June 10, 2015

Johnson Controls Split Is Prelude to Industrial Deals: Real M&A

Source: Bloomberg Business

Johnson Controls Inc.’s industrial transformation may need a jump-start.

Johnson Controls said Wednesday that it’s considering options for divesting its auto unit, marking a major shift for a company that was once the largest U.S. supplier of car parts. Post-split, the building systems and services division that made up only a third of the $35 billion company’s sales last year would be its top source of revenue.

Left with a slower-growing business, the maker of York air conditioners will need to find ways to fuel expansion. On a conference call to discuss the breakup, Chief Executive Officer Alex Molinaroli suggested he may be willing take on more debt to do that, as long as the company maintains its credit ratings.

Shifting the focus to the industrial side of the business “gives us flexibility to do things we couldn’t do in the past,” Molinaroli said. The company has a robust deal pipeline for both the building-efficiency business and the smaller battery unit, which will also remain with Johnson Controls after the split, he said.

“They’ve always been actively looking at M&A,” said Colin Langan, a New York-based analyst at UBS Group AG. “I definitely think that’s something they would love to do. If they do a divestiture, it’s very likely that they would turn around and use some of those proceeds to make an acquisition.”

Lennox Fit

Lennox International Inc. is a perfect fit to bolster Johnson Controls’ weak strategic position in the heating, ventilation and air conditioning market, according to Jeffrey Sprague, an analyst at Vertical Research Partners.

Johnson Controls would have to pay up for the company, but a takeover at a 25 percent premium -- about $7.5 billion including debt -- would still add to earnings, he said. Lennox rose as much as 4.4 percent on Wednesday amid speculation of an acquisition by Johnson Controls.

Another option is Hussmann, the refrigeration company that’s majority-owned by Clayton Dubilier & Rice. The private-equity firm is probably near the point of wanting to exit its investment in Hussmann. Selling to Johnson Controls could be a good solution, said Joel Levington, an analyst at Bloomberg Intelligence.

Refrigeration could complement Johnson Controls’ HVAC business, he said. The company could also consider expanding into fire and security systems, said Langan of UBS.

Fraser Engerman, a spokesman for Milwaukee-based Johnson Controls, declined to comment, as did representatives for Richardson, Texas-based Lennox and Clayton Dubilier.

Spin or Sell

How big of an acquisition Johnson Controls considers will probably be dictated by the fate of its auto division. While the company could free up cash by adding debt to any spinoff of the business, a sale would give it more deal firepower. Brian Sponheimer of Gabelli & Co. estimated the unit, which makes car components such as seats and door systems, could command as much as $9 billion in a sale.

Magna International Inc. is one of only a few logical buyers, though. That doesn’t give Johnson Controls a very strong negotiating position, and may encourage it to do a spinoff instead, Langan of UBS said.

Still, “to try to accelerate growth, M&A has to be a component of the story,” Levington of Bloomberg Intelligence said.