Industrials

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

If there's one key lesson from activist investor Cevian's battle with ABB it's this: trying to force a merely mediocre company to change is much harder than a bona fide basket case.

The Swiss conglomerate's strategy update on Tuesday didn't deliver the fireworks Cevian had hoped.

The low-margin power grids division, which accounts for about a third of ABB's revenues, won't be spun off.

ABB's shares are up 28 percent year to date thanks to a much better cashflow performance. The stock trades at a premium -- 19.3 times estimated earnings versus a peer average of 17.5 -- so Chief Executive Ulrich Spiesshofer probably felt he had sufficient cover to keep the conglomerate structure intact.

Sales Stagnation
Flat revenues haven't helped ABB's case to keep its conglomerate structure
Source: Bloomberg
Nb 2016-2018 are the Bloomberg consensus estimate

Still, it's questionable whether all of that premium is warranted: ABB continues to target 3-6 percent revenue growth but hasn't grown anywhere near that amount lately.

So it's important that shareholders, who've enjoyed a free ride from Cevian's efforts to pressure management to boost performance, now hold Spiesshofer to his promise to boost the grid division's profitability.

Activist Pressure
Cevian has pushed ABB to boost performance but the operating environment remains tough
Source: Bloomberg
nb. Cevian's stake became public in June 2015

If he can't, then either he or the grid division should find a new home.

ABB's capital markets presentation was full of shareholder-friendly promises to "unlock value." A 30 percent increase in cost savings and a new $3 billion share buyback program are welcome.  

But the company didn't offer much of an explanation about why it's the best owner of the power grids business, other than that its four divisions benefit from sales collaboration and common research and supply chain management.

Hardly Electrifying
Profits at ABB's Power Grids lag behind the conglomorate's other units, but the division won't be spun off
Source: Bloomberg

ABB hired McKinsey to evaluate its options but the consultancy's usual prescription that "spin-offs typically lead to significant improvements in operating margins for both parents and spun-off businesses" seems to have been ignored in this case.

It's conceivable that ABB will be successful in lifting the grid unit's Ebita margin to as much as 14 percent from 2018 compared to a less-than-satisfactory 7.5 percent last year. Project execution has been improved, and the ongoing switch from a centralized fossil fuel power system to decentralized renewable one should provide growth opportunities.

But in the long term, ABB's grid business will be challenged by Chinese competition. Greater management focus and less complexity as a stand-alone company might aid that fight, though a bigger company might offer a better defensive position. Either way, this will be a big test for Spiesshofer's decision. 

For its part, Cevian almost certainly overplayed its hand in pushing for a break-up of Switzerland's most important industrial conglomerate.

Its calculation that a split would help lift value per share from 22 Swiss francs to as much as 35 Swiss francs involves some pretty optimistic earnings assumptions. Morgan Stanley described the touted 28 billion Swiss francs ($28.6 billion) in value creation as "unrealistic."

Even so, Europe's cozy corporate governance could benefit from a more assertive shareholder base.

Spiesshofer is well paid,  but there's nothing in his contract that says he's required to sleep soundly at night.  

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

  1. The quotation is from the sixth edition of McKinsey's Valuation text book.

  2. Spiesshofer was granted 9.1 million Swiss francs in compensation last year.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net