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Argent in the News

Rebuilding Emerson

21 July 2015

(St. Louis Business Journal) 

“It’s not going away, but it’s not getting bigger,” Ken Crawford, an Argent Capital Management analyst, said of Network Power. “Previously, they thought that would be an area of growth. I’m sure they were not alone in that position.”

July 17, 2015 (Jacob Kirn)

In his 15th year as Emerson CEO, David Farr, 60, is making big moves to create a smaller, faster growing and more profitable business.

Long a Wall Street darling, Emerson’s stock and dividends largely went in one direction — up ­— for decades. Now, it seems to have lost its way.

After reaching a high of $70.21 a share in December 2013, the Ferguson-based company’s stock has tumbled more than 20 percent, to below $55 per share this month. The reasons are many.

Large parts of its business, including Network Power, which provides environmental controls to help data networks, have struggled. And some acquisitions, made just a few years ago, have not produced desired results, analysts said.

A consensus for decisive action emerged, so last month Farr made a major announcement: Emerson would spin off Network Power and explore “strategic alternatives” — likely divestitures — for its motors and drives, power generation and storage businesses, perhaps shrinking by about $8 billion in annual sales. The moves are designed to remake Emerson, focusing it on what company officials hope are segments with more growth potential: Process Management and Industrial Automation, and Commercial and Residential, which, following the moves, would have annual revenue of about $10.6 billion and $5.7 billion, respectively, according to the company.

“You’re going to see an Emerson that’s very much focused on two core markets,” Farr told the Business Journal. “It’s going to be more of a commercial aspect of the marketplace versus consumer.”

Though few details have been given, shareholders and analysts already are asking how the actions — to be completed no later than Sept. 30, 2016 — might affect profitability and Emerson’s sizable workforce of about 115,000. In the past 15 years, the company has embarked on several major initiatives to realign its businesses, including a foray into power equipment for the communications industry. In a later initiative, in 2010, Emerson made a big buy: London-based Chloride Group for $1.5 billion.

The segment, which designs, manufactures, installs and maintains products providing “grid-to-chip” electric power conditioning for telecommunications networks, is global: 29 percent of its sales are in Asia, with another 19 percent in Europe. It made up some 20 percent of Emerson’s 2014 sales, which totaled $24.5 billion.

Farr told the Business Journal in 2010 that Network Power would become a $5 billion business within five years. Farr said the move was aimed at concentrating on uninterruptible power supply systems, or what he called a “faster-growing business.”

It exceeded that expectation, generating sales of nearly $6.4 billion in 2012. But since then, it has slid.

Sales totaled $6.2 billion in 2013 and then dropped 18 percent last year, to less than $5.1 billion, as demand from financial customers weakened and technology rapidly changed. Network Power profit slipped to $459 million in 2014, down from $554 million in 2013.

Further, its profit margin, at about 9 percent, is less than some of Emerson’s other core businesses, which routinely report profit margins of more than double that.

“It’s not going away, but it’s not getting bigger,” Ken Crawford, an Argent Capital Management analyst, said of Network Power. “Previously, they thought that would be an area of growth. I’m sure they were not alone in that position.”

Farr told the Business Journal Network Power is still a viable business — for another owner.

“Its profile of growth and profitability don’t fit with our longer-term targets,” he said. “The decision was, basically, do we see being able to change that or are we swimming upstream into market dynamics? It became clear that, yes, we are better off allowing this business to have its own life.” Farr compared the move with Emerson’s 1990 spinoff of Esco Technologies, now a $531 million company focused on automated meter-reading products.

In a June 30 conference call, Farr lamented what’s happened to Network Power; Emerson has spent about $3.8 billion on acquisitions for the division, according to Bloomberg.

“I created a unique, new space called network power,” Farr said. “It’s not been one of my better approaches in life, and I wouldn’t say I would put that on my tombstone to say that was a strong accomplishment.”

Argent’s Crawford said Farr could “set his legacy” by successfully navigating the moves, paving the way for a new CEO in several years. Further, “it wouldn’t be unrealistic to think the future CEO of Emerson is working at Emerson today,” Crawford said. Few would speculate about a possible successor for Farr. In 2000, Farr, then COO of Emerson’s global operations, was named CEO, replacing longtime Chairman and CEO Chuck Knight.

Scott Barbour, Emerson executive vice president and business leader for Network Power, and Jamie Froedge, Emerson vice president, acquisitions and development, are leading the Network Power spinoff effort. Shareholders would get a stake in Network Power, and Emerson said the separation does not require their approval. A sale of Network Power could occur before a spinoff, according to Scott Davis, a Barclays analyst.

Emerson has hired several legal advisers for the move: Bryan Cave LLP, Davis Polk & Wardwell LLP, Latham & Watkins LLP and Baker & McKenzie.

Other businesses have contributed to Emerson’s recent slide. Its Industrial Automation segment, with brands including Kop-Flex and Rollway, saw sales decline 4 percent from 2012 to 2014. For the three months ended March 31, things got worse, as sales were down 16 percent year-over-year, to $1.03 billion. Emerson may unload two business groups within Industrial Automation: motors and drives and power generation.

For example, Farr said Leroy-Somer, a French firm he had a hand in acquiring in 1990, is tied to the drive business, and no longer “makes strategic sense for us.”

Another segment, Commercial and Residential Solutions, with brands like RIDGID and InSinkErator, has not performed as poorly. Sales increased 3 percent from 2012 to 2014. But this year, in the first quarter, sales were up just 1 percent compared with the prior-year period. Emerson is exploring a sale of brands within its storage solutions offerings, part of Commercial and Residential Solutions. Those brands could include ClosetMaid and InterMetro.

Farr said Emerson is working with New York-based Centerview Partners and J.P. Morgan Chase on the sales, which would occur by summer 2016. Mark Bulanda, Emerson executive vice president and business leader for Industrial Automation, is leading the process internally. “They’re good assets,” Farr said of the targeted businesses, “but their underlying growth profile is very low.”

Though it’s not clear who would lead a spun-off Network Power or exactly which subsidiaries will be sold, analysts were generally pleased — though not wowed — by the announced moves.

“The company really had no choice,” Davis, the Barclays analyst, said in a June 30 note. “We strongly agree with management here and think (Emerson) is making the right decision.”

Emerson officials said on a pro forma basis, the company — post strategic actions — would see profit margins of 19.7 percent, up from 16.5 percent, and underlying sales growth of 6.9 percent, up from 4.5 percent. For its Commercial and Residential segment, Emerson sees HVAC and e-commerce as near-term drivers of growth. In Process and Industrial, it’s counting on wireless solutions, pipeline management, and hybrid and discrete automation. The slimmed-down Emerson would generate an annual operating profit of $3 billion, according to a Morningstar report.

“We believe the move will ultimately create greater long-term value for shareholders, as the repositioning will allow Emerson to use capital, talent, and time much more efficiently,” Morningstar analyst Barbara Noverini said in a June 30 note. “Furthermore, this strategic shift provides more leeway for M&A, as excess capital will likely be deployed toward enhancing or expanding the footprint of the remaining portfolio, which we believe houses Emerson’s moatiest businesses,” she said, referring to Morningstar’s ratings system.

The moves, including a previously announced $225 million restructuring, aren’t good news for everyone. Farr said layoffs will occur in western Europe, Latin America and Asia. “All companies,” he said, “have to evolve and change to the market dynamics if you want to be successful.”