The activist investors Bill Ackman and Dan Loeb are calling for the break-up of United Technologies into three publicly traded companies–the aerospace, the elevator, and the climate-control units.
Ackman offered the following comments to the press: “Other than Berkshire Hathaway, conglomerates have not had a great track record.”
That comment is bizarre because United Technologies, the company he wants to break up, is an example of a conglomerate delivering exceptional returns. It has a forty-year track record of 15% annual compounding, turning every $1 into $340. Put $25,000 into United Technologies back in the day? Boom, $8.5 million today. Even over the past decade, the compounding has occurred at a rate of 8% annualized (while dividends have grown by 10% annualized). Various sources say different things for the dividend history, but it has been growing annually for at least the past three decades.
The best part? During the 2008-2009 financial crisis, United Technologies only saw its profits dip from $4.6 billion to $3.8 billion. While the rest of the world was falling apart, these three core businesses were gushing out so much cash that the dividend was raised and stock was repurchased while all the reinvestment needs of the business were met.
It has been a delightful holding. Because the dividend payout has only accounted for 30% to 40% of United Technologies’ annual profits over the past generation, the company has been able to retire gigantic blocks of stock. There were over 1 billion shares of stock existing in 2005 and now there is under 800 million shares outstanding. Even if you did nothing but passively collect the dividends, and not reinvest or add anything at all, your ownership stake in the enterprise increased by 23% over the past thirteen years.
In a way, industrials aren’t supposed to be dividend growth stocks. Over the course of a full business cycle, profits can fall 75% from the previous high to the subsequent low. It typically requires unusual discipline and low dividend payout ratios to keep the dividends going up each year. Or, you can maintain a diversified collection of cash-generating assets that are at least a little bit uncorrelated so you can have profits gushing out from somewhere during the lean years to keep the cash payouts to shareholders steady.
Historically, there have been four industrial companies that were publicly traded that could fill the industrial investing niche for the average mom and pop investor. You had Emerson Electric. You had Honeywell. You had General Electric (which, for a wide assortment of self-inflicted reasons, is down but not out right now but never needed to be down in the first place). And then there’s United Technologies. If United is broken up, industrial investing opportunities for long-term retail investors takes another blow.
That does not mean that the three independent companies of United Technologies won’t prosper. They can and will. But the individual performances of each will be far more volatile. The problem is that only the shrewdest investors tend to be capable of holding on through the dark days. People like Warren Buffett, institutional investors like pensions and university endowments, and the family offices of America’s rich, have no problem holding shares of businesses like BHP Billiton when they cut the dividend and fall to $19 and then hold through to the day of dividend hikes and the return to a stock price in the $40s. A service I try to perform on this site is the encouragement of everyday investors to adopt the mindset of America’s “patient wealthy”. That said, the expected additional volatility in share price, earnings, and dividends from a broken-up United Technologies will turn these businesses into transfer mechanisms from the well-intentioned but frightful to the patient and wealthy when this change was altogether unnecessary.
The timing of Ackman’s comments is also relevant. He cited that the three businesses would fetch a higher P/E multiple, i.e. “the unlocked value” argument. This is the type of argument that has permit during good economic conditions. But there is a price that must be paid. During the next recession, these businesses will fetch a lower P/E multiple than they would receive if they remained the combined United Technologies that we know today.
One thing I have long admired about companies like Johnson & Johnson and Nestle is that, despite their massive size, they do not play gin rummy with their businesses too much. They don’t focus on the one-time pop. They look at what they have, and figure out, “How we can we improve the business operations itself so that it can be put to a higher and better use?” Trying to figure out the best way to tend to the flowers you already have in your garden will reap better results than pulling out some flowers and buying new ones to put in every month.
I’d rather hear Ackman talk about ways Otis elevators can build an app network for elevator repairs that can be done instantly so that it’s massive competitive advance in the elevator market can be burnished further.
Long story short? United Technologies (UTX) stock is a fantastic holding to carry with you through life. I hope it stays together, as you will gain a vaster source of financial resources to fund improvements to its capital-intensive businesses. Also, a combined enterprise will be able to continue the record of raising the dividend every year through thick and then. If the businesses are broken up into three, I would still hold onto for dear life, though the terms will change so that you’ll get a higher pop in the share prices of all three during good times but you will see deeper falls and the possibility of a dividend cut at one of them or more during the next deep recession.