Activism Spotlight: Pentair's Breakup Shows Trian's Analytics at Work
Trian Fund Management's Ed Garden

In August, Pentair plc (PNR) decided to sell a valves and controls business it had acquired a few years earlier to Emerson Electric Co. (EMR) for $3.2 billion.

Behind the scenes, as that deal was carried out, activist investor Ed Garden, CIO of Trian Fund Management, a Pentair director since 2015, began collaborating with Pentair CEO Randall Hogan to identify the next step to drive shareholder value. For Garden, the sale to Emerson acted as a catalyst to drive the company into splitting its remaining water and electrical business into two separate companies.

"The decision to monetize valves and controls was the catalyst to allow us to look at the business and say, 'we have two businesses, water and electrical, that have critical mass, that could be standalone businesses on their own,'" Garden said at "Corporate Governance: Navigating New Challenges to Value Creation," a June 5 event sponsored by The Deal and BoardEx, business units of The Street.

Garden and Hogan spoke to The Street founder Jim Cramer at the conference about how they came to agree that—once that unit was sold off—it was time to split its remaining largest businesses into two separate companies. Trian, an activist fund that prefers to be known as a "liquid private equity" or a "highly engaged shareowner," became a Pentair investor, reporting a 7.2% stake, in 2015.

Around that time, Hogan explained, he had become so focused on the valves and controls business, partly because it has been struggling due to a commodity prices downturn, that he didn't have time to focus on water and electrical.

"That was a tough time," Hogan said. "That sale let us pivot to splitting the company... Ed [Garden] was early in thinking on that idea and helped me bring the whole board there. The whole board is on board with doing it."

Pentair CEO Randall Hogan
Pentair CEO Randall Hogan
The Pentair breakup, which was announced in May, will create a water business that includes filtration and environmental systems with $2.8 billion in sales and an electrical company with $2.1 billion in revenue. Hogan plans to retire as CEO and chairman of Pentair when the split-up is completed and will take the role of chair at the electrical firm.

Activists often urge companies to break themselves up with the goal of extracting value by focusing the market on various parts of a business that might be hiding inside confusing conglomerate structures. A key issue is that analysts following large multifaceted companies often have expertise only in one part of the business, which often results in skewed coverage and undervalued stocks. 

Some activists may push for a spinoff to create a short-term pop in the stock price, with plans to cash out their investment shortly after the division is consummated. In other cases, they want one or both of the spun off units sold down the road.

Sometimes spinoffs don't make sense, as was the case when Timken Co. (TKR) divested its steel business from its bearings unit under pressure from an activist in 2012. After the breakup, the newly formed Timken Steel Corp. (TMST)'s share price has mostly been on a downward trajectory, from roughly $50 a share in 2014 to trade recently at $14 a share.

However, in other cases activist-driven breakups work, as can be seen at Ingersoll-Rand Inc. (IR), a diversified industrial company ultimately agreed to spin off its commercial and home security operations division into a new public company called Allegion PLC during Trian's involvement. Allegion's share price is up significantly since the split, trading at roughly $77 a share; the parent, Ingersoll-Rand saw its stock increase to $88 a share.

In addition, General Electric Co. (GE)  announced Monday that its embattled CEO Jeff Immelt plans to step down this year, a move that came as the iconic U.S. industrial conglomerate continued to face pressure from Trian. In the wake of the C-Suite shuffle, some analysts suggest that more M&A at GE could be on the horizon.

At Pentair, Garden, who submitted a white paper, argued that a split made sense because there were few synergies between the company's electrical and water businesses. In addition, he added that once divided the two companies could maintain investment grade credit ratings.

"Each could be investment grade because of the valves and controls sale," Garden said. "And it's not as if they shared the same distribution, technology, raw materials or manufacturing process. They were very separate businesses which got us thinking about how to maximize organic growth...."

Activists often face backlash if their strategies result in damaged credit ratings. For example, David Einhorn's recent plan to have General Motors Co. (GM) set up two classes of shares was overwhelmingly defeated, partly because two major credit rating firms—Standard & Poor's and Moody's Investors Services Inc.—warned that the adoption of Einhorn's proposal would prompt them to lower GM's debt ratings.

At Pentair, there is reason to believe that Trian will stick around for the long-haul. Garden said Trian plans to remain the largest shareholder of both companies, once they are divided. In addition, the fund will have director seats at both the water business and the electrical firm. The large stake and board seat suggests that Trian believes both companies will do well on their own—or that one or both could become acquisition targets in the months to come.

One analyst following the situation suggested that there is a much higher probability of a sale of one or both of the two units once the division is completed because potential buyers will have an easier time integrating one of the businesses into their operations than both of them. 

In addition, it's possible that the separation will make capital available for bolt-on acquisitions. The analyst noted that the valve and controls business sale significantly deleveraged the remaining Pentair operation, injecting an approximate $3 billion cash cushion that will be divided between the separated water and electric operations. The new capital, he argued, will make it easier to allocate capital for such deals, particularly since the water and electrical businesses won't have to fight with one each over what kind of M&A is a priority. He added that the company's balance sheet had not previously been ideal for the kind of split but that the valves unit sale made a division possible.

Hogan, in his comments, suggested that separation will make each company more nimble and independent. "For this company to thrive it doesn't matter the size," Hogan said. "It matters whether they can control their own destiny. I know when the two units are separated they will be able to control their own destinies."

However, for Garden, Pentair and the two companies that emerge, the most important thing is that both businesses have strong futures. And they do, he contends.

"Water is a critical resource," Garden said. "It's needed for recovery, reuse and purification and it is only going to get more important," he said. And Garden described the world's increasing digitalization is "a tailwind for our electrical business."

General Electric is a holding in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells GE? Learn more now.

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