Deals

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

Nortek just announced it's getting taken over, but investors are wagering another bidder might swoop in with a better offer. United Technologies should give the people what they want.

Back to the Future
Nortek soared past its takeover price, but it isn't much more expensive than when UTX looked at buying it in August 2015.
Source: Bloomberg

The industrial conglomerate led by CEO Greg Hayes was reportedly in talks to buy Nortek -- a maker of ventilation fans and air-conditioning systems -- back in August. Now, Nortek is selling itself for $2.8 billion including debt to Melrose Industries, the investment company known for buying down-on-their-luck targets and sprucing them up. No doubt Hayes noticed that Melrose soared almost 50 percent on the news. He'd do well to crash the party.

The idea of  United Technologies doing some kind of acquisition has been a topic of conversation since Hayes took the top post in 2014. Initially, he was in the driver's seat, ready to pull out the big guns for a growth-juicing deal and even approaching Honeywell CEO Dave Cote about a mega-merger. But repeated cuts to the company's earnings guidance, the rollout of a costly new jet engine and a slowdown in China weakened Hayes' hand and he soon found himself on the receiving end of Cote's advances.

Little To Cheer About
United Technologies has declined over the past year, while its would-be mega-merger partner Honeywell has climbed.
Source: Bloomberg

Having successfully rebuffed Honeywell's $100 billion-plus takeover bid, Hayes seems to have developed a certain queasiness for big deals, and that's fine. Big purchases are risky and distracting; done wrong, a deal could deepen the growth and margin challenges United Technologies is already wrestling with internally. But Hayes is going to have to give investors something to help reinvigorate sales and boost United Technologies' slumping stock price.

Restarting the Engine
Sales growth has stalled at United Technologies over the past few years, with only modest expansion projected for 2016
Source: Bloomberg

The divestiture of the Sikorsky helicopter business (announced last summer and completed in November) was a smart move for United Technologies, but it looks like small ball compared to the larger reshufflings being undertaken at Danaher, General Electric and Johnson Controls. And it was a while ago at this point. United Technologies shares are down about 8 percent in the last year, compared with a more than 4 percent climb for the broader S&P 500 Industrials Index. The conglomerate is valued at about 9.5 times its projected Ebitda this year -- compared with 18 times at General Electric and 11 times at Honeywell.

Nortek could be just what it needs. The company fits within United Technologies' targeted deal range of $1 billion to $2 billion. It also meshes well with the company's strategic goals of expanding in security systems and filling holes in its HVAC business, particularly on the air handling equipment side. And Hayes could avoid the "pricey" valuations he's bemoaned are prevalent in building-controls M&A.

Bidding wars aren't known for their bargains. But before Melrose entered the picture, Nortek had slumped about 16 percent from where it was when United Technologies was looking at a deal last year -- meaning the industrial giant may not end up paying that much of a richer pricetag than it would have initially. The $50 million breakup fee associated with the Melrose deal means a counterbidder would need to offer $89.11 a share at minimum, estimates Jefferies analyst Philip Ng. Considering that a 30 percent premium to Nortek's average trading price last August would have equated to almost $100 a share, that doesn't look too bad.

Even at $100 a share, United Technologies would be paying just over 1 times Nortek's projected revenue for 2016, a discount to the median for major industrial purchases of the last five years.

Yet while Nortek hasn't gotten all that more expensive, its business has gotten better. Revenue growth for the three-month period ended April 2 was the fastest on a quarterly basis since 2014. Adjusted Ebitda -- removing certain items such as interest and tax expenses -- is on track to swell to the highest annual level since Nortek emerged from bankruptcy, thanks in part to restructuring efforts targeting as much as $60 million in savings.

How Do You Like Me Now?
Melrose Industries soared after announcing it would buy Nortek.
Source: Bloomberg
Intraday times are displayed in ET.

Melrose thinks it can wring out more value by upgrading Nortek's supply chain and IT systems, reducing its interest expenses and lowering overly high administrative costs. United Technologies could follow that same playbook and reap even more savings by incorporating Nortek into its existing industrial infrastructure.

Your move, Mr. Hayes.

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