Emerson Veers Off Course

It just expanded in a business that's been giving it headaches. Great.
As of 4:15 PM EDT
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Just when you thought things at Emerson were getting back on track, it goes and makes another questionable purchase.  

The maker of automation and processing technology announced late Thursday that it's buying Pentair's valves and controls business for $3.15 billion. On Friday, the stock slumped as much as 4.8 percent for the worst performance among industrial stocks in the S&P 500.

You're Doing What?

Emerson's acquisition of Pentair's valves business left investors with a bad taste.

Source: Bloomberg

Intraday times are displayed in ET.

Investors' disappointment is understandable when you consider that the unit Emerson is buying gets a large chunk of its revenue from the oil and gas industry -- you can guess how that's worked out lately. Actually. it looks kind of similar to how Emerson itself has been doing.

Downward Slope

Sales have fallen at Pentair's valves business amid the slump in oil prices. Emerson felt the same pain.

Source: Bloomberg

Emerson's fiscal year ends in September, while Pentair's follows the calendar year.

Emerson's outsized exposure to the energy sector via its business that sells processing tools and software to oil and gas producers has left it harder hit than most multi-industrial peers by the commodities downturn. There had been some hope among investors that Emerson might use acquisitions to increase its exposure to less-volatile industries like packaged food, or build out its small presence in discrete automation (the equipment and software for assembly lines). Instead, it's asking investors to buckle up for what risks being a continued wild ride.

The Pentair acquisition will likely be dilutive to 2017 earnings, with Emerson CEO Dave Farr saying things are still "very challenging" for the companies' combined businesses. As to the future? We'll see. Emerson says it expects the purchase will be cash accretive in 2018.

Even if you think Emerson is buying pretty close to the bottom of the cycle, it's not necessarily paying bargain prices. Pentair's valves and controls business is largely composed of assets it acquired via a $4.9 billion deal (including debt) with Tyco International in 2012. That price worked out to less than 1.5 times the business's revenue in fiscal 2011. Emerson, meanwhile, is paying about 1.8 times the revenue Pentair's valves unit generated in 2015 and 1.9 times its projected sales for this year. It's not a perfect comparison because not all of the units Pentair bought from Tyco went to its valves business, but Emerson is also paying a slight premium to the multiple that compressor and pump maker Gardner Denver received in its 2013 private equity buyout.

Paying Up

Emerson's purchase of Pentair is reasonably priced and looks more expensive given the trough results. But it's not dirt cheap.

Source: Bloomberg

Emerson multiples reflect the valuation relative to Pentair's 2016 projected Ebitda and sales. Gardner Denver numbers are trailing 12-month.

From the perspective of Pentair's shareholders, it's not a great referendum on the logic of the Tyco flow-control transaction to be cashing out a mere four years later. But CEO Randall Hogan deserves some credit for realizing it wasn't working and taking advantage of an opportunity to cut and run.

It wasn't a total failure. Pentair did get a handy foreign address and lower tax rate out of the exchange. And now it's got some cash flow to put to work on the water and electrical component parts of its business, which have better growth prospects in the near term. Pentair's stock fell less than 1 percent on Friday.

This transaction could end up working out for Emerson, but the pressure is on Farr to prove it. He doesn't have the luxury of a long leash. His last big foray into M&A -- the $1.5 billion purchase of Chloride in 2010 -- has largely been a giant whiff that Emerson has only JUST managed to distance itself from. Emerson had to take a $508 million charge on the deal in 2014, Farr took a cut to his bonus because of it and the company eventually gave up on the problem-ridden network power division that included the Chloride assets. It agreed just weeks ago to sell it for $4 billion to Platinum Equity and other investors.'

When Emerson first floated plans to cut loose the network power unit last year, Farr admitted  that creating it in the first place had "not been one of my better approaches in life, and I wouldn’t say I would put that on my tombstone to say that was a strong accomplishment.”  

Shareholders can only hope he'll have better things to say about his latest deal. 

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

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