Ingersoll-Rand (NYSE:IR) just pulled the trigger on its largest acquisition in more than a decade. The deal should provide a number of growth and portfolio-shaping options for this industrial conglomerate that's been a market-beater in recent years.
The company said Feb. 11 that it will buy Precision Flow Systems (PFS) for $1.45 billion from funds advised by BC Partners Advisors and Carlyle Group, greatly expanding its portfolio of fluid management products. It's Ingersoll-Rand's largest deal since its $10 billion purchase of HVAC company Trane in 2008.
Ingersoll-Rand has successfully marched to the beat of its own drummer in the past, but this deal seems particularly contrarian, given that it comes as many of the company's peers are more focused on separations. General Electric is shedding a number of businesses to raise money to pay down debt, Honeywell last year spun off two slower-growth units as independents, and United Technologies last fall announced plans to separate into three publicly traded entities.
Ingersoll management seems much more content with its portfolio, which also includes Club Car golf carts and Thermo King refrigeration units, in addition to Trane air conditioners and the fluid management operations. Here's a breakdown of the planned acquisition, and a look at what investors should expect from the company and its businesses following the deal.
A platform for growth
Claiming $400 million in sales, Precision Flow Systems makes engineered pumps, boosters, mixers, and other systems for water, chemicals, and food and beverage customers. The business generates EBITDA margin in excess of 20%, with revenue about evenly split between new sales and aftermarket business.
The deal would dramatically expand Ingersoll-Rand's existing fluid management business, which brings in $150 million in sales, and would add more than 1,000 employees spread across seven facilities. It's no bargain, but the price, at about 11 times EBITDA after expected synergies, is attractive for the high-margin businesses being added to the fold.
On a call with analysts following the deal's announcement, company CEO Michael Lamach said PFS has long been on Ingersoll-Rand's radar, describing the target as a foundational piece that broadens his company's portfolio and opens up opportunities for further bolt-on acquisitions.
Lamach said there aren't any "large-scale opportunities" in the sector to complement PFS, but there are a number of add-ons that would make sense for the combined operation.
What comes next?
Lamach said the PFS purchase, which will be funded with cash and debt, is structured such that Ingersoll-Rand will "retain significant capital deployment optionality," including the ability to proceed with its previously announced plan to buy back up to $500 million in stock. Given the target's strong margins and healthy free cash flow, Ingersoll-Rand intends to quickly pay down any borrowings it uses to fund the transaction.
Still, Ingersoll is no stranger to portfolio trimming, and management didn't totally rule out eventual divestitures. The company sold a majority stake in refrigeration equipment manufacturer Hussmann International to private equity in 2011 and spun out its Allegion security business in 2013.
Analysts on the call asked whether Ingersoll-Rand, as it invests capital and places management's attention on fluid control, would de-emphasize other parts of its portfolio. The company's power-tool operation and its material handling unit have been mentioned as potential divestiture candidates in the past.
Lamach said there is no need to do asset sales but added that the company is constantly considering who is the best owner for each of its businesses.
Some on Wall Street have also predicted a round of consolidation among HVAC equipment manufacturers, sparked by United Technologies' forthcoming spinoff of its Carrier business. Ingersoll-Rand, owner of Trane, would probably have regulators block it from merging with Carrier. But it could target a tie-up with Lennox International or Johnson Controls, especially if Carrier makes a move to consolidate.
The PFS deal seemingly makes it less likely that Ingersoll-Rand would buy an HVAC company outright. But the company could still attempt to orchestrate a tax-efficient spinoff and merger between Trane and a publicly traded rival, should it wish to focus its attention elsewhere.
Ingersoll-Rand is an intriguing industrials buy
While others are busy with divestitures and splits, Ingersoll-Rand is focused on expansion. The company just last month forecast organic sales growth of upwards of 6%, thanks to strength in key end markets led by climate, and it said it expects free cash flow conversion of more than 100% of adjusted net income in 2019 and beyond.
Adding PFS and its 20%-plus margins to the Ingersoll-Rand base that generated adjusted operating margin of 12% in the fourth quarter only makes the long-term outlook stronger.
There are always risks when it comes to mergers and acquisitions. Ingersoll-Rand is an experienced acquirer, buying nearly two dozen companies over the past five years, but this purchase is considerably larger than those deals. The purchase is also set to close in the months to come, which should mean no prolonged distractions, and Lamach said much of the PFS management team is expected to stay aboard after the deal to ease the integration.
Ingersoll-Rand trades at about 19.4 times earnings, in line with United Technologies, despite having a much clearer near-term course and better earnings momentum in its various business lines.
The company even before the PFS deal was an attractive buy. Adding this high-margin flow control unit only strengthens the bullish case.