The questions that most industrial sector followers must be asking themselves about General Electric Company's (NYSE:GE) intended purchase of Alstom's energy business, are whether it will kick-start a prolonged bout of takeover activity in the industrial sector, and which companies could be involved? Moreover, what does the deal mean for General Electric and the industrial sector at large?
More deals to come
The answer to the first question is that the intended GE-Alstom deal isn't so much a catalyst for deal making in the sector, but rather a reflection of what many of its peers have already been saying.
For example, Danaher's (NYSE:DHR) management recently outlined that they felt they had the ability to deploy $8 billion toward acquisitions, and that dealmaking would be the "primary focus" of its capital allocation strategy. Market speculation will inevitably focus on Agilent Technologies, not least because it's spinning off its test and measurement business away from its core life science and diagnostics operations. Another potential target could be filtration and separation company, Pall Corp., although it's hard not to think that its current valuation of 30 times earnings doesn't have some sort of takeover premium built in.
3M Company (NYSE:MMM) is also on the acquisition trail, and its management recently outlined that they were hoping to make $5 billion-$10 billion in acquisitions by the end of 2017. 3M is not really known for making large acquisitions, and CEO, Inge Thulin recently affirmed that "We maybe need to do slightly bigger than" a billion or so, in an individual transaction. Moreover, Honeywell International is on record as planning to spend $10billion or more on acquisitions within five years.
Does General Electric-Alstom make sense?
In one way, General Electric's move is unusual, because CEO Jeffrey Immelt has worked hard over the years to diversify the industrial giant away from its previous reliance on power solutions, and gas turbines in particular.
However, in the aftermath of the great financial crisis there has been a new emphasis on reducing the scope of GE Capital, and investing on the industrial side, with oil and gas being a particular target. For example, it bought oil field services company Lufkin Industries for $3.3 billion in 2013, and it agreed to buy Cameron International's compression unit for $550 million earlier this year.
The Alstom deal marks a return to General Electric's core business, and the opportunities for synergies should be obvious, however there are some valuation doubts over the deal. A recent JP Morgan research report argues that, instead of accepting GE's definition of the deals enterprise value to earnings multiple of 7.9 times trailing earnings, "a balanced approach could yield a multiple as high as ~10x". The report argues that the valuation should include $900 million in restructuring costs, a provision for legal liabilities (Alstom is being investigated for bribery) and include an adjustment for JP Morgan's estimate for a 5% organic profit decline.
Ultimately, the deal will be judged on how well General Electric can generate cost synergies out of integrating Alstom. This is partly an internal execution issue, but Immelt's job will be a lot easier provided end-demand improves. In other words, it's highly unlikely that the deal was thought up without assuming that medium-long-term demand was going to improve.
A sign of confidence
With companies like General Electric, Danaher, 3M Company and Honeywell International all making or planning substantive acquisition activity, it's a sure sign that business confidence is coming back. Industrial companies tend to be more cyclically exposed, so when they enter the acquisition trail it's an indication that they feel economic growth is on a sustainable path.
Mergers and acquisition activity usually tends to be late-cycle activity. Typically, companies strengthen their balance sheets in the early phase of the cycle, and then use the cash generated in order to chase acquisition lead growth in the later stages of the cycle. It's been a long time coming, but it finally looks like the industrial sector is set to spend again, and General Electirc's move is symbolic of a wider trend.