Role reversal: Smaller industrials bet big on M&A

BOSTON Mon May 21, 2012 3:45pm EDT

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BOSTON (Reuters) - Burned by the memory of deals gone bad, top U.S. conglomerates including General Electric Co (GE.N) and Honeywell International Inc (HON.N) have backed away from big acquisitions, saying the risks of $10 billion takeovers aren't worth it.

That is leaving room for smaller, hungrier rivals to move in. The latest example is Eaton Corp (ETN.N), which on Monday made an $11.8 billion bid for rival Cooper Industries Ltd CBE.N - no small feat for a company with a $14.3 billion market capitalization.

Investors say the move, and a similar effort by Pentair Inc (PNR.N) to double in size by buying the flow-control unit of Tyco International Ltd (TYC.N), carry considerable risks but may be necessary gambles.

"Big deals don't tend to work out the way people think. There are a lot of unintended consequences of these things that you don't realize until you get into the middle of them," said Peter Klein, senior portfolio manager at Fifth Third Asset Management in Cleveland, Ohio, with funds holding a range of big industrial companies including GE, United Technologies Corp (UTX.N) and 3M Co (MMM.N).

That is a lesson known all too well by Honeywell Chief Executive David Cote, who spent the past decade at the helm of the company cleaning up turf battles that were the aftermath of Honeywell's 1999 acquisition by AlliedSignal.

BIG GUYS PLACE SMALLER BETS

Cote has looked at large acquisitions in his time at the helm, but has never been sure the risk was justified, he told a conference in Florida on Monday.

"Over 10 years I've never really been able to find a big deal as in the $10 billion to $20 billion range that really made a lot of sense," Cote said. "Every time I've looked at it, saying, 'Could we do it? Maybe. But I'd be better off placing ten $1 billion bets than one $10 billion bet.' Usually that's where I've come out."

That in part reflects the conservatism needed at the helm of a company with $43.03 billion market capitalization and $38.56 billion in forecast 2012 revenue, analysts said.

"He wants a deeper keel underneath his share price," said Nicholas Heymann, an analyst at William Blair & Co who covers the industrial sector.

Cote's conservatism is shared by Jeff Immelt, CEO of GE, who has also repeatedly told investors this year that he has no interest in pursuing big acquisitions.

"I just don't want to do a big deal this year," Immelt said in an April conference call. "We might do a few small bolt-on acquisitions in businesses we are already in."

Immelt has come under criticism for some large deals early in his term as CEO, particularly a $9.5 billion buy of British healthcare equipment maker Amersham.

The largest U.S. conglomerate has a slightly different idea of what constitutes a "big deal" than some of its smaller rivals. With a $200 billion market capitalization, GE sees $2 billion to $3 billion targets as reasonably sized.

After an $11 billion spree of deals of that size in the energy sector following last year's sale of a majority stake in NBC Universal media to Comcast Corp (CMCSA.O), GE has focused on turning over more cash to shareholders through higher dividends and share buybacks.

To be sure, not all blue-chip U.S. manufacturers are shying away from mega-deals. United Tech this year aims to close its $16.5 billion takeover of Goodrich GR.N, the largest deal in the company's history.

DIFFERENT SIZE, DIFFERENT RISKS

Investors said smaller companies have clear motivations to pursue large takeovers; while there is risk in the deals, there is also risk in being outmaneuvered by larger rivals.

"For the little guys, it's either get squeezed or bulk up and have a seat at the table," said Peter Sorrentino, senior vice president and portfolio manager at Huntington Asset Advisors in Cincinnati.

And as more of their growth opportunities are coming from outside the United States, companies like Eaton, which makes electrical equipment, and Pentair, a supplier of water filters and pumps, need to provide a wider range of products to win bids, Sorrentino added.

Pentair's acquisition of Tyco's flow control unit will roughly double the company's revenue to $7.7 billion, while Eaton's deal for Cooper will grow its top line by about $5 billion to north of $21 billion.

"Look at the projects that are being done around the globe: They have to have the kind of scale and gravitas that will make them a credible bidder," he said. "Siemens, Hitachi and some of other rivals just dwarf them."

Eaton CEO Sandy Cutler said buying Cooper would give the company a "larger continuum" of electrical products and services to sell.

"It's a transformative deal," Cutler said.

The combination of slow growth in U.S. markets and low interest rates is also fueling smaller companies' desire to do large deals, said Fifth Third's Klein.

"It speaks to me of limited growth prospects, so folks are stretching a little bit to align themselves with what they see as a good growth opportunity," Klein said. "And financing is cheap."

(Reporting By Scott Malone in Boston; Additional reporting by Nick Zieminski in New York; Editing by Tim Dobbyn)

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