Third Point LLC
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New York, NY 10022
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Tel 212 715 3880
April 27, 2017
First Quarter 2017 Investor Letter
Equity Investment: Honeywell International Inc. (“Honeywell”)
Honeywell is an industrial conglomerate with a $100 billion market capitalization organized into four primary business segments: Aerospace, Home and Building Technologies, Safety and Productivity Solutions, and Performance Materials and Technologies. The company is a key player in an IoT (Internet of Things) world that is
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becoming more automated, connected, and energy efficient. Honeywell recently named Darius Adamczyk to succeed long-time CEO David Cote. We are pleased by Mr. Adamczyk’s appointment based on his track record, initial communications to shareholders, and our personal interactions with him.
During Mr. Cote’s tenure, Honeywell shareholders enjoyed an 11.5% annualized return (with dividends reinvested) versus the comparable 7% return of the S&P 500. During this period, Honeywell executed a successful operational turnaround and achieved peer-leading earnings growth and returns on invested capital. Through disciplined capital allocation, such as the recent acquisitions of Elster and Intelligrated, as well the AdvanSix spin off, the portfolio has been gradually upgraded in quality. However, despite the attractive positioning and financial characteristics of Honeywell’s assets today, the stock trades at a substantial discount to its industrial peer group.
Mr. Adamczyk has committed to enhancing the company’s organic growth profile and is actively evaluating the portfolio with the assistance of the Board of Directors. Third Point believes that a separation of the Aerospace unit via a spin off transaction would result in a sustained increase in shareholder value in excess of $20 billion. Spinning off Aerospace would transform Honeywell into an industrial growth company with a focus on automation and productivity. The large-cap industrial peer group that most closely resembles Honeywell (ex-Aerospace) in terms of profitability, returns on capital, growth characteristics, and end market exposures consists of Emerson Electric, 3M, Fortive, Rockwell Automation, and Illinois Tool Works. This peer group currently trades at an average forward P/E multiple of 23x, a nearly 30% premium to Honeywell’s forward P/E multiple of 18x. A more focused Honeywell should match or exceed the multiples of its peer group, especially if management delivers on its commitment to return to free cash flow conversion in excess of 100% by 2018.
It is clear to us, as well as several sell-side analysts, that Aerospace’s presence in the portfolio is the chief cause of Honeywell’s discounted valuation and that Aerospace would be better off as a stand-alone entity. Its organic growth has lagged its US large-cap
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aerospace equipment peers and was the main driver behind recent earnings disappointments. An independent Aerospace public entity would be in a better position to invigorate growth by aligning management incentives with long-term value creation and deploying capital to enhance its strategic position. It would also benefit from increased management accountability and a dedicated Board of Directors with relevant industry experience. While some successful new product introductions such as JetWave are encouraging, we are concerned that annual margin improvement has come at the expense of investments to drive growth.
The industrial landscape is rich with examples of corporate separations that have created more focused companies and delivered tremendous shareholder value. Prominent examples include Tyco, Ingersoll-Rand, ITT, and, more recently, Danaher. We believe the case for Aerospace’s separation at Honeywell is just as compelling as these precedents.
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