Urge to Merge : 2000

By : Jim Pinto,
San Diego, CA.
USA

Lack of growth in industrial automation is forcing publicly-held companies into a steady stream of mergers and acquisitions to maintain or improve stock-market valuations. This update of my previous article includes the famous-list of industrial-automation majors, ranked by size.

The original version of this article was published in
Controls Intelligence & Plant Systems Report, August 2000.

In the current financial environment, the top management of most publicly held companies is focused primarily on stock-market valuations, which come from short-term growth of revenue and profit. After a blip in the stock market this year, the high-tech players continue to surge forward while industrial automation remains in the doldrums.

Industrial Automation Stocks Slide

Most of the automation majors are consistently behind projections and as a result, their stock market valuations have plunged to precarious levels.

Both Honeywell and Rockwell recently traded at a 52-week low, on profit-warnings and general bad news. Last year, Honeywell and Allied Signal combined 2 relatively fragmented businesses and made rosy projections to justify the merger. Honeywellís stock dipped fairly low when it finally admitted that the projections were overly ambitious and actual results would fall short. Rockwell stock is down simply because its results are poor.

Emerson, Eaton and Danaher have fared a bit better, but each companyís stocks too have gone nowhere in the past year. Tyco hit some rough spots, but seems to be recovering. In Europe, Invensys is down significantly, while Siemens and ABB continue to bump along, buffered perhaps by a different long-term view.

Emerson has had 42 years of consistent growth and yet its stock remains unexciting. In the quest for the higher valuation that comes with links to faster growing markets, they have recently been downplaying industrial automation and emphasizing involvement in standby power and markets related to the growing use of computers and the Internet.

The Merger Urge

The industrial automation market has shrinking margins, a flat worldwide market and no organic growth. The problem is that older, supposedly strategic core businesses continue to shrink and lose money. The only remaining alternative for the large automation companies is to merge with another major with a similar problem. This would allow consolidation of the shrinking core businesses and hopefully generate cash savings through shared overhead and divestiture. For this fundamental reason, I predict that the Industrial Automation Big 10 will inevitably become the Big 5 within the next year. Hey, if I'm wrong, I still won't be far offÖ.

The Famous List

To make my point, I have included a table showing the annual sales and market-cap (total number of shares outstanding x recent stock price) for the industrial automation leaders. Price-to-Sales is simply a ratio of the two. Iíve included the price/earnings ratio as an indication of market acceptance.

It seems that no one has published a similar sales/market-cap and P/E-ratio comparison of the industrial automation majors. Perhaps this is because comparable numbers are hidden and buried in annual reports and websites, with differing financial timetables, markets and currencies.

These numbers are typically available from financial news and company websites, though different fiscal years, currencies and stock-market information makes coorelation difficult. However, Peter Reilly, senior industry analyst from Deutsche Bank in the UK provided the latest numbers from Datastream, the best source for this kind of financial information. The P/E ratios are based on year-2000 estimated earnings.

Note : The Yokogawa numbers are estimated. If anyone can give me good, up to date numbers, I'll appreciate it.

Table 1: Annual sales and market-cap for industrial automation leaders

Company

Annual Sales

($bn)

Market Cap ($bn)

Price-to-Sales Ratio

P/E 2000(Est)

SIEMENS

62.44

89.14

1.43

42.5

HONEYWELL

23.73

28.09

1.18

11.6

ABB

23.27

34.75

1.49

21.4

TYCO

22.5

91.22

4.05

25

EMERSON ELECTRIC

14.27

29.95

2.10

21.2

INVENSYS

13.66

13.7

1.00

12.7

EATON

8.4

5.28

0.63

10

SCHNEIDER

7.63

10.97

1.44

19.1

ROCKWELL

7.04

7.13

1.01

11.1

DANAHER

3.2

7.84

2.45

25.1

YOKOGAWA (est)

1.8

1.5

0.8

8

Source : Datastream
All dollar amounts are in billions.

The USA Majors

Itís interesting to note that one cannot value Honeywell's industrial controls segments (sales $2 billion) separately-itís lumped into the total. Honeywell recognizes that industrial control will not contribute much to its future and so itís my guess that the entity will sell off the Industrial Automation Controls division and related activities fairly soon. Itís not a good fit with the rest of the Honeywell businesses and may be better off (read, worth more) as part of someone else's primary focus. Honeywell keeps insisting that IAC isnít for sale until after the post merger consolidation. But, my read is that a reasonable offer wouldnít be refused. Interested buyers should be approaching Honeywell now, rather than waiting for a formal process that will simply result in an auction among the potential players. Emerson Electric includes a string of acquisitions-Rosemount, Fisher Controls, Intellution, part of Westinghouse, Daniel Industries and others. The industrial automation focus was a strategic miscalculation and its lack of growth has impacted Emerson stock, which remains at a ho-hum level-though itís dong better than Honeywell or Rockwell.

Rockwell got out of aerospace and fax/modem-chips and moved into industrial automation with the purchase of Allen-Bradley (which up to that time was privately held). As it kept divesting unrelated businesses, revenue dropped from about $13 billion in 1995 to $7 billion in 1999-the automation focus simply didnít yield desired results. Market-cap is now about $7 billion (from about $11 billion last year). This makes Rockwell a prime acquisition target.

Danaher includes Fluke, Namco, Partlow, and Pacific Scientific-all relatively recent acquisitions. Notice its more attractive market-cap to sales ratio (2) and compare this with the others (all less than 2, Rockwell 1, and Eaton 0.6). Expect a big merger or acquisition from the Danaher direction, to help multiply market-cap. TYCO (Keystone, AMP and a host of others) has indulged in merger-mania, making it the revenue runner-up behind Siemens. But, its headlong rush caused a hiccup, which brought market-cap down from the heady levels a year ago. It must be noted that, just because a company is trading at a low market cap doesnít mean itís acquirable. The acquirer would have to offer a premium, to get the willing involvement of the acquired companiesí board, management and shareholders. A hostile bid is possible, but expensive, and only the last resort.

The International Group

Then there is the international group, operating with somewhat different ground-rules; market-cap doesn't have quite the same significance, though revenue and global market-share are still major drivers.

Particularly for Japanese companies like Yokogawa and Omron, a low market-cap does not mean the company is acquirable. The Japanese have a different financial and time perspective and are prepared to wait patiently for new growth to emerge.

Siemens, based in Germany, is the king-of-the-hill in industrial automation. The company isnít very profitable, by American and British standards, and its high P/E ratio is misleading. It gained significant automation market share in the US when it bought the PLC Division of Texas Instruments and most recently Moore Products, the last of the $100m+ independents, as I had predicted. (See The Urge to Merge in the September 1999 issue.) Siemens is still hunting for US market growth and will continue to be a regular player in the bidding game. With its revenue clout and cash-reserves, look for it to be landing a big catch before too long.

ABB (itself a combination of ASEA and Brown Boveri) bought Combustion Engineering, Taylor, Kent and then Elsag Bailey with and all its accumulated ingredients-Fisher & Porter, Hartmann & Braun and other adjuncts. It is aggressive, well run and continues to be a strong player in the mating dance of the majors.

Schneider Electric is a combination of French Telemechanique, April and Merlin-Gerin. It bought Square-D and Modicon in the US and the company is still a contender for further global gobbling, to help disguise its indigestion.

Invensys is the new name for the merger of British companies Siebe and BTR, themselves the result of combinations of Foxboro, Robertshaw, Wonderware, Eurotherm, Unitech, Hawker Siddeley and a host of others-about 200 companies in the group. Invensys is now clearly one of the leaders in industrial automation, with an aggressive management that is looking for bold ways to overcome the growth malaise.

The Mating Game

Obviously all the majors are talking with each other-but mergers and acquisition are always stalled by ego problems. With more than one lion in the room, it quickly becomes a matter of who will be in charge. Of course, when the merger is dictated more by necessity than by choice, the lion quickly loses its claws and becomes a pussycat, ready for the exit.

As the game continues, at the very least the players get to see each others cards and negotiate sale or divestiture of the pieces. So, the negotiation shifts to the sale of products or businesses that may be more valuable in anotherís hand. When youíre trading pigs, talk with farmersÖ.

Alliances & Joint Ventures

In the quest for growth, Rockwell has formed an alliance with Japanese Omron, hoping perhaps that this will lead to merger or acquisition. In my opinion, the Japanese culture doesnít facilitate acquisitions-in their minds itís akin to defeat. This inhibits anything but a joint venture. But, a 50:50 partnership (like Johnson-Yokogawa previously) disintegrates with the inevitable culture-clash. Rockwell and Omron are doomed to a similar dead-end.

Joint ventures seldom succeed. GE Fanuc (a joint venture between GE and Fanuc) is an exception, achieved through a complicated formula of different ratios of ownership in the different major market areas. The numbers for GE Fanuc arenít available separately, and they have no market-cap-hence I havenít included them in Table 1.

Gutsy Tactics Needed

In the current environment, top management needs guts to get beyond just re-arranging the deckchairs on the Titanic. To get beyond Foxboroís fizzling growth and mediocre margins, Invensys bought Wonderware, the HMI software leader, for a healthy price. And, Emerson had already bought Intellution, the other leader. But these were strategic errors - growth in HMI software fizzled.

In a quest for continued growth in the software arena, Invensys made a gutsy move-takeover of Baan, Europe's 2nd largest software company (behind Germany's SAP). Once valued at about $10 billion, Baan has been suffering worsening financial difficulties and is currently valued at about $600 million, when compared with the Invensys cash offer of about $725 million.

This was a gutsy move for Invensys, but then, prizes arenít awarded to the meek. If Invensys does not go ahead with the Baan acquisition, itíll be hard-pressed to come up with other alternatives for growth. If the Baan deal starts to turn sour and the Invensys share price collapses, then Invensys itself becomes a target. As the company stated at a recent strategy presentation, any top 5 controls company could buy any other top 5 controls company with limited anti-trust problems.

The $1b threshold

Down below the $1 billion level, there are the mini-conglomerates like US-based Ametek, which bought Drexelbrook Engineering and others, with performance that merits a market-cap of just 0.7 times revenue.

There are 2 similar British mini-conglomerates: Bowthorpe and Fairey, who keep buying up smaller companies (often as small as $ 5-15 million) and try to run each with healthy growth and profit. But, itís not easy to apply your management algorithms to a bunch of small companies-attention gets diverted to the problems, which clutters up the consolidations.

Climbing the growth curve profitably isnít easy and Fairey's market-cap has suffered. To raise the ante, Fairey recently bought $400 million Spectris-almost its own size-a combination of several instruments and sensors companies like B&K and HBM. Still remaining to be seen is whether this larger fish will follow Faireyís formulas.

The other UK mini-conglomerate, Bowthorpe has changed its name to Spirent and has been moving its mix towards ďhigh-growth, high-margin, high technology marketsĒ to find a better valuation. But, the new mix still includes some of the old dogs, and it remains to be seen whether they can make the transition beyond just a new name.

Going Private

As a result of the bad rap for industrial automation stocks, some relatively healthy smaller companies are going private with the help of private equity and venture capital. Roxboro, the $200 million Cambridge, UK-based group (Solarton, Mobrey and similar acquisitions) has become the latest small company seeking to leave the stock market. It insists that industrial automation is in an ďunloved sector of the market."

An interesting example of things gone sour in industrial automation is ICS Group (in the UK). They bought a bunch of dogs-MAX Control Systems from Leeds & Northrup which itself had been sold off piecemeal to Honeywell and others) and also Triplex and Transmitton. At about $70 million in sales a year ago, its recent market-cap of $17 million (down from about $70 million a year ago) reflected serious losses and sales decline. To bail them out of default on bank-loans, a cash-bid of just $2.5m was made by a low-ball venture group in late July. The bid has apparently been accepted by the board of directors, though rumors abound that rival bids are brewing - probably wishful thinking on the part of disgruntled shareholders. The problem with this type of company is that, although it has some good pieces and management, nobody wants to buy it, because nobody wants the headaches. The only ones willing to buy a pig in the poke are vulture-capitalists who will carve up the carcass and sell it off piecemeal. I suppose thatís another way to go private....

Playing with Pigs

Some time ago, I asked a venture-capitalist friend why he never got involved with turnarounds. His reply: ďNever play with a pig. You both get dirty, and the pig likes it.Ē

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