Eaton Corporation plc (NYSE: ETN) bought Cooper Industries in late 2012 for roughly $12 billion. It was a huge deal for the power management company, vastly increasing its position in electrical products. It was so big, though, that the company swore off further dealmaking until the integration process was complete. At the company's investor day on March 1, it basically told the world that it was shifting to a new game plan. Here's what you need to know.
Nothing big coming your way
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Cooper was a transformative acquisition for Eaton, which traces its history back over 100 years to the early days of the auto industry. Prior to that deal, the company's vehicle division was one of the biggest drivers of corporate performance. Its electrical products and electrical systems & services divisions were important, to be sure, but neither was as large of a contributor to revenue as was vehicles. Following the Cooper deal, the vehicle division is now roughly half the size of either of its two electrical operations.
To be fair, Eaton didn't swear off all deal-making following the nearly $12 billion purchase of Cooper, it simply wanted to avoid big moves so it could focus on successfully integrating the two businesses. That was a multiyear process during which it made small deals to fine-tune the portfolio. So, there was more going on than just Cooper, but all of the changes were really at the fringes.
The end result, though, was a shift away from the vehicle industry to what management believed would be a more compelling opportunity -- the ongoing electrification of the world.
Picking up the pace of change
That said, 2017 saw a slight shift in the company's approach. Eaton formed a joint venture with Cummins toward the end of that year, merging the two companies' automatic transmission businesses. Cummins was left to run the business. Not a massive move, but it was a notable change in direction.
It followed that up with the creation of the eMobility division at the start of 2018. Eaton cobbled this still-tiny business together from internal operations. But because supporting the electric vehicle market is very different from supporting the combustion-engine side of the auto industry, Eaton separated it out as its own division. It believes eMobility could be a $4 billion business some day, putting it in the same league as its aerospace, hydraulic, and vehicle operations.
These weren't giant changes, but they represented shifts that were larger than what had been undertaken in the years following the Cooper deal. This leads us up to the company's early 2019 investor meeting, at which it basically announced it was ready to throw off the self-imposed shackles: Management explained at the meeting that it planned to spin off its lighting business -- with $1.7 billion in revenue -- by the end of 2019.
For a number of years, the company has been dealing with questions about the lighting division. It isn't a bad business, per se, but falling LED prices have been a headwind and have resulted in intense competition for business. Eaton's focus isn't on producing LEDs, but instead working on massive installation projects (think stadium lighting systems) that use LEDs. However, it had been having a hard time finding deals that it believed were worth inking, and margins in the business had remained relatively weak.
These are key factors, here. Eaton has been working hard to improve its margins, and finding great success. The company's operating margin fell to 12.6% in 2016, a 50-basis-point drop from the previous year. Cost-cutting and efficiency efforts, though, were able to push operating margins to 15.8% in 2017 and 16.8% in 2018. At this point, the easy fruit has been picked, and the company needs to start making more notable shifts if it wants to continue to improve its performance on this metric. Eaton doesn't break out the lighting division, but it was pretty clear on the fourth-quarter conference call that neither growth nor margins in the group have been living up to expectations. And, looking forward, it was noted that growth might only be in the low single-digits, which is better than recent performance, but not as robust as the company's growth expectations in other divisions.
This move, then, will allow Eaton to jettison a lower-margin business that is constraining its performance and focus its efforts on businesses with better growth outlooks. The remaining operations should be more profitable as a whole. Perhaps more importantly, it also signals that the company is no longer holding back on the change front: Bolt-on deals in the hundreds of millions of dollars range are nice, but management is again willing to size up. It even laid out its criteria for acquisitions, spotlighting above GDP growth, average margins in the mid to high teens, and cyclical trough margins at least in the low teens. It's mentioned these before, but putting them on their own slide looks like a big hint that Eaton is in a buying mood.
Keep an eye on the transaction flow
At this point, Eaton says it is happy with its portfolio. However, with the lighting move, it has made a major statement about the future. Watch the news out of Eaton on the acquisition front. It will likely continue to focus on smaller, bolt-on deals. But with the Cooper integration process complete, it looks like management may again be willing to do something much bigger.
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