would be more capable of participating in any HVAC-related M&A.
You’d almost need some kind of deal to make this breakup really pay off. RBC analyst Deane Dray and Stephens Inc. analyst Rob McCarthy estimate a breakup could push Ingersoll-Rand shares up by 6 percent or 15 percent, respectively – a healthy gain, but hardly a game-changer in the risk-reward equation. There’s also merit to a deal like Parker-Hannifin’s, where the company buys, rather than spins, its way to a stronger financial profile. Parker had only just paid down the debt it took on to buy filtration company Clarcor Inc. in 2017 for $4.3 billion, but management has been vocal about its interest in more M&A. Lord will increase Parker’s exposure to the faster-growing and more profitable materials science market at a time when organic sales and orders are slowing for its industrial arm.
The cry for breakups and M&A moves on a pendulum and I’m starting to wonder if this latest divestiture push has gone a step too far. Clearly, takeovers have their risks, too, and there are more failures than knockout successes. But it may also be that a few years from now, investors look back and wish there’d been a few more deals in the Parker vein and a few less Ingersoll-Rand-style splits.
The deal structure allows companies to dispose of units in a more tax-efficient way than a straight asset sale but requires the two businesses to be of roughly equal size.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
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