Illinois Tool Works: Why a Private Equity Buyout Doesn't Make Sense

An analyst put out a note last week regarding Illinois Tool Works (ITW) being a private equity target. On a superficial level, this would make sense as Illinois Tool Works provides a nice steady cash flow, the business is pretty solid and the stock's not expensive. But if one pokes deeper, ITW would be a difficult private-equity buyout.

The private equity game-plan normally goes like this: find a company with a solid balance sheet that throws off tons of cash, buy the company, pocket the cash, leverage up the company with debt, sell off some of the assets, streamline the business and finally, flip it onto the equity markets or some other buyer. Does this sound easy? Heck no! And it'd be a lot harder with ITW.

ITW is a decentralized collection of over 750 businesses, each largely self-operating. The majority of these businesses are pretty small. Please see the report if you want more specifics, but in a nutshell, the decentralized business model and their philosophy of buying mostly small businesses would make it hard for private equity on a couple of fronts.

First, it would be very difficult to streamline segments. If a segment is a collection of, say 50 businesses (ITW doesn't break out their segments in much detail), then a new owner trying to streamline operations has to get buy-in at 50 different businesses. If they wanted to sell that segment, the prospective buyer would face the same issue.

Trying to dismantle ITW would be an intensive undertaking as I'm not even sure the current CEO is aware of all of the individual businesses comprising the enterprise. The Wilsonart or Signode operations may be attractive to prospective buyers, but what's going to attract the end buyers when private equity wants out? The corporate culture may also present problems with anyone looking to slash and burn.

And finally, the valuation isn't that cheap (that's why we don't own it, duh!). It's not expensive either, but any buyer will have to pay a premium and have less room for error.

Nevertheless, the stock jumped 5% or so on the rumor and will probably get taken out, because who says Wall Street has to make sense? There's probably lower-hanging fruit left for private equity to pick over, though so I wouldn't include a buyout as part of the investment story.

ITW 1-yr chart

Disclosure: Author has no position in this stock.