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Strategies & Market Trends : Speculating in Takeover Targets
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From: richardred7/20/2019 9:49:52 PM
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VPG-Speculation





Illinois Tool Works is going shopping again.

The manufacturing conglomerate, once an enthusiastic buyer that made 600 acquisitions over 25 years, paused seven years ago to focus on profitability and improving internally generated revenue growth. While ITW's operating profit margin climbed to 24.3 percent during that time, "organic growth" lagged.

The company raised its target for the operating margin in December, aiming for 28 percent by 2023. That's hard to do, though, without the higher marginal returns that come from increased revenue.

CEO Scott Santi's answer is a return to dealmaking. He's looking for buyout targets and planning to sell off seven slower-growing businesses with $1 billion in aggregate revenue by the end of 2020. (The company hasn't specified which ones.) Glenview-based ITW, which makes products ranging from ovens to auto parts to adhesives, says it will consider only acquisitions that enhance the company's organic growth potential. The stock has risen 16 percent since the start of the year, to $146.87 on July 11, while an index of industrial stocks rose 22 percent.

ITW will likely buy two or three businesses a year with about $150 million in revenue, Robert W. Baird analyst Mig Dobre wrote in a June 19 note, citing conversations with company executives. The company will consider acquisitions in any of its business lines, except automotive, where organic revenue fell 6 percent in the first quarter. That opens the door to dealmaking in six other business segments: test and measurement/electronics; food equipment; polymers and fluids; welding; construction products; and specialty products. Deals could also provide entry into new markets, Dobre wrote, like health care, industrial printers and aircraft support products.


"There's no question in my mind that acquisitions remain a core component of our long-term growth potential," Santi said May 21 at an industry conference. "We can add a nice additional 1 percent to 2 percent to our overall growth rate over time with some really solid, right-in-our-wheelhouse acquisitions."

Company executives previously thought ITW "didn't need acquisitions to meet its long-term performance goals," Bloomberg Intelligence analyst Karen Ubelhart writes in a note. "Disappointing progress on growth may have changed this perspective."

ITW's revenue rose 3.2 percent last year to $14.8 billion, with the largest business, automotive, accounting for less than a quarter of sales. Operating margin in the automotive business has lagged the other segments, at 23 percent, and Ubelhart writes that the unit's first-quarter revenue decline was "worse than expected."

The decentralized company has 87 divisions, down from about 800 seven years ago as part of the strategy shift to improve margins and boost organic growth. It also has been pruning product lines and saved $350 million in procurement costs since 2013.

The operating margin went from 15.9 percent in 2012 to 24.3 percent last year, eclipsing an earlier goal of 20 percent. Now it is shooting for 28 percent, well above the midteens margins many industrial manufacturers post.

The company said in 2012 that it planned to grow organic revenue 2 percentage points faster than overall industrial expansion. But ITW's annual organic growth started at 0.6 percent, shrank 0.4 percent, then rebounded to 2.2 percent between 2012 and 2018, trailing global GDP growth of 2.5 to 3 percent during the same period.

REVISED GUIDANCE

Chief Financial Officer Michael Larsen said on an April 25 earnings call that because of a slow start to the year, the company was revising its organic growth guidance for 2019 to a range of 0.5 to 2.5 percent, down from 1 to 3 percent. Still, Santi said at the conference that ITW plans to add another 1 or 2 percentage points of organic growth by 2023 to "finish the job" and bring the growth rate to 3 to 5 percent annually.

That won't be easy. In 2018, even though 44 of the company's divisions grew 7.6 percent organically, 36 divisions saw revenue decline 3 percent while other industrial companies grew. That's "surprising and disappointing," Ubelhart writes, and "proving Illinois Tool can get a significant part of its portfolio on an accelerated growth path will be a challenge over the next few years."

To make those 36 divisions grow faster, the company is giving them a refresher course on its "80/20" management process, derived from the Pareto principle, where it focuses on the 20 percent of customers and products that generate 80 percent of the revenue.

"The byproduct of 50 or 60 acquisitions a year is the fact that we didn't really integrate any of them," Santi said. "We gave them six months of training and then onto the next 50 or 60, when 80/20 takes three to five years to really be good at."

chicagobusiness.com




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