GE-Honeywell: How Jack Stumbled
The first whiff of trouble came on Feb. 26. Shareholders of Honeywell International Inc. (HON ) were expecting General Electric Co. (GE ) to wrap up its huge buyout of the limping conglomerate, finally rescuing Honeywell from further decline. Instead, Mario Monti, one of Europe's most powerful regulators and the same one who had torpedoed such deals as the MCI WorldCom-Sprint merger, delivered a stunning blow. Following a contentious meeting with GE Chief Executive John F. Welch in Brussels, Monti said the European Commission would delay the merger for up to four months to review whether the deal would give GE unfair competitive advantages. Two weeks later, GE threatened to bail out of the merger if the commission forced it to divest businesses that would prevent GE from supplying planes from the cockpit to tail. Though the EC has sometimes backed off from tough stances in the past, so far, Monti is hanging tough.
So much for the swift conclusion that Welch confidently predicted just after he swooped in to grab Honeywell. From the get-go, the deal was all about speed, having come together in just four hectic days. As rival United Technologies Corp. was preparing to announce a $40 billion bid for Honeywell, Welch snatched the prize away by offering $45 billion. Announcing the agreement Oct. 23, Welch said he could finish the deal by the end of February.
Now, with the European Commission preparing to deliver a list of objections within weeks followed by hearings, both companies face a messy--and costly--delay. While investors and high-ranking aerospace executives still predict that Welch will land this final jewel, they say that Honeywell's value diminishes each day the deal lingers. "It slows down momentum, particularly to the extent that Honeywell hangs out there rotting away on the vine," says Goldman, Sachs & Co. analyst Martin A. Sankey. A GE spokesman, Gary Sheffer, says GE is "disappointed, but not surprised," by the delay.
Since the merger announcement, Honeywell's performance has continued to slide. After repeatedly downgrading expectations, the company still surprised analysts when it reported 10% lower operating earnings of $569 million for the fourth quarter. For all of 2000, earnings growth--initially forecast by the company at 20%--stalled out at 5.5%. And without a $380 million boost from pension fund income, growth would have been close to zero.
The downturn in industrial markets would have slammed Honeywell anyway. But the company has been in limbo since last June, when management became focused on closing a sale. Unable to buy new businesses or sell laggards, Honeywell has seen marked erosion of its old-line auto-parts and chemicals businesses. Several key managers have left or are said to be looking for jobs. And the sale of several underperforming lines, including brake products and some specialty chemicals, with revenues totaling some $4 billion, was halted after the merger announcement. "They're completely stopped," says Paul H. Nisbet, president of JSA Research Inc., an aerospace consulting firm in Newport, R.I.
Even Honeywell's strongest units are feeling the pinch. The vaunted aerospace operation, which generated a robust 22% profit margin last year and is the real lure for GE, was built in part through acquisitions. But with the deal stalled, it can't easily bid for anything. Honeywell's factory automation and control unit managed to eke out a slight sales gain in the fourth quarter, but only because of a previous acquisition of Pittway Corp., notes Nisbet. Without that, sales actually fell 12% as manufacturers cut back on spending.
Rotting away? "That's nonsense," snaps Honeywell Chairman and CEO Michael R. Bonsignore, adding that a "22% aerospace operating margin certainly doesn't sound like rotting away." He and other top Honeywell execs note that Welch has labeled two-thirds of Honeywell's businesses as "beachfront property." Sheffer maintains the company is still excited about Honeywell's prospects and is confident the deal will be approved. "The payoff is spectacular: We are paying 8% of our market value for a company that will produce 16% of our earnings," he says.
MISSION IMPOSSIBLE? To be sure, turmoil comes with any big merger. But Honeywell was already stumbling when GE pounced. In December, 1999, Honeywell was acquired by AlliedSignal Inc., which owned a mishmash of mature businesses and was running out of steam. Bonsignore took command, but critics, including some Honeywell directors, say he failed to marry the warring cultures of the two companies. Last spring, Bonsignore concluded that a merger with United Technologies offered the "best strategic partner." Then Welch jumped in.
GE boosters say that the savvy conglomerate can boost Honeywell's sagging businesses by combining them with its own high performers. GE's $7.8 billion plastics business, for instance, is twice the size of Honeywell's. And while both got hit hard in the fourth-quarter downturn, GE's unit still cranked out a 21% increase in profit despite a meek 2% rise in revenues. But as the economy tanks, the resuscitation effort will get harder. Given the purchase price, Honeywell would have to generate average profit margins of nearly 30% to make the economics work--more than doubling margins in such laggards as plastics, chemicals, and transportation products, says analyst Brian K. Langenberg of First Union Securities Inc. GE says no one has studied Honeywell as closely as it has and it remains bullish on the opportunities.
Nobody is saying GE can't goose performance, but to do so will take massive cost cuts. Indeed, Welch continues to ramp up estimates of the costs he can squeeze out. These were initially predicted at $1.5 billion, but GE on Mar. 13 bragged it can whack $3 billion out of the combined company's annual costs. However, that amounts to 100% of Honeywell's overhead for 2000, says George W. Tall, portfolio manager at Boston's David L. Babson & Co. "You can't just turn out the lights all in one year. This is a complex organization with 100,000-plus people," Tall cautions.
In retrospect, Welch was way too bullish on his prediction that GE could win fast approval of the deal. The companies overlap in 90% of their business lines, but Welch argued that there is virtually no duplication of specific products. U.S. government sources say that the Justice Dept. is looking very closely at the deal. It's clear, though, that the toughest opposition will come in Europe.
MISSED CUE. Antitrust lawyers say Welch should have been tipped off by the EC's earlier concerns about the Honeywell-AlliedSignal combination. Worried about that company's ability to leverage its dominance in aircraft ground-proximity warning systems, regulators required that it make the gear available to aviation competitors. That should have told Welch he couldn't avoid a second-stage EC antitrust review, the lawyers say. Philippe Camus, co-CEO of EADS, parent company of Airbus Industrie, said that such extended reviews almost always produce one of two outcomes: "Either they disagree," effectively killing the deal, "or they ask for some disinvestment."
In a Washington visit in late March to coordinate with Justice officials, Monti made it clear he will ask for some disinvestment. The EC will hold a final vote in July. But no one expects GE will let things drag on that long. On Mar. 13, GE President Jeffrey R. Immelt floated a trial balloon, saying GE will walk away from the deal if regulators insist on aerospace divestitures that substantially alter the merger. But bailing out would be difficult, say several GE investors. GE has its managers deep into Honeywell, making decisions on everything from hiring to accounting matters.
When Welch announced the deal last fall and said he would delay his long-anticipated retirement to see it through, analysts assumed that he wanted to go out with one last hurrah. But one longtime Honeywell adviser predicts the deal could instead go down as Welch's Waterloo. "Although we all deify Jack, this was a very bad move," he says. Worse, though, are the implications for Honeywell if the deal falls through. "They'll just take it up to a place in the Bronx and chop-shop it," says Prudential Securities Inc. analyst Nicholas P. Heymann. Without a quick resolution, the parts look cheaper by the day.
By Pamela L. Moore in New York, with Bill Echikson in Brussels, Dan Carney in Washington, and Jeff Green in Detroit