Analysis: Emerson pays dearly to shore up defenses

By Nick Zieminski

NEW YORK (BestGrowthStock) – Emerson Electric Co’s (EMR.N: ) $1.5 billion deal for British power supply systems maker Chloride Group Plc (CHLD.L: ) marks a rare case when the disciplined U.S. conglomerate may have overpaid for an asset.

But David Farr, chief executive of the maker of industrial automation systems, may have felt he had no choice, needing to dig a “moat,” as one analyst put it, around a fast-growing business that Swiss engineering group ABB AG (ABBN.VX: ) was eyeing.

Buying the maker of uninterruptible power supplies allows St. Louis-based Emerson, which bought network equipment company Avocent last year, to further expand its network power business, which serves companies investing heavily in building new data centers and computer networks.

That market access, especially in Asia, could prove critical at a time when Europe’s economy is looking increasingly shaky and the U.S. environment remains sluggish.

“It’s a very rich valuation to put on an asset right now,” said analyst Daniel Holland of Morningstar.

Holland said Emerson overpaid by up to $300 million when it boosted its bid to top rival ABB’s $1.3 billion offer for Chloride, which generates annual sales of about $510 million (340 million pounds).

“If at the end of the day they can generate better profitability and better sales, it’s something that you can look past,” Holland said.

Chloride’s board has backed the sale to Emerson.

Key rivals Schneider Electric SA (SCHN.PA: ) and U.S.-based Eaton Corp (ETN.N: ) are beefing up their backup power businesses, and Emerson does not want to fall behind, Holland said. He called the deal mostly defensive and said it would likely temporarily sideline Emerson in the game for bigger mergers and acquisitions.

Global industrial companies — cash-rich, attracted by depressed valuations and keen to find future sources of growth — are on the lookout for assets. But when they face off in a bidding war, those valuations can quickly become lofty.

Bernstein Research analyst Steven Winoker called the all-cash deal “expensive by most measures.” It will cut Emerson’s net income by about 1 percent next year and add about 3 percent to earnings in 2012, he said in a note to clients.

“The price saps most if not all of the upside to the deal. (It) is at best neutral to Emerson investors,” Winoker wrote.


By winning Chloride, Emerson remains dominant in the uninterruptible power supply market, estimated at about $7 billion a year and expanding by at least 7 percent in each of the next three years. Sterne Agee estimates Emerson has about a 30 percent share of that market, ahead of Schneider and Eaton.

Emerson is paying a “pretty rich price” of about 11 times next year’s earnings for Chloride after accounting for promised cost savings, said Sterne Agee analyst Nick Heymann, who believed Emerson was surprised by ABB’s rival bid.

“They’ve been doing due diligence for close to two years,” Heymann said. “What wasn’t due diligence done very well was who might be their potential opponent.”

Once ABB stepped in, Emerson was caught in a bidding war for a company whose main assets are in slow-growing Europe. So Emerson needed to build a defensive “moat” around a market with only two other major competitors, Heymann said.

“Emerson wants to be dominant and well positioned in the market for network power,” Heymann said. “This further solidifies their position in Europe and Eastern Europe. (But) it’s a pretty full price.”

One long-term Emerson shareholder has faith in the Emerson strategy.

“We’d love for them to pay a lower price, but based on the management team’s track record, we feel OK with it,” said Eric Schoenstein of Jensen Investment Management, who said there was a strong case for growth in the network power business.

“That build-out and that need for better backup systems, more automation, more efficiency, is not going to abate any time soon.”

Chloride is Emerson’s second largest purchase in this area. Last year, it made a $1.2 billion cash deal for Avocent, whose products manage the temperature and energy use of computer networks for clients such as Yahoo Inc (YHOO.O: ) and Brocade Communications Systems Inc (BRCD.O: ).

“The Avocent deal was pretty savvy. This one remains to be seen how savvy it was from an absolute price perspective,” Schoenstein said.

He added the company was clearly assuming it will realize strong “top-line synergies” — selling Emerson products to Chloride customers and vice versa.

Indeed, Emerson has long argued large deals do not immediately pay off. It has also said it expects to wring annual cost savings of $50 million or more from Chloride.

“The Avocent transaction and the Chloride transaction will greatly increase the value of our business in network power, and that will be over time,” CEO Farr said during a May conference call with investors. “That’s how we look at them.”

(Reporting Nick Zieminski; editing by Andre Grenon)

Analysis: Emerson pays dearly to shore up defenses