Spin-offs are en vogue, and it certainly seems like nearly every large cap industrial conglomerate has had a discussion on breaking up their businesses over the past year. General Electric (GE), United Technologies (UTX), Honeywell (HON)... all three have seen significant pressure from Wall Street analysts and activist hedge funds to create shareholder value, with spin-offs or divestitures often at the top of the list. Conspicuously absent from all of these musings from the buy side and the sell side has been everyone’s favorite post-it note manufacturer: 3M Company (MMM). 3M Corporation dodging all of this is just a simple reality of past performance: investors will willingly forgive a mish mash of businesses if the stock price is moving in the right direction. Given the company’s long-term track record on annualized total return basis, shareholders that have been in the name for some time are content to sit back and ride the waves. To them, this blip is nothing. That comes through in its reputation as a “buy and hold forever” stock here on Seeking Alpha.
However, shares are now down 13% year to date and have fallen more than 20% from highs earlier in the year; material underperformance versus the S&P 500. If this continues through December, this will be a highly unusual occurrence. Excluding 2008, the last time 3M Corporation posted double digit annual losses was 1998. Before that, the last time that occurred was all the way back in 1979! Investors have gotten very used to easy alpha, a situation that can cause aggressive blowback if the good times start to fade.
Guidance for 2018 was not particularly impressive – nor was the 2016 to 2020 plan released during the 2016 Investor Day. Unless management has absolutely low-balled its outlook, a repeat of market-beating returns has to be predicated upon further trading multiple expansion - unless management can pull a rabbit out of its hat (material acquisition). Given that reality, more and more professionals are now starting to question if the multiple expansion that has taken place in the firm in recent years is justified. For perspective, current sell side expectations are for $9,471mm in EBITDA this year. 14x likely 2018 EBITDA is a high price to pay for a business growing revenue in the low single digits, no matter how recession resistant it might be perceived to be.
Breaking Up A Giant
While not necessarily a call I will get behind this early in the juncture, it won’t be long until investors start to hear rumblings on the Street if underperformance continues. The sale of the Communications Markets division to Corning (GLW), alongside other major divestitures such as the identity management and tolling businesses in 2017, have raised nearly $2,000mm in proceeds in under eighteen months. 3M Corporation CEO Inge Thulin is at least receptive to the idea of trimming and pruning the portfolio of the giant – there might be some appetite for more major action if share prices break down. Given the age of many of these businesses, 3M Corporation is likely to run into the same problems General Electric has: low tax basis. Outright sales in some of the older divisions are off the table, making tax-free spin-offs a likely result absent a unique deal structure (GE Transportation combination with Wabtec (WAB)).
3M Corporation has all the makings of a successful spin-off story in my opinion. Any one of its divisions is large enough to stand on its own, but the company will not have to go that far. In my view, the natural way to do this would be to split 3M Corporation “low tech” and “high tech” lines. By and large, the problem segments for growth have been the Industrial and Consumer segments, both of which are reliant on tapes, adhesives, abrasive, and woven products. These are the products that built 3M Corporation into the company it is today, but there is not a lot of technological advancement going on here and the businesses are more capital intensive than the rest. Since 2015, these divisions together have only grown their top line by 4.6% and GAAP operating income contribution has actually been down. This is despite a broad-based global economic recovery (recent European issues notwithstanding) and a revitalization of consumer health, all of which should have been strong tailwinds to these businesses. This weakness has carried over into 2018: just incrementally above 2% local currency growth year over year in the first quarter.
Meanwhile, standout segment Safety and Graphics has posted massive margin expansion over the same timeframe – a similar story has taken place in Electronics and Energy. In Q1 2018, Safety and Graphics comped 21% year over year growth in operating income; Electronics and Energy 31%. These have been the savior segments that have kept 3M Corporation share prices from falling off the proverbial cliff. And while Health Care results have stagnated somewhat, investors continue to be willing to pay high multiples for medical and surgical supply companies. Even as a stagnant business, those assets would trade at a higher EV/EBITDA multiple than 3M Corporation does on a consolidated basis.
Taking it further, much of 3M Corporation’s value falls within these three sets of operations. While there are carryover benefits from the more traditional products made in Consumer and Industrial into products like optical film solutions and commercial graphics systems, a split along these lines should carry little in the way of costs from loss of manufacturing expertise. Like many conglomerates, 3M Corporation tries to run these businesses as silo-d entities, giving leadership as much autonomy as possible. But I think there is a case to be made that separated, with their own independent executive leadership that sets capital policy, that these businesses could do better independently.
Does 3M Corporation need to spin off some of its businesses? No, I don’t quite think we are there yet. This is more of a thought piece on where 3M Corporation could be headed down the line if it can’t begin to post broad-based improvement across all of its business lines. Time and again, spin-offs have been proven in research to create immense shareholder value, boosting share prices in both the immediate and medium term after completion. If 3M Corporation continues to lag, expect activist investors to jump in and encourage the company to at least explore the potential opportunity.
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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.