Manitowoc-Enodis: Not a Poison Pill, But Not Good Strategy Either

Manitowoc (MTW) is primarily engaged in the manufacture and distribution of mobile and tower cranes used in construction and other lifting applications. It operates secondary businesses such as the manufacture and marketing of foodservice equipment, and the design and construction of marine vessels. On April 14, 2008 the company announced that its Board of Directors have agreed to acquire British foodservice equipment maker Enodis PLC for $2.1 billion, including the assumption of $200 million of Enodis debt.

This strategic move by MTW to expand a minority business segment allays fears of a classic poison pill defense. Sound preposterous? Read on, and you will find my reasons plausible.

Poison Pill Defense

When a company fears being taken over, or wants to fend off a hostile bid, it assumes a poison pill defense by undertaking an enormous amount of debt, or makes an acquisition that is not necessarily good for the company or its shareholders. To begin with, MTW made an all-cash offer (at a particularly weak point in the dollar, might I add) of 258 pence per share of Enodis or $1.9 billion. The acquisition is being financed by a consortium of investment banks that includes JP Morgan Chase (JPM), Deutsche Bank (DB), Morgan Stanley (MS), and BNP Paribas (BNPQY.PK).

According to Yahoo Finance, MTW's current cash position is $366 million with $231 million in debt of its own. MWT's operating cash flow is $238 million. Assuming a 7.5% cost of capital, post acquisition interest expense alone will decrease cash flow by $158 million, putting the company in a precarious situation during any industry downturn. While Moody's reaffirmed MTW's corporate debt rating as stable after the Enodis acquisition announcement, Standard & Poors placed the MTW unsecured debt rating on "credit watch with negative implications," implying an immediate risk of downgrade.

Never mind the rosy outlook presented by management on the acquisition and the synergistic benefits that the two companies expect to derive, I do not believe the Enodis acquisition is a compelling buy. The company trades at a high P/E multiple of 23, has much lower net margins, which averaged ~ 5% for 2005 and 2006, averaged ~ 10% revenue growth during the same period, and posted flat revenue and EPS growth in 2007 (compared to an average revenue growth rate of 28% that MTW reported for 2005 - 07). But perhaps my biggest reason for disliking the Enodis acquisition is based on the core competency of the Manitowoc Company.

Manitowoc and Textbook Strategy

After the company made the announcement that it was acquiring Enodis, MTW shares retracted ~ 18% from a recent high of $45. The market probably does not view the Enodis acquisition favorably. Leaving aside my fears (or call it a schizophrenic reaction if you must!) of a poison pill defense, I am in agreement with market sentiment that the Enodis acquisition intent is poor company strategy. I would like to see MTW consider strategic alternatives along their core competency in crane and construction equipment manufacturing and services as opposed to seeking to develop an unrelated horizontal strategy.

Do you think veteran business strategists such as Hamel & Prahalad (authors, Competing for the Future) would agree less? Another apparent motive to divest and grow secondary businesses may stem from a need to hedge against unsteady earnings in a cyclical market or during a construction industry downturn. But to be honest with President & CEO Tellock and MTW management, a move to expand an unrelated horizontal strategy from the company's core business and competency in cranes, no matter how promising it appears to be, is an uninspiring strategic play. In such a situation, I would favor being a cyclical company and choose to grow my business vertically, expand services, consider consolidation, or even a strategic merger within the construction equipment manufacturing sector.

An obvious name that comes to mind could be the global construction conglomerate Caterpillar (CAT), for whom a merger with Manitowoc could be "the missing piece in the jigsaw puzzle." CAT markets an immense portfolio of construction & mining, and power generation equipment. However, CAT does not carry cranes in its portfolio of products. I believe CAT can reap synergistic benefits from a strategic acquisition of MTW, easily integrate MTW products into its global manufacturing and distribution systems, and even augment its service offerings.

As an investor in the Manitowoc Company, I am definitely not hoping that someday the Board will spin off the entire foodservice business as a healthy dividend to the shareholders. We would rather like to see the company sell their minority foodservice business now, retire some debt, improve their cash flow,or maintain the pre-Enodis status quo. Those in agreement with my opinion include CNBC show Mad Money host Jim Cramer, who recently commented on his show that MTW should consider selling the foodservice business.

Forward Business for Cranes

If a strategic merger with CAT does not inspire MTW, I would like the MTW Board to consider the following: There are factors changing the dynamics of the construction industry today. Among them include the need to develop businesses in emergent markets such as India where growth alone in construction and infrastructure spending exceeds 40% YOY. I don't foresee any cessation of demand coming from India / China in the near term as a rising middle class in a combined 3 billion populace will continue to create a critical need for housing and modern public services such as roads, bridges, and airports. Compound this with a near double digit growth in GDP of these two economies alone and you have as much business as you can handle.

Furthermore, environmental performance standards promulgated by USEPA are creating emergent mobile crane product lines with low polluting diesel engines, starting a whole new product life cycle. Limitations to retrofitting in-use mobile crane engines with pollution control devices makes replacement with new equipment mostly the only alternative to stringent State requirements for limiting pollution from diesel powered construction equipment. The message here is MTW should focus their resources and energies into addressing the issue of servicing and producing an environmentally compliant portfolio of products.

Concluding Remarks

Two billion dollars is a lot of money for an unrelated horizontal strategic acquisition that offers marginal growth prospects at this point, and which MTW cannot afford. I urge MTW shareholders to take action by refuting the MTW Board of Directors' decision to acquire Enodis PLC, and taking the decision to a shareholder vote instead. President & CEO Tellock, did you slip a tablet in our coffee?

Disclosure: Author is long MTW.

Comments

[Damyata]

I'm long MTW as well, but I think you are missing a larger picture.

First, MTW already has substantial operations in the developing world, such as India and China. And they made $100M in CapEx in cranes business in 2007, so I'm not seeing any neglect of the lifting segment.

Second, global food services is a high-growth industry as well. Modernization in China and India also means more modern restaurants with better sanitation. MTW is exercising forethought. Cranes are hot right now, but food equipment will be hotter in five years.

Third, the price for Enodis seems high given Enodis' recent performance. But that's a classic buying situation. Buy the underperforming company to get it at a cheap price. They paid a pretty steep premium to the market closing price, but not necessarily to the value of Enodis' assets under more aggressive management. The currency is not a critical issue since Enodis' revenues were largely dollar-denominated, one reason that Enodis' recent performance on the London exchange has been in the toilet. So they paid with cheap dollars to get a dollar cash flow cheaply.

At the end of the day, why not trust the MTW management on this one? They've done a great job building the lifting business.

[loonsong]

I agree completely; look where refrigeration and sanitation will be critical in the immediate future. Mgmt knows what they are doing.
Also, look three yrs or five yrs down the road, not the day to day
blips.
loonsong

[BT310]

I agree that MTW was surely a fair-valued acquisition target by CAT and other Industrial giants looking for a pure(mostly) Crane addition. To hinder future cash flow on an acquisition that won't substantially improve the bottom line is beyond me. I am long, however I expected better judgement by management to increase shareholder value.

[I Hop]

OK but what about MTWs' case for the food service business?

[Kamal Ahuja]

Hi, this is the author. As a reply to the comment posted by Damyata, I'd like to reply that this article in no way undermines the foodservice sector. It may be a terrific sector to invest in. This article is about two issues; developing core competencies (which I believe is in cranes for MTW), and the means of financing the acquisition by undertaking ~ 10X present debt level. And again, I am not challenging Enodis valuation.

[Damyata]

If you're not undermining food service, then what is the problem exactly? Companies can have, and frequently do have, core competencies in more than one business. The problem that companies run into is when they let a particular business line sprawl so that they are trying to do too many different things at once. Like Microsoft.

But there are tons of industrials that effectively manage many different businesses at once. Ingersoll-Rand is just one example. Walter Industries. Cummins.

[ACapitalist]

The problem is most investors own this company for the Crane biz. They just complicated the picture and the market has voted. The food service biz may be great but MTW is not a conglomerate in the market's view. They are a Crane company. The market did not care much about the food service biz. Now they have too.

[tczlq]

I have only recently come to watch MTW and its acquisition of Enodis. I agree with the author that it was a bad idea to do this acquisition.
Food service is a low return and low growth business. The acquisition will lower MTW’s future ROIC, and therefore, lower its value. While I won’t debate the validity of the prediction that “food equipment will be hotter in five years” (it might very well be true), I question how much benefit MTW (with its acquisition of Enodis) can derive from this presumed trend. Restaurant equipment is a “low tech” business in the world of machinery. It is easy entry, highly fragmented, and highly competitive (therefore, its low ROIC). I really do not see any long-term value being generated here.
It makes more sense for MTW to shed its food equipment business entirely.
Of course, it will be a different story, if MTW is truly trying to make its company less attractive to discourage acquisitions (i.e. being acquired). MTW management had run a successful operation so far… why would they make such a bad judgment in acquiring Enodis? Maybe there is really something going on (they have been approached?)….

[sixdelta]

It seems management is not in touch with what is going on. It appears that they are just lucky to be in the right business and the current success is due to circumstances beyond their control. After their thoughtless stock dilution a few months ago, now this I see them as a short term investment on the way down and not a long term as I had once thought. Burned once, (sold half) burned twice, a third time ain't gonna happen.