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Honeywell International Inc. (HON): Why Dan Loeb’s $20 Billion Spinoff Proposal May Be Far-Fetched

Billionaire Dan Loeb, the head of $15 billion hedge fund Third Point, has his eyes set on a $20 billion prize. The money manager’s first-quarter letter to investors, which was released on April 27, revealed a plan for Honeywell International Inc. (NYSE:HON) that Third Point believes could increase shareholder value by more than $20 billion. Third Point opened a Honeywell position in the fourth quarter containing 1.375 million shares worth over $159 million, ranking it as the fund’s 21st-most valuable position. That position has since been increased substantially according to a source, which told CNBC that it’s now one of the fund’s five largest positions.

Loeb’s plan for the company calls for it to spin-off its Aerospace unit, one of the industrial conglomerate’s four major divisions, the others being Home and Building Technologies, Safety and Productivity Solutions, and Performance Materials and Technologies. Third Point believes that doing so would force investors to revalue the company closer to its industrial peers like 3M Co (NYSE:MMM) and Rockwell Automation (NYSE:ROK), which collectively trade at forward P/E multiples about 30% higher than Honeywell’s 18x figure. Honeywell shares surged by as much as 4% following the news of Loeb’s proposal, but later retreated.

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Third Point

Third Point’s main argument in favor of the move is that the organic growth from Honeywell International Inc. (NYSE:HON)’s Aerospace division has lagged behind its peers and deserved the blame for the company’s recent earnings misses. The hedge fund is convinced that Aerospace is responsible for what it believes to be Honeywell’s discounted valuation.

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Indeed, the Aerospace unit has grown revenue by just 0.6% annually over the past five years and organic growth for the division was flat in the first quarter. Nonetheless, it’s a high-margin division (22.4% in Q1) that also accounted for 37% of Honeywell’s revenue in 2016 and nearly 45% of its profit in Q1. Given Honeywell’s ambitious capital allocation plans over the next three years (up to $18 billion is being earmarked by new CEO Darius Adamczyk for dividends, buybacks, and M&A), ridding itself of its top source of U.S free cash flow could present serious challenges, even should Honeywell also sell off some of its other assets, like its automotive group.

In response to Loeb’s proposal, Honeywell offered the following regarding its Aerospace unit: “We have a strong portfolio of businesses with great positions in growing industries.  Aerospace is no exception. Our substantial investments and outstanding OEM platform wins will contribute to top-line growth and margin expansion for years to come.”

While Honeywell International Inc. (NYSE:HON) said that it would carefully consider Loeb’s proposal, it sounds like it is more intent on sticking with the vision of its new CEO, including more aggressive capital deployment, which simply doesn’t mesh well with Loeb’s $20 billion vision.

Dan Loeb
Dan Loeb
Third Point

Disclosure: None