Timken Investors Backing Split Seen Reaping 29%: Real M&ABrooke Sutherland
Ralph Whitworth’s proposal to break up Timken Co. helped boost shares of the ball-bearings maker 26 percent in five months. With the stock still trading at a discount to peers, shareholders stand to more than double that gain by voting in favor of his plan in May.
Timken’s shares have climbed to $51.99 since Whitworth’s Relational Investors LLC and the California State Teachers’ Retirement System called for a spinoff of the steel business in November. That still makes Timken cheaper relative to profit than any of its industrial peers, according to data compiled by Bloomberg. The $5 billion company’s units are worth $70 a share when valued separately, according to SunTrust Banks Inc.
“I have a fair amount of confidence that this actually will happen,” Jason Detzi, an analyst at Philadelphia-based Penn Capital Management Co., which oversees $7.7 billion, including Timken shares, said in a telephone interview. “When you look at the merits of the proposed spinout, we think it makes a lot of sense.”
Timken’s rise since November beat the 15 percent advance for industrial stocks in the Standard & Poor’s MidCap 400 Index, a sign of support for Whitworth’s proposal. On average, analysts and investors project a breakup could extend Timken’s gains by another 29 percent. Whitworth said that none of the “dozens” of Timken shareholders he’s spoken with say the spinoff is a bad idea. The activist said he could try to oust directors and run a competing board slate if his proposal fails.
Relational and the California retirement fund known as Calstrs disclosed stakes in Timken in a Nov. 28 filing. Calstrs, the second-biggest U.S. public pension, submitted a proposal to be voted on at Timken’s annual meeting May 7 that recommends hiring an investment bank to spin off the steel business into a separate publicly traded entity.
In calling for a split, Relational and Calstrs -- with a combined stake of 7.3 percent in Timken as of this week -- said the company’s two businesses don’t fit, and their “widely divergent business characteristics” have left Timken trading at a discount to peers. One unit produces anti-friction bearings and power-transmission components, while the other produces alloy steel used in vehicle chassis and engines as well as steel forging bars and seamless tubes for oil and gas drill bits.
“These are incongruent assets inside a single business,” Whitworth said yesterday in a phone interview. “It will always have a conglomerate discount. One part of it is industrials and one part is metals. They are not even followed by the same analysts.”
Even after the company’s stock gains, Timken trades at almost 13 times this year’s estimated earnings, lower than any of the 12 companies it describes as its peers in the steel industry and the bearings and power-transmission group, according to data compiled by Bloomberg. The median of the group, which includes Carpenter Technology Corp., SKF AB and Nucor Corp., is about 16, the data show.
James Griffith, Timken’s president and chief executive officer, said he first met with Relational last May and reviewed the firm’s breakup analysis before the board concluded that it wasn’t in the company’s best interests. Management has instead advocated a plan to boost shareholder value that includes bolstering margins, repurchasing shares and making acquisitions.
Relational’s action “doesn’t change our analysis,” Griffith said in a phone interview yesterday. “We are confident that our plan will create more shareholder value.”
Timken’s shares have surged 26 percent since the November filing by Relational and Calstrs, exceeding the gain of the S&P MidCap Industrials Index. At least some of the rise can be attributed to the activist’s involvement, said Stephen Volkmann, a New York-based analyst at Jefferies Group LLC.
Today, Timken shares fell 1 percent to $51.49.
Analysts and investors reckon Timken would be valued at $67 a share if the company were split, based on the average of four estimates ranging from $65 to $70 a share. Whitworth and Calstrs said in a presentation filed with regulators this week that Timken could be worth about $68 a share, a 31 percent increase from yesterday’s close.
The steel business, which is more volatile and faces greater competitive threats, “creates a distraction” that drags down Timken’s overall valuation, said Michael Willemse, an analyst at Toronto-based Taylor Asset Management Inc., who estimates Timken could be worth $65 a share based on the sum of its parts.
“Investors are not putting an appropriate valuation on the core business,” Willemse, whose firm oversees about $900 million including Timken shares, said in a phone interview. “Relational and Calstrs have made pretty convincing arguments.”
The chance to boost the company’s languishing valuation will likely lure enough support for Whitworth’s proposal to make it a reality, according to shareholders Penn Capital and James Investment Research Inc. Penn Capital owned a 0.3 percent stake in Timken as of Dec. 31, while James Investment had a 0.4 percent stake as of March 31, data compiled by Bloomberg show.
“Shareholders will say, ‘This is what we want, it’s a much better value to us,’ and ultimately I think that’s what the company will have to listen to,” David James, director of research at Alpha, Ohio-based James Investment, which oversees more than $4 billion including Timken shares, said in a phone interview.
Still, even without a spinoff, Timken shares are poised to rise to $63.13 in the next 12 months, a 21 percent gain, according to the average of analysts’ estimates compiled by Bloomberg.
Steve Barger, a Cleveland-based analyst at KeyCorp, boosted his 12-month price target for Timken shares in March to $66 a share from $58, citing expectations for “solid” margins and strong free cash flow generation. Timken itself said sales may reach $6.1 billion by 2015, a 22 percent increase from 2012.
“Some of that valuation discount will take care of itself,” Stanley Elliott, a Richmond, Virginia-based analyst at Stifel Financial Corp., said in a phone interview. “I’m still on the fence on whether it’s the magic bullet approach to what this company needs. Part of me thinks it’s just going to be a little bit of time for some of the things the company is working on internally to kind of manifest itself.”
Elliott estimates Timken may be worth $65 to $69 a share based on the sum of its parts, compared with his price target for the consolidated company of $65 a share.
While the argument behind a breakup has “economic foundation,” it may make more sense for Timken to wait to consider a split until the economy improves and the company has completed planned investments in the steel unit, according to Eli Lustgarten, an Independence, Ohio-based analyst at Longbow Research. Timken is reducing costs and investing $225 million in its Faircrest steel plant.
Timken management has also said that untethering its steel unit from the ball-bearings business would cost the company about $200 million in one-time expenses and about $60 million to $80 million in annual savings tied to keeping the two divisions melded.
The loss of those benefits would be “minimal” though compared to the boon to shareholders from jettisoning the steel unit, said Detzi of Penn Capital.
“We’d like to see it done,” Detzi said. “The underlying value of the company is not recognized.”