Illinois Tool Works Looks to Get Lean and Mean
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Under continuing pressure from shareholders – most notably activist investor Ralph Whitworth, manager of Relational Investors LLC – Illinois Tool Works Inc. (NYSE: ITW) has agreed to sell a 51% stake in its Decorative Surfaces segment. While the sale is not enough alone to bring the company to the truly lean and streamlined status that Mr. Whitworth seems to envision, it is a solid first step; other divestitures have been openly discussed. The sale comes in the midst of a period that has seen many large corporate players using asset sales to strengthen or firm up the bottom line. When considered in the context of the company’s standing amongst its peers, the move may represent a buying catalyst for the big conglomerate.
The Relational Relationship
Mr. Whitworth’s firm is a 3 percent stakeholder in Illinois Tool, owning 14.6 million shares. In January, the two firms reached a cooperation agreement that, amongst other things, gave Relational Investors the option to appoint a member to Illinois Tool’s board of directors in 2013. Subsequent to the conclusion of this arrangement, regulatory filings show that the firm bought an additional 6.8 million shares during the second quarter to bring it to its current ownership level.
One of the primary focuses for the investment firm was to push the company toward becoming more streamlined and disciplined. To this end, on Aug. 16, Illinois Tool announced the sale of 51% of the Decorative Services business to the private equity firm of Clayton Dubilier & Rice LLC. The sale will generate $1.05 billion in cash and debt for Illinois Tool. While other specific transactions have not been disclosed, the combined details of the company’s desire to divest its consumer packaging business and its recent sale of its finishing businesses in April give some indication which parts of the conglomerate are on the block. Each of these businesses fall under the All Other segment. If and when more streamlining is effectuated, Illinois Tool will be even leaner; the supplemental income generated by asset sales should be a strong plus for the stock.
Is Illinois Tool Attractive Already?
The involvement of Relational could be a strong positive for the stock, particularly longer-term if the investment firm adds a board member. A relationship with a large institutional investor can be a significant driver of performance. Even after the announcement that the company had been sold last May, Cooper Industries Plc (NYSE: CBE) is getting new attention because of a significant holdings increase by John Paulson. The head of Paulson & Co. seems to be returning to the success he has found in classic merger arbitrage. While this is a somewhat different situation, it highlights the impact a big name investor can bring to a stock.
On a valuation basis, Illinois Tool’s multiple of 12.3 looks very attractive relative to some of its biggest competitors. General Electric (NYSE: GE) is trading at a trailing twelve month P/E of 18.1 and The Manitowoc Company (NYSE: MTW) is trading at a 21.7 multiple. Additionally, Illinois Tool’s operating margin is 16% relative to 12% for GE and 7% for Manitowoc. While these are not perfect comparisons, finding true comps when considering conglomerates can be difficult. Where GE is primarily known for its consumer electronics, aerospace and medical units, Illinois Tool is diversified in fasteners, adhesives and others; Manitowoc is primarily in the business of farm and construction equipment. Still, despite the imperfect juxtaposition, the message should not be lost. Even before the streamlining process is complete, Illinois Tool is trading at an attractive relative multiple and is operating efficiently. The plans to further focus the company should be a positive and explains why the recent news should serve as a buying catalyst.
Overview
Recent divestitures coupled with the future plans of Illinois Tool make the company a solid candidate for one’s core portfolio. The company has an attractive valuation and is operating efficiently. With a dividend yield of 2.7%, the stock offers an income element that can compete with U.S. Treasuries. The sum total of all the factors mean that recent news should serve as a catalyst to initiate a position in this stock.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Illinois Tool Works. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
