Below, I'll argue that Honeywell could create lots of value by imitating DowDuPont with the right partner.
The splitting and off-spinning trend
Honeywell is often viewed as a supplier to the Aviation & Defense industry. However, it has also decent market shares in industries as distinct as energy, automotive, chemicals and industrial automation. Many investors don't like companies that lack focus. They prefer players that can fully leverage a certain trend.
Therefore, conglomerates are often punished with a lower valuation. It appears to be likely that Honeywell managers are elaborating a plan to change this situation by recombining its business units together with one or more partners.
Ideally, Honeywell finds a partner with activities in several of these business areas. The process would be somewhat easier, if it would be a North American group, but overseas options should not be discarded.
Even the traditionally hesitating Japanese are slowly opening to more innovative corporate transformation initiatives. The planned merging of personal computing businesses around Vaio comes first to my mind.
Besides, Mitsubishi Heavy Industries (OTCPK:MHVYF) has created several champions in recent years with partners, among them an offshore wind power company, a steelmaking equipment supplier and a Fossil Power Systems group, and several others.
Transatlantic deals of this kind can currently been studied with the General Electric (NYSE:GE)/Alstom (OTCPK:ALSMY) merger that led to the creation of Railway, Wind Power, Grid Solutions, and Fossil Power Generation champions.
Essentially, almost every technology group is working on streamlining its portfolio by focusing more on core competencies. Activist investors seem to be pressing for splits and spin-offs everywhere.
The fact that Honeywell has been in talks with UTC recently gives evidence that the management might be planning to restructure its conglomerate.
Will Honeywell stick to traditional portfolio management?
Currently, Honeywell is basically doing some empire building. In 2015 the group spent $8b for its expansion, most of it for M&A transactions: 3 of the deals are for Aero, 2 for ACS, and 3 for PMT. At the Q4-2015 earnings call CEO David M. Cote said that they are prepared to act when new opportunities arise.
Another type of opportunity would be to envision a DowDuDont type of deal, alternatively to spin-off its Aerospace & Defense business or to create some MHI-style joint venture champions with several partners.
Obviously, options are almost infinite. However, I would like to present some appealing deals that would in my opinion - if done right - benefit investors to a large extent.
Idea 1: Creating champions with Emerson
Emerson (NYSE:EMR) and Honeywell are two great American companies with much overlap. With a merge & split deal, they could create several champions:
- A building and climate technology group with Honeywell businesses like Buildings Controls, Consumer & Home, and Safety & Security as well as Emerson's Climate Technologies and Commercial & Residential segments
- An industrial automation group with Honeywell Industrial Process Control, Emerson Process Management ad Emerson Industrial Automation
- An energy management group with Honeywell's Energy and Smart Grid solutions as well as Emerson Network Power
All Emerson divisions would go into these new market leaders, each of which big enough to successfully compete in the global market on its own.
Competition authorities might have some minor objections, but in general, none of the three new combinations would be a dominant entity, since domestic and overseas competition is strong, as far as I can see.
Remaining Honeywell businesses would mainly include chemical, automotive, and aerospace & defense.
Idea 2: Do it with Eaton
Again, three focused businesses could be forged:
- Eaton's Electrical segment would be an excellent fit to Honeywell's Energy & Smart Grid solutions and Buildings Controls
- Eaton's Hydraulics and Vehicles segments together with Honeywell's Automotive & Transportation business would create a major automotive supplier, particularly for commercial and off-road vehicles
- Eaton's Aerospace segment would complement Honeywell's Aerospace & Defense activities
All activities of Eaton would go into these merged entities, which appear to be viable from a competition perspective. Honeywell's remaining businesses in this case would mainly consist of Chemicals, Consumer & Home, Industrial Process Control and Safety & Security.
Idea 3: Creating champions with Japanese partners
The MHI way is definitely an option for Honeywell to further improve the global market position of its business units.
Starting with Aero, we should take note of the ambitious Japanese aviation programme. The same MHI will launch a commercial airplane by 2017 and aims to take 50 % of the regional jet market.
The most advanced programs of Boeing and Airbus rely heavily on Japanese technology. Therefore, it might be a good idea to join forces with one of these aerospace suppliers. There are several interesting business units that could contribute a lot of complementary technology to a combined aerospace company, though it's difficult to decide what could be feasible.
Process Control could easily find a Japanese counterpart for a merged entity. E.g. together with Mitsubishi Electric (OTC:MIELF), it could forge a top 5 automation vendor. Additionally, Mitsubishi could contribute some of its Energy Management Assets.
Concerning Performance Materials, Japan has a lot to off, too. I would like to suggest Sumitomo Chemical (OTCPK:SOMMY) which has a similar market position with a complementary product portfolio. Together they could raise visibility for their innovative specialty products, share R&D efforts, and cover a broader range of applications.
The result of such transactions would be three or four focused companies that count among the leading industry players.
Currently, Honeywell appears to be a very well managed group of companies with profit margins that are superior to most of its peers. However, going forward there should be a strategy to further create value for all stakeholders. Organic growth is weak and might translate one day into margin erosion, too.
Forging focused industry leaders with one or more partners could be a great opportunity for Honeywell and I believe that there is a real possibility that the management will come up with something this year. Accordingly, there is much more upward potential than downside in my point of view.
Above, I proposed my favorite combinations. Let me know which are yours in the comments section.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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