The industrial conglomerate model has hindered Honeywell’s ability to innovate and drive shareholder value.
Shares of Honeywell International (HON -0.06%) hit a new all-time high on Tuesday on news that activist investor Elliott Investment Management had amassed a more than $5 billion stake in the industrial conglomerate. With ownership of between 3% and 4% of the stock, it’s now the largest activist investor in the company.
Here’s why breaking up Honeywell could be a net positive for the company, a noteworthy example of a recently successful breakup, and whether Honeywell is a dividend stock worth buying now.
Image source: Getty Images.
Falling out of favor
In August 2020, Honeywell replaced defense contractor Raytheon Technologies (now RTX) in the Dow Jones Industrial Average — giving the Dow more exposure to a variety of industrial end markets. Defense is only one aspect of Honeywell’s business.
The company makes everything from household fans and thermostats to personal protective equipment, automation systems for distribution centers, actuation systems for aerospace applications, control panels, and more. And under the Honeywell Forge umbrella, it offers software that companies in an array of industries — life sciences, industrial, retail, and more — can use to improve the efficiency of their operations.
The company is organized into four segments: aerospace technologies, industrial automation, building automation, and energy and sustainability solutions.
Despite its diversification and industry leadership in several business-to-business categories, Honeywell has failed to meaningfully grow its earnings in recent years. It has gone from an outperforming stock in the market to a laggard. Even after its recent post-earnings rise and the added boost from the Elliott news, Honeywell stock is still up only 28% over the last five years compared to about a 90% rise for the S&P 500.
To make up for years of underperformance, Honeywell has been on an acquisition spree — spending over $9 billion so far in 2024. The idea is to focus on the most attractive opportunities and sell off or scale down areas that aren’t contributing to growth. That strategy could work over time, but it isn’t delivering impressive results yet. Honeywell expects organic growth of just 3% to 4% in 2024.
The thesis outlined in Elliott Investment Management’s 23-page letter to Honeywell is simple: “The conglomerate structure that once suited Honeywell no longer does, and the time has come to embrace simplification.”
Elliott proposes that Honeywell split into two companies — Honeywell Aerospace and Honeywell Automation — a move it believes could result in total share price appreciation of 51% to 75% over the next two years. Honeywell Aerospace would focus exclusively on aerospace and defense — areas that produce nearly half of Honeywell’s profits today. The aerospace and defense industries have been booming, with record valuations for many top players such as RTX and Lockheed Martin. Elliot argues that making Honeywell Aerospace its own business would help it bridge the valuation gap between it and its peers.
Honeywell Automation would combine Honeywell’s other three business segments under one entity. Elliott blames the conglomerate model, rather than Honeywell’s products, as the main cause of its disappointing results in recent years.
Taking a page out of GE’s book
Perhaps the most critical line from Elliott’s letter was this:
The benefits of a separation can be broken down into two primary areas: A) an enhanced strategic focus that will allow each company to drive improved operating performance, and B) a set of simplified investment narratives that will deliver superior valuations.
Narratives are an essential aspect of investing. They can transform a company’s description into a compelling argument for putting your hard-earned savings into its stock. The narrative behind Nvidia isn’t that it designs chips — it’s that its chips are powering an entire technological evolution through artificial intelligence. Apple became a great company because it vertically integrated complex software and hardware into easy-to-use consumer products.
Honeywell doesn’t have a coherent narrative right now because it does so much. GE was in the same boat not long ago. And then, it broke up into three entities: GE Aerospace (GE 0.33%), GE HealthCare (GEHC 1.17%), and GE Vernova (GEV -1.33%). All three of those companies have clear, specific narratives that can help drive investor loyalty and purpose.
GE Aerospace develops integrated systems for commercial, military, business, and general aviation aircraft. It’s a technology and industrial play in the aviation market. GE Healthcare makes products and services for healthcare, from imaging and ultrasound equipment to digital solutions for data management, visualization, and more. It’s an industrial and technology play in healthcare.
GE Vernova makes gas and steam turbines, generators, heat exchangers, wind turbines, hydrogen, carbon capture solutions, and more. It has marketed itself as a provider of solutions for the entire energy transition, not just oil and gas or renewables. Since its spin-off on April 2, GE Vernova is up a staggering 154% — making it one of the five best-performing stocks in the S&P 500 this year.
GE Aerospace remains the largest of the three ex-GE businesses by market capitalization at about $198 billion — up 238% in just two years. GE Vernova now is valued at a little over $91 billion, and GE Health Care sports a $39 billion market cap. All told, the post-break-up company is valued at about $328 billion today. For context, GE’s market cap at the end of 2018 was a mere $41 billion.
Its breakup drove one of the most successful business turnarounds in recent history, providing a clear case against the conglomerate model.
A direction worth taking
Honeywell has looked great on paper for years, but has failed to deliver on investor expectations. Management recognized a need for change, so it has been aggressively pursuing acquisitions. Yet a breakup may be just what Honeywell needs to capitalize on the megatrends it has been so adamant about for years, such as the Industrial Internet of Things, automation, and the clean energy transition.
Trading at a price-to-earnings ratio of about 27 and with a dividend yielding 1.9% at the current share price, Honeywell is a decent value with an OK yield, but there’s nothing about it that jumps out as an investment. Management has offered no indications that it’s considering a breakup of the company, so it’s all speculation at this point.
Still, the fact that a prominent activist investor has taken such a large stake in the conglomerate and believes that it could be a coiled spring for growth is a sign that Honeywell could have a lot more value than meets the eye.