Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Emerson Electric Co.'s plan to direct its M&A dollars toward software fits with the times. Even so, it's going to test investors' patience.  

The $38 billion maker of food-waste disposers and industrial automation technology is reportedly in talks to buy software company Paradigm Ltd., the latest example of an old-school manufacturer looking to stay competitive by increasing its digital prowess. 

It's one of the few things industrial companies have been willing to spend money on these days as they await details of Brexit and the outcome of proposed tax and healthcare reform in the U.S. The push to increase industrial productivity by arming equipment with sensors and data analytics needs no regulatory clarity, after all. Of the roughly 840 deals industrial acquirers in North America and Western Europe have undertaken this year, nearly 20 percent have had some kind of technical or electrical bent, according to data compiled by Bloomberg. That's a higher percentage than the same periods over the past five years. 

iBuy
Industrial dealmaking is slowing down, but of the transactions that are happening, technology-related purchases make up a growing percentage
Source: Bloomberg
Data for past years reflects deal counts over the period equal to that which has already passed in 2017.

But this digital push hasn't always gone over smoothly with traditional shareholders in manufacturing companies, who are unaccustomed to the richer multiples software makers require and less tolerable of earnings pain while companies try to make these bets pay off. As we've seen with Ford Motor Co. and General Electric Co., it's a lot harder to spend for the future when your industrial roots are in trouble. Emerson risks getting caught in the same dilemma.

Paradigm specializes in seismic data interpretation and imaging equipment to help oil and gas companies know where to drill. The logic of such a deal seems sound and will help Emerson stay competitive as GE merges its oil and gas business and industrial software expertise with Baker Hughes Inc. You can't really do something in oil and not talk about software these days. But investors haven't been so sure that being big in oil and gas is really the right move for Emerson to begin with.

Seeking a Rebound
Estimates for Emerson's 2018 earnings have improved lately, but that's dependent on a sustained recovery in oil prices
Source: Bloomberg

Demand from North American oil and gas companies was a primary driver behind the 8 percent increase in orders Emerson reported last week for the three months ended in May. But look at the decline in oil prices in June. As Stifel Financial Corp. analyst Rob McCarthy notes, those strong trailing numbers may be behind the times as an indicator of activity. A lack of a sustained recovery in oil and gas markets could pressure his earnings estimates. And Emerson is even more exposed to swings in crude after agreeing last summer to buy Pentair Plc's valves and controls business for $3.2 billion.

That purchase disappointed some holders who had been hoping the company would instead minimize its energy exposure by investing in less-volatile industries like packaged food or building out its discrete automation offerings. Emerson CEO Dave Farr argued he was buying close to the bottom of the demand slump and priming the company to capitalize on a recovery that would make the deal seem less expensive than it might have appeared. (About that: at a conference earlier this month hosted by The Deal, Pentair CEO Randall Hogan didn't object when Jim Cramer suggested his firm got the better end of that transaction.) 

Hunting for a Good Deal
While Emerson has outperformed Pentair since agreeing to purchase the company's valves and controls business, it has trailed a basket of industrial peers.
Source: Bloomberg

The reported price tag for Paradigm is $1.5 billion. It's hard to judge how reasonable that is because Paradigm is owned by private equity firms Apax Partners and JMI Equity and doesn't publish financial statements. But those firms bought Paradigm for about $1 billion in 2012. The premium for anything software-related has certainly gone up, but the outlook for oil prices was decidedly more optimistic back then.

With the $1.5 billion price soaking up a hefty chunk of the M&A capacity Emerson has earmarked for the next three years, investors are going to be counting on an ultimate payoff from a Paradigm transaction. They're already jittery about the valves and controls deal, having overreacted to a lack of detail on the earnings impact when Emerson last reported results. Betting big again on the oil and gas industry -- even in software -- will only further ramp up the pressure on Farr to prove he knows what he's doing.

 

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

  1. Emerson later said the acquisition will reduce earnings by about 5 cents this year, in line with its initial forecast of "slightly dilutive."

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