October 17, 2019

Breakingviews: Emerson Electric is only half as bad as Shaw says

by Breakingviews.

Sometimes rookies try too hard. That may explain the withering letter Emerson Electric received on Tuesday from D.E. Shaw, a relative newcomer to shareholder activism.

The $50 billion investor best known for using algorithms to make money, urged the $42 billion conglomerate to break itself up and ditch its board, bloated pay packages and “Barbarians at the Gate” era fleet of corporate jets. These changes will supposedly unlock $20 billion in value. So far, the market isn’t buying it. D.E. Shaw has some valid points but may also be overstating its case.

D.E. Shaw is right that the 129-year-old company – which makes everything from valves to air conditioning compressors – is showing its age. Unlike almost 90% of Fortune 500 companies, Emerson has a staggered board, which means only a third of directors faces re-election annually. That looks like a sign of defensiveness about its shortcomings.

Emerson’s bulky structure has generated employee productivity 46% below its best-in-class peers, according to Deutsche Bank. It has 18 buildings in Houston alone. And, outdoing even General Electric’s former boss Jeff “two jets” Immelt, it has eight planes and a helicopter serviced by 40 staff. This has all saddled Emerson with sales, general and administrative expenses that are higher than peers.

But this isn’t the whole story. Emerson’s gross margins and segment margins are among the highest in its peer group. It also boasts a 5% cash flow yield and 3% dividend yield. D.E. Shaw’s cost analysis also may have some flaws, Deutsche Bank argues. The fund’s bottom-up analysis may be seeing something top-down analysts are missing. But this is tough to verify.

Splitting Emerson would unlock some value, according to Breakingviews calculations. Emerson’s separate divisions would be worth around $49 billion, including debt, if median peer multiples provided by Morgan Stanley are applied to the consensus 2020 EBITDA forecasts cited by D.E. Shaw. This results in $45 billion of equity and a share price around $72 – only 7% above current prices.

Emerson’s stock has inched up since D.E. Shaw’s involvement was originally reported by Reuters. The market agrees with part of the fund’s thesis – but only part. Rookies can often be game changers, but they can also get a little ahead of themselves.

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