The dilemma of cross-border acquisitions: Tyco International and Johnson Controls
Nowadays, Tyco has become a mere shadow of the diversified engineering group that used to be in the 1990s. Over the years, it has expanded under an aggressive acquisition strategy overseen by former CEO Dennis Kozlowski. The slice of the once $130bn conglomerate, which nowadays sells only fire safety and security systems, will be acquired by Johnson Controls in a deal valuing the total of Tyco’s equity at $14.5bn. The merger is believed to set close on October 1st. The deal is said to lower the company’s tax rate by 2 percent (from 19% to 17%).
Tyco International Ltd
Tyco International is an American security systems company based in Princeton (NJ, USA). It was founded in 1960.
The majority of its business is in security solutions and fire protection. The company has three operating segments: North America Installation and Services (NA), Rest of World Installation & Services (ROW), and Global products. The firm, in all its divisions, produces goods for commercial, industrial, retail, institutional, and governmental customers.
Tyco’s work force is made of about 57,000 employees. In 2015, revenues were as high as $9.9bn with a market capitalization of $15.6bn, and an enterprise value of $17.5bn. 53% of its revenues was generated in the US, 27% in Europe, 15% in Asia pacific and the remaining part in other parts of America.
Johnson Controls Inc.
Johnson Controls is a diversified technology company with global activities founded in 1885 and operating in 150 countries. It is based in Wisconsin, USA. The Company operates in two main segments: Building Efficiency and Power Solutions. The range of products offered is very heterogeneous: from services and solutions which optimize energy and operational efficiencies of buildings to lead-acid automotive batteries. Moreover, it produces advanced batteries for hybrid and electric vehicles, as well as seating and interior parts for automobiles.
The company serves both automotive original equipment manufacturers (OEMs) and the general vehicle battery aftermarket.
In 2015, Johnson Controls had approximately 139,000 employees. It had revenues for $36.5bn, market capitalization of $25.4bn and an enterprise value of $31.8bn. The Building Efficiency segment with $10.5bn in revenues accounted for 28% of total revenues, 42% of which was generated in the US.
Tyco International has grown predominantly through acquisitions since the 1970s, taking control of companies within and without the scope of its core operations.
In 1997, Tyco merged with the smaller ADT limited in a reverse takeover: ADT limited subsequently changed its name to Tyco International limited.
In 2002, Tyco was accused by the SEC of non-disclosure of pertinent financial information and inflating earnings. Following the resolution of the scandal, Tyco divested all non-core operations. In 2007, the company split into three publicly listed companies, one of which is the current Tyco International limited.
Johnson Controls Inc. entered the automotive seating industry in 1985: this was possible with the acquisition of Michigan-based Hoover Universal, Inc. Twenty years later, in 2005, the Company took control of York International, a global supplier of heating ventilating, air-conditioning and refrigeration equipment and services.
Johnson Controls posted a net loss although the industry has been performing rather strongly. In particular, there is an imbalance in the car sector between the US and European market, which has led to lower sales. Moreover, sales in South America have also plummeted, while in Asia there has been a slowdown in sales growth and inconsistency in terms of sales. The main drivers of change are: consumer demand change, increased regulation, and increased availability of information on cars.
On the other hand, the security systems industry is expected to grow significantly by 2020. This growth is due to an increase in demand for security systems, which stems from the increase of insurgency at a global level. The Americas are due to see the most growth while Europe (UK & Germany) and the Asia-Pacific region (Japan & India) are also expected to perform well. Tyco competes with companies like Honeywell International, UTC Fire & Security, and ASSA ALBOY.
Drivers of the deal
The merger has stirred a lot of controversy in the press, being labeled as another tax inversion deal similar to the Pfizer-Allergan mega merger.
If the transaction is approved, the headquarters of the new entity will be in the current domicile of Tyco, Cork, Ireland, where it would benefit from the lower Irish corporate tax rate of 12.5% compared to the 35% in the US. The tax savings of the combined company will amount to $150 million dollars on a yearly basis. Following Johnson Controls’ inversion, the effective tax rate of the company will be 18% or 19%, said people familiar with tax structure. Tyco has paid on average 12% of its profits in taxes for the past three years: this has to be compared with an average of 29% by Johnson Controls. Johnson Controls said its effective tax rate before certain items was around 19% over the past two years ended on September 30th.
However, the tax saving is not the main driver of this transaction.
The merger can also be considered a highly strategic combination of bringing together best-in-class product, technology and service capabilities across controls, fire, security, HVAC, power solutions and energy storage in the commercial building-products marketplace. The companies have a strong complementarity in their building products portfolio as well as in their geographical presence, with Johnson Controls being strong in building systems in US and in key emerging markets like China and India, while Tyco has a strong footprint in Europe. It is expected that operating synergies can bring another $500 million in savings.
The deal is expected to have a lot of upside potential for revenue synergies.
The two firms are building business that owns every aspect of the so-called smart buildings, that is, buildings where everything from the air conditioning to the light bulbs are connected to the internet.
The implication is that the data which are collected and then analyzed allow to make substantial gains in productivity and energy efficiency. Therefore, the merger between JCI and Tyco seems to be driven more by increasing capabilities of Internet of Things rather than the $150 million tax savings which does not seem extremely high compared to the pro-forma revenues of the new entity of about $32 billion.
Exhibit 1. Stock price evolution for Johnson Controls (in green) and Tyco (brown), compared to the S&P 500 (blue).
During the last two years, Johnson Controls has gone through a restructuring of the company that had the main objective of cutting costs and focusing the business on high margin activities in order to achieve higher profitability. This process was characterized by three major events prior to the announcement of the Tyco Deal.
First of all, in Early 2015 JCI decided to sell its Real Estate Unit to CBRE in a $1,475 Billion deal. Then, By September 2015 the company announced a plan to cut 3,000 jobs, corresponding to 2,5% of the total workforce. Finally, by mid-January 2016 the company announced that it is planning to spin off its Automotive Seating business, which will become a public company with the name Adient by October 2016.
Looking at the stock performance of JC we can clearly see how the stock underperformed the market throughout December 2015 and January 2016, up to the day of the announcement of the Deal with Tyco. The same can be said for Tyco, whose performance was lower than the S&P 500 for the same period.
On January 25, 2016 Johnson Controls and Tyco announced that they reached an agreement for merging the operations of JC that are not part of the Spinoff and the entire operations of Tyco. The deal is expected to be completed by the end of 2016, after the approvals both from shareholders of the two companies and from regulatory authorities.
On the day of the announcement of the deal Johnson Controls stock price fell 3,9%, while Tyco hiked 11,6%. This movement in the stock price represents the correction for the premium implicit in the conversion ratio offered in the deal to Tyco Shareholders. It is interesting to note how both JC and Tyco stocks started performing in line with the market after the announcement. This means that markets perceived in a positive way the announcement of the deal, and that investor have overall a positive outlook for the two merged companies. The positive outlook for the companies is also supported by analyst consensus, which as of today is strongly shifted toward the “Buy” recommendation.
Structure of the Deal
Exhibit 2. Overview of the deal.
From what has emerged, Tyco International and Johnson Controls have structured the transaction on the model as a reverse takeover, which will see Tyco’s shareholders own 44% of the combined group, while Johnson’s investors will hold the remainder 56% and receive $3.9bn in cash payment.
On one hand, Tyco will conduct what is called a reverse stock split, whereby Tyco’s shareholders will receive a ratio of 0.955 shares for each one of their existing shares of the company. On the other hand, Johnson’s shareholders will get one share of the combined company or a cash payment equal to $34.88 a share, which is a weighted average of the price of Johnson’s shares over the past five trading days prior to the public announcement to the SEC.
As it possible to infer from above, Johnson will pay an 11% premium for Tyco’s shares, which is lower than typical premiums in deals regarded as “merger of equals”. The average premium paid in a merger between equal companies was 20% during last year, according to data provider Dealogic.
The Senior Vice President of Moody’s, Mr. Clark, has explained that “should the deal be completed, the merger could boost Johnson Controls’ earnings and cash flow exponentially”. This explains why Johnson’s top management is so keen to complete this transaction under Obama’s administration.
A significant portion of the deal is structured in stocks. However, Tyco will incur $4bn of new debt to fund the cash portion of the merger directed to Johnson’s shareholders. This will force the company to triple its current debt amount as in its 2015 balance sheet.
Johnson has set plans to spin off its automotive seating and interior unit, to be named Adient, in the beginning of its fiscal year in 2017. Shares of the independent Adient will be then distributed to both Johnson and Tyco shareholders as a form of additional compensation for the merger.
Regarding the external figures involved the deal, Centerview Partners served as the lead financial adviser to Johnson Controls while Lazard served as the lead financial adviser for Tyco. The UK bank Barclays also advised Johnson Controls, while Tyco selected Goldman Sachs. Wachtell, Lipton, Rosen & Katz and A&L Goodbody were the legal advisers to Johnson Controls. Simpson Thacher & Bartlett and Arthur Cox gave legal advice to Tyco instead. Finally, Citigroup is providing all the financing for the transaction.
To conclude, the new board of directors of the combined group will consist of six members from Johnson Controls and five from Tyco. Alex Molinaroli, who is currently the Chairman of the Board and CEO of Johnson, will initially hold both roles in the new group.
Sources and References: FT, S&P Capital IQ, Dealogic, Bloomberg World Federation of Exchanges, LSE Group, Deutsche Börse Group
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