Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

The days of being a steady-as-she-goes industrial company are over. Eaton Corp. appears to be one company that hasn't gotten the message yet.

The $24 billion maker of lighting gear and truck parts has been relatively quiet on the deal front since its purchase of Cooper Industries in 2012. Its lack of action is becoming increasingly noticeable as its peers transform themselves by bulking up or breaking up (or a combination of both) in an effort to revive slackening revenue growth and improve profitability.

Building Blocks
U.S. industrial acquirers announced almost $100 billion of takeovers in 2015 -- a record.
Source: Bloomberg

U.S. industrial companies spent almost $100 billion on takeovers in 2015 and announced more than half that in asset sales. Many are being rewarded for doing so: General Electric and Danaher -- which both announced big breakups and takeovers in the past few years -- are some of the best performers among investment-grade multi-industrial companies. Eaton, on the other hand, handed shareholders one of the group's worst returns for the year. After a more than 20 percent slump, it's trading near its lowest multiple of sales since December 2012 -- around the time it closed the Cooper transaction. 

Falling Behind
Eaton was one of the worst performers among multi-industrial peers.
Source: Bloomberg
Non-U.S. companies' stock performance is calculated using U.S.-traded shares. Siemens performance is based on its German traded shares.

The company's valuation has been dragged down by the division that makes parts for cars and trucks. It's not a bad business (especially when truck sales are rising) and can be quite profitable. But manufacturing vehicle parts is a more volatile business than, say, lighting gear because it's more sensitive to swings in the economy and requires higher fixed costs. That's kept Eaton from trading more in line with its diversified industrial peers.

Investors have been teased with the prospect of a divestiture of the vehicle parts operations for years, especially after the purchase of Cooper -- a maker of industrial circuit breakers and LED lighting -- shifted Eaton's focus more toward electrical products. In 2013, the company weighed selling a chunk of its auto business, while keeping the part that supplies truck makers. Speculation bubbled up about a spinoff of the whole division in 2014 after Eaton settled an antitrust suit over its dealings in the truck transmissions market. But then CEO Sandy Cutler quashed any hopes of that, saying on a July 2014 call that the company would be hit with a big tax bill if it tried to spin off any business before the five-year anniversary of the Cooper deal (an inversion transaction that moved Eaton's domicile to Ireland for tax benefits.)

There may be ways to get around the five-year waiting period if you're crafty, says tax consultant Robert Willens. Take Pfizer and Allergan: The drugmakers are combining in a record $160 billion deal and plan to make a decision on whether to spin off Pfizer's established products business (and likely some Allergan assets) by the end of 2018 -- only two years after their merger is set to be completed.

Regardless, there's not that much time left in Eaton's five-year holding period. As of the end of 2017, there's nothing holding the company back from a spinoff. It takes a while to get spinoffs organized and completed (sometimes as long as 18 months), so the clock is starting to tick. And of course, Eaton could sell the business at any time if it got an attractive enough offer. 

Another option -- and possibly a better one -- would be to structure a deal focused on its lighting business, arguably its crown jewel.  Separating that unit from the company's more cyclical operations could be a simpler and more effective way to boost shareholder value, said Bloomberg Intelligence's Joel Levington. Because most of Eaton's lighting unit came from Cooper, that's an easier spinoff to do tax-wise, said Willens.

The idea of splitting off lighting into its own stand-alone business makes sense when you look at a company like Acuity Brands. Essentially a pure-play manufacturer of lighting gear, Acuity surged almost 70 percent last year, making it the best performer among top multi-industrial companies. Acuity's $10 billion enterprise value is about 23 times its Ebitda over the last year. That's a higher multiple than Google parent Alphabet.  

If Eaton wanted to strengthen the lighting business ahead of a spinoff,  it could consider acquiring Hubbell, a $6 billion maker of electrical products that's been speculated as a possible target for the company or GE. If a takeover is done in a tax-free way (all-stock), a spinoff of the combined business should be tax-free as well, Willens said. Eaton has indicated it prefers buybacks to M&A, but a combination with Hubbell could be very attractive. 

Eaton CEO Cutler is stepping down in May so the chances of him making a big move right now are slim. His successor will need to make some decisions on dealmaking. Good thing he's got options.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net