• Shares drop after acquisition of Pentair valves business
  • Purchase follows Emerson’s recent $5.2 billion in asset sales

Emerson Electric Co.’s $3.15 billion purchase of a valves business sparked the same reaction from investors as an asset sale earlier this month: a stock selloff.

The shares slumped the most among major U.S. industrial companies, after Emerson announced the acquisition from Pentair Plc. The decline was the biggest intraday drop since Aug. 2, when proceeds from Emerson’s sale of a network-power division came in at the low end of expectations.

The purchase of Pentair’s valves and controls unit deepens Emerson’s exposure to a fragmented industry that has slumped as the price of crude oil declined. Emerson is trying to revamp its portfolio under a June 2015 plan to cut costs and exit underperforming operations, which it announced after disappointing earnings growth.

“For Emerson, the deal looks troubling over the near term, with the oil-centric valves business still in decline,” Deane Dray, an analyst with RBC Capital Markets, said Friday in a note to clients. “Its addition does not advance Emerson’s reach in automation technologies, as opposed to a deal in robotics or discrete automation, for example.”

Emerson dropped 3.5 percent to $52.75 at 11:55 a.m. in New York, the biggest decline on the S&P 500 Industrials Index. Pentair fell 1.3 percent to $65.70.

‘Stronger Hand’

While acknowledging weak demand for valves and controls in the foreseeable future, Emerson Chief Executive Officer David Farr said the acquisition offers expansion at an attractive price. The Pentair unit -- which serves customers across the chemical, power, mining and oil and gas industries -- will complement Emerson’s existing valve business and lead to cost savings, he said.

“It really gives us a much stronger hand,” he said on a conference call late Thursday after the deal was announced. “We can take the best of each of our businesses and really have a strong growth opportunity.”

For a look at Emerson’s recent asset sales, click here.

The deal boosts Emerson’s share of the $105 billion process-automation market to 9 percent from 7 percent while almost doubling its piece of the $29 billion final-control industry to 13 percent, the company said.

Weak Economy

Emerson has faced headwinds this year from a sluggish global economy, causing the company to fall short of analysts’ fiscal third-quarter profit estimates and to lower its adjusted-earnings target for the year.

Its latest acquisition may lead to additional pressure on earnings. Sales in Pentair’s valves and controls business fell 23 percent last year to $1.8 billion as the price of oil declined.

The purchase “adds definitive risk to Emerson’s earnings over the next several years,” Buckingham Research Group analyst Joshua Pokrzywinski said in a note. Emerson is setting aggressive targets for the margin potential of the valves business, he said.

He cut the company’s rating to underperform from neutral and lowered his target price to $44 from $49. Credit Suisse downgraded Emerson to neutral from outperform while leaving its price target at $57. Stifel Financial Corp. maintained its buy rating but said shares would be under pressure because of the deal.

“Investors will be rightly cautious of this pitched ‘strategic deal’ at the wrong time of the cycle,” Stifel analyst Robert McCarthy said in a research note. He cited “the perception that Emerson has caught a falling knife in the same general end market where it struggled for the past two plus years.”

Pentair Debt

Pentair plans to use the proceeds to repay $1.5 billion in debt and fund acquisitions in areas such as water quality, filtration and equipment protection. All three remaining Pentair units have attractive opportunities to grow through acquisitions, CEO Randall Hogan said.

“We’ve been on the defensive a little bit now for a while because of our balance sheet,” Hogan said on a conference call Friday. “Now we can get back on the offensive.”

Share buybacks are also a possibility for Pentair, which has been a target of activist investor Nelson Peltz’s Trian Fund Management. Pentair bought the valves and controls unit in 2012, in an all-stock merger with the flow-control business of Tyco International Ltd.

‘Missed Opportunity’

Emerson said it expects to boost the operating profit margin in the final-control business to more than 18 percent on sales of $4.5 billion. The transaction, which is subject to regulatory approval, is expected to close in the next four to six months. Pentair’s valves and controls unit has almost 7,500 employees.

Emerson’s decision to buy the business “removes the possibility of a larger, transformational acquisition that could have reset” investors’ perceptions of the company, said Gautam Khanna, an analyst at Cowen & Co.

“The bull case of a big, better deal is now moot, and the thing they bought is in a cyclical downturn that will take time to reverse,” Khanna said by e-mail. “So it is viewed as a missed opportunity.”

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