Mergers and Acquisitions: What are Honeywell International Inc.’s options?

Trautwein (1990) offers several theories of merger motives including efficiency, monopoly, raider valuation, empire building, and process and disturbance theory. Berkovitch and Narayanan (1993) suggest three major motives for the takeovers: synergy, agency and hubris.  Other motives include diversification, tax considerations, management incentives, purchase of assets below their replacement cost, and breakup value (Mukherjee, Kiymaz and Baker, 2004). Although the rationale may differ from one merger or acquisition to another, a common measure of success of a merger is the increased value of the combined firm (Bruner, 2004).

Mergers can be classified into three categories:

• Horizontal mergers – when two companies that are engaged in similar lines of activity are combined.
• Vertical mergers – when firms from different stages of the production chain amalgamate. 
• Conglomerates – the combining of two firms which operate in unrelated business areas. 

On the 6^th March 2015, Bloomberg announced that Honeywell International Inc., the $80 billion maker of industrial products including refrigerators and thermostats, was “warming to big acquisitions after largely sitting out on last year’s surge in deals”. This blog will identify the motives behind this announcement and potential targets.

So what were the main reasons behind Honeywell’s search? Firstly, dimming growth prospects are encouraging industrial companies to put their cash into takeovers. Secondly, with $9.1 billion in the bank, and the ability to add approximately $7 billion to its current debt load, (whilst maintaining its current credit rating), demonstrates that Honeywell has adequate cash reserves to acquire (Bloomberg, 2015). With such large cash reserves, I believe Honeywell should be looking for investment opportunities, to prevent investors becoming frustrated. Finally, this could be a potential way to help speed sales growth, as analysts have identified that Honeywell have had its worst year for sales growth since 2009 (Bloomberg, 2015).

On the other hand, Arnold (2013) suggests that managerial motives may be another reason behind mergers and acquisitions activity, rather than focusing on maximising shareholder wealth.  Honeywell is no stranger acquisitions, with the latest one being of Datamax-O’Neil in December 2014 for $185 million.  Perhaps this suggests that David Cotes (CEO) may just enjoy creating an empire as it provides them with a sense of accomplishment and satisfaction (Arnold, 2013). In addition, the increase in responsibility of controlling a larger enterprise means more money in his back pocket! However, Cotes has recently announced a profit forecast of $1.23 to $1.27 a share, which should reassure investors.  

So what are Honeywell options? Aerospace and security are Honeywell’s “sweet spots” and those are among the areas it looks for acquisitions (Bloomberg, 2015). Analysts have identified the following as potential takeovers:

• Brady Corp., a $1.3 billion company, which manufactures identification, tools such as employee badges. A potential horizontal merger, as this would complement Honeywell’s safety products.
• Woodward Inc., the $3.1 billion airplane-parts maker. Another horizontal merger opportunity, as this would complement Honeywell’s aerospace offerings.
• Yokogawa, the Japanese industrial company. As a vertical merger, Honeywell could buy the company just for the company’s field-instrumentation operations and then shut down the control-systems business since Honeywell already excelled in that area.

By combining any of these companies with Honeywell would increase the value of the combined firm. This is also known as a ‘synergy’. Sirower (1997) defines synergy as increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently. By acquiring a company that engages in similar activities as Honeywell (horizontal merger), the company should be able to exploit economies of scale and enhancement of market power as a result of the reduction in competition (Eckbo, 1983). Internally, shared know-how, shared tangible resources, pooled negotiation power, coordinated strategies, and combined business creation will be created (Goold and Campbell, 1998). In contrast, a vertical merger with Yokogawa could increase the certainty of product supply and market outlets (Chen, 2001). There is also an opportunity to reduce costs of research, advertising and co-ordination of production (Arnold, 2013). Analysts have also suggested that a conglomerate could be on the table. The biggest opportunity for Honeywell may lie within the oil and gas industry, as prices of oil have slumped which could mean a potential discount (Bloomberg, 2015).

I believe that there is huge synergy potential for Honeywell. If they allow cash reserves to continue to grow, investors will become frustrated that they are not looking for ways to expand the business which could potentially cause investors to sell their shares, thus damaging market value. A synergy as a merger motive will allow the combined entity to have a value greater than the sum of its parts. Due to the combining of the companies, it will increase value from the boost to revenue and cost base. Companies engaging in the same activities will have complementary skills enabling the combined firm to sell more goods (Arnold, 2013).

Honeywell are in a very promising position. Without acquisitions, sales are projected to rise to as much as $51 billion in 2018. The company expects to generate free cash flow of as much as $28 billion during the next five years, outpacing the $19 billion from 2010 to 2014 (Bloomberg, 2015). I am sure we will hear a lot from Honeywell over the next five years regarding their expansion.

References

Arnold, G. (2013). Corporate Financial Management. (5^th ed.), Harlow: Pearson.O’Brien

Berkovitch, E., & Narayanan, M. P. (1993). Motives for takeovers: An empirical investigation. Journal of Financial and Quantitative analysis, 28(03), 347-362.

Bloomberg (2015). Honeywell ramps up deal hunt armed with $10 billion: Real M&A. Retrieved from http://www.bloomberg.com/news/articles/2015-03-06/honeywell-ramps-up-deal-hunt-armed-with-10-billion-real-m-a

Bloomberg (2015) Honeywell plans to spend $10 billion on deals by 2018. Retrieved from http://www.bloomberg.com/news/articles/2014-03-05/honeywell-plans-to-spend-10-billion-on-deals-by-2018-correct-

Bruner, R. F. (2004). Applied mergers and acquisitions (Vol. 173). John Wiley & Sons.

Chen, Y. (2001). On vertical mergers and their competitive effects. RAND Journal of Economics, 667-685.

Eckbo, B. E. (1983). Horizontal mergers, collusion, and stockholder wealth.Journal of financial Economics, 11(1), 241-273.

Goold, M., & Campbell, A. (1998). Desperately seeking synergy. Harvard Business Review, 76(5), 131-143.

Honeywell (2013) Press Releases. Retrieved from http://honeywell.com/News/Pages/press-releases.aspx

Mukherjee, T. K., Kiymaz, H., & Baker, H. K. (2004). Merger Motives and Target Valuation: A Survey of Evidence from CFOs. Journal Of Applied Finance, 14(2), 7-24.

Sirower, M. L. (1997). The synergy trap: How companies lose the acquisition game. Simon and Schuster.

Trautwein, F. (1990). Merger motives and merger prescriptions. Strategic management journal, 11(4), 283-295.