Industrials

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

Capital allocation is one of a CEO's most fundamental responsibilities but -- as Warren Buffett complained almost 30 years ago -- most leaders don't know how to do it properly.

After a wobbly start, Siemens AG CEO Joe Kaeser is beginning to demonstrate he can. He just needs to temper a taste for acquisitions that is expensive as his monogrammed shirts.

His latest move to reshape the German engineering giant's sprawling portfolio came on Monday with the $4.5 billion acquisition of Mentor Graphics, a maker of software used in designing computer chips and circuit boards.

Future Factory
Siemens' digital factory, which includes industrial software, is one of the company's most profitable units
Source: Siemens
Data refer to fiscal 2016 margins

You can see why Kaeser would want to expand Siemens' software operation: profit margins in Siemens' digital factory were almost double the average of its traditional industrial activities in the most recent three-month period. But those returns are luring others to take an interest in the business -- firms like General Electric Co. and International Business Machines Corp.

Turbulent Year
Mentor Graphics' shares plunged last year but they made up that ground before Siemens pounced
Source: Bloomberg

Mentor is therefore no steal. A year ago, its shares were floundering following a profit warning. In September, activist investor Elliott Management Corp. disclosed it had built a stake, helping the stock to rebound 66 percent this year.

With the benefit of hindsight, it looks like Siemens moved too slowly. The company is paying 3.6 times Mentor's revenue, more than the 3.2 times seen in similar recent deals, according to data compiled by Bloomberg. 

Mentor's sales fell last year as the semiconductor industry was swept by massive consolidation. Revenue is expected to grow only 3 percent this year, according to analysts surveyed by Bloomberg. That's a pretty anemic rate of growth for a software company -- although Siemens believes the worst is over for companies supplying the chip sector.

It says the deal will create 100 million euros of annual synergies within four years. UBS Group AG estimates those have a present value of about 1 billion euros. There are reasons to be skeptical that all those synergies -- equivalent to almost 50 percent of Mentor's current operating profit -- will be achieved. About half are revenue synergies, which are typically harder to achieve than cost reductions, and it won't be easy for Siemens to cross-sell Mentor's software to its industrial clients.

Kaeser is no stranger to richly priced deals. Shortly after he become CEO in 2013, he paid $7.6 billion -- 28 times trailing operating profit -- for oilfield equipment maker Dresser-Rand. That looked unfortunately generous when oil prices collapsed soon after.

Since then, it's been harder to fault Kaeser's re-positioning of Siemens' portfolio -- he's sold the hearing aids business and lined up the the healthcare division for a public listing. He's also merged the wind-turbine business with Spain's Gamesa Corp., giving Siemens (whose expertise lies in offshore wind farms) a relatively capital-efficient way to tap demand for turbines on land.

Back on Form
Under CEO Joe Kaeser, Siemens shares have climbed to almost the highest in 16 years
Source: Bloomberg

While it's still early days, Kaeser's tinkering appears to be bearing fruit. After stagnating for several years, revenue is growing again and the shares are close to their highest in 16 years. They now trade at about 14 times estimated earnings, more than the five-year average of 12.4, according to Bloomberg data.

To maintain that trajectory, Kaeser will need to convince investors he can allocate capital profitably, and that will require him to temper his willingness to pay top dollar for deals.

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

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

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net