Pentair Sets a Breakup Blueprint
Welcome to the breakup club, Pentair Plc.
The $12.5 billion industrial company announced on Tuesday that it was splitting into two parts: one that provides fluid-processing and water-filtration technologies, and another that sells protective enclosures for electrical equipment, among other things.
The value proposition is clear: neither business has much to do with the other. Pentair probably got a helpful push from activist investor Trian Fund Management, which became its second-largest holder in 2015 and garnered a board seat. It's the latest in a long line of industrial splits, putting an even bigger spotlight on those conglomerates that could use some whittling down. Honeywell International Inc., freshly targeted by Third Point, General Electric Co., United Technologies Corp. and Eaton Corp. could all go in this group.
At Pentair, the move was set in motion by the sale of its valves-and-controls unit to Emerson Electric Co. That deal rid the company of a business that had been plagued by the downward spiral in energy prices. It closed less than two weeks ago, but while Emerson is still trying to figure out which way is up on the acquisition (much to investors' chagrin), Pentair is wasting no time carrying out its master simplification plan.
Before Tuesday's news, Pentair shares had climbed less than 3 percent since Trian disclosed its stake, well short of the gains reaped by the S&P 500 Industrial Index. A breakup should help it close some of that gap.
Pentair's filtration and fluid-processing operations are good, growing businesses and make up the bulk of its revenue, but the company currently trades at a discount to more focused flow-control equipment providers such as Mueller Water Products Inc., or Xylem Inc., itself the product of a successful spinoff from ITT Inc. RBC analyst Deane Dray, who correctly predicted a spinoff of Pentair's electrical business, uses a sum-of-the-parts analysis to arrive at his price target of $77 -- about 17 percent more than where the company was trading as of Monday. (Pentair rose as much as 4.5 percent in early trading Tuesday.)
Dray has also in the past suggested a Reverse Morris Trust combination of the electrical part of Pentair with Hubbell Inc., a merger that's still possible and could create even more value for Pentair holders. The electrical business is expected to have a tax residency similar to Pentair's current Irish domicile, with a spin-off set to be completed by the second quarter of 2018.
Spinoffs don't always work, but in the industrial sector, they often tend to create more value than expected, argues Barclays Plc analyst Scott Davis. It's hard to estimate what a properly incentivized and more focused management team can do to margins and earnings once freed from conglomerate bureaucracy. Davis also argues that the rising dominance of exchange-traded funds has shifted active portfolio managers' focus to smaller-sized companies with growth stories -- i.e. not a big giant industrial behemoth. Bottom line is it's getting harder for companies to argue that they're stronger with a bundle of disparate businesses.
I'm not convinced the aerospace spinoff Third Point is pushing at Honeywell is a great idea, in part because the company has the operational chops to improve the business without such a drastic move. But Honeywell could stand to part with some other businesses, such as turbochargers. Even after all of GE's divestitures, there's still plenty of speculation over the next piece to be carved out. 1 United Technologies still has to prove that climate controls need to be sold alongside jet engines. And it's about time Eaton gives investors the spinoff of its vehicle business they’ve been eyeing for years.
This is the first big industrial breakup announcement of the year, but it won't be the last.
The leading favorites are a more distinct split from the oil and gas business that's set to merge with Baker Hughes Inc., a spin-off of the health-care unit or less likely a divestiture the locomotive division.
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