The $20 Billion Takeover Target That Wasn't
Good things come in small(er) packages for ABB Ltd.
The Swiss maker of circuit breakers and industrial robots on Tuesday announced it was buying Bernecker & Rainer Industrie-Elektronik GmbH to help it catch up to rival Siemens AG in automation and associated software. It's ABB's biggest takeover in five years with a reported cost of close to $2 billion, but the company reportedly also considered a much bigger, $20 billion-plus prize: Rockwell Automation Inc. Minor difference.
A Rockwell deal would make some sense for ABB strategically. There's a reason Rockwell's been the subject of takeover speculation for years: In the words of one analyst, it's "one damn good industrial automation business." Its software, sensors and monitoring equipment have only become more valuable as a growing number of industrial companies bet on data-driven efficiency and proactive maintenance as the sector's next growth driver. But B&R was likely still the better choice right now. That's not a great sign for Rockwell deal watchers.
For one, the Austrian company does many of the same things as Rockwell, just on a smaller scale. The deal offers a way to fill in missing puzzle pieces in ABB's own automation portfolio, specifically programmable logic controllers, industrial PCs and servo motion-based technology. A deal for Rockwell would be more like buying another whole puzzle -- and a very big, expensive one at that. Rockwell's historically been on the pricey side, but that's even more true lately:
ABB intended for its B&R offer to be in line with Rockwell's valuation. Indeed, its purported $2 billion proposal works out to around 3 times the Austrian company's more than $600 million in revenue in fiscal 2016. That ABB paid that much for B&R is itself a head-scratcher, considering many analysts think Rockwell's valuation has gotten way ahead of itself and B&R isn’t as well run. William Blair & Co. analyst Nick Heymann notes the company has Ebit margins of about 12 percent versus 20 percent at Rockwell. But doing a deal in line with Rockwell's current valuation is very different than adding a premium on top of that.
For what it's worth, Gabelli & Co. analyst Justin Bergner recently downgraded Rockwell's stock to sell because it had blown past his 2018 estimate of what the company could rightly command in a takeover ($150 a share). But logic tends to go out the window when you're dealing with scarcity value in one of the hottest areas in the industrial sector. Rockwell is one of the few large pure-play automation companies and any bid for the company would almost surely spark a counteroffer from the likes of General Electric Co., Honeywell International Inc., Emerson Electric Co., Schneider Electric SE or Siemens. A deal would easily rank among the most expensive industrial takeovers of its size.
Before the B&R announcement, Bloomberg Intelligence estimated ABB had about $9.9 billion in debt capacity, in addition to about $5.6 billion of cash on its balance sheet. If it used a hefty chunk of that to cover a cash portion of a Rockwell deal at, say, a 40 percent premium (about $220 a share), it would still have to come up with more than $1 billion of synergies to make the deal meaningfully accretive in the short term, according to data compiled by Bloomberg. Doable in theory, perhaps. But the challenging thing with Rockwell is that because it's already so well-run, buyers don't have many avenues to improve it. Rockwell already has one of the highest returns on invested capital among North American automation peers and strong operating margins. It's more of a growth play, which is riskier.
So where does ABB's wandering eye leave Rockwell?
To justify a meaningfully higher stand-alone price, Sanford C. Bernstein & Co. analyst Steve Winoker says you have to believe organic growth will accelerate beyond the 5 percent high end of Rockwell's 2017 projections in subsequent years and that Congress will successfully reform the corporate tax system in just the right way (i.e. cash repatriation, but no border-adjustment tax, which would actually hurt the company as a net importer). Or you need a deal -- and that looks unlikely any time soon.
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