Picking the Winners of the Honeywell Breakup

0:01Tyler Crowe:We're talking matchups and breakups today on Motley Fool Hidden Gems Investing.

0:09Tyler Crowe:Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors Matt Frankel and Lou Whiteman. So we just got to the end of the Honeywell kind of breakup phase that's been going on for a year. So we're going to dive deep into that today. And of course, we're also going to hit the mailbag like we always do. But we wanted to start today with, you know, it's July 4th weekend coming up, and apparently Wall Street bankers want to clear their plates before the July 4th weekend, because there's been a ton of deals that have happened in the last couple of days.

0:39Tyler Crowe:Yesterday, John Quast, the host and company, they covered the Comcast split and the Rocket Lab acquisition. Matt, I think you were part of that discussion there. And since then, we've seen even more deals come through. I've read four of them within the past 24 hours. And what I want to do today is we're going to go through all four of them. And then I want you guys to tell me which one of these do you actually like the most? We had Digital Realty buying data centers from Blackstone for about$3.5 billion. We have Carlisle Companies, a building supply company, doing an unsolicited bid for Owens Corning.

1:10Tyler Crowe:So not done yet, but looks like something's going to happen. You've got a materials company, Martin Marietta Minerals, buying a limestone supplier for $13.5 billion. And then On Semiconductor is buying Synaptics for about$7 billion. So, Matt, I feel like somebody who loves REITs is going to go in a certain direction here. Am I right? Yeah, I mean, I like playing the AI boom with stocks that I understand, like the picks and jubbles plays, the infrastructure plays, like the data center REITs. Digital Realty has been probably one of the top two or three longest running dividend stocks in my portfolio.

1:48The deal is interesting to me. The stock is down 5 % after the deal. The company is purchasing Blackstone's roughly two-thirds interest when you combine all of them in three data centers in Northern Virginia for$3.5 billion. $1.2 billion is coming in cash. The other$2.3 billion, Digital Realty is issuing new shares. They're going to need about$1.4 billion of additional CapEx to complete the development of these. None of them are occupied or operational yet. And Digital Realty is assuming some debt as part of the deal as well. So they were already the minority owner of these three properties, just to be clear.

2:27They're just buying out Blackstone's majority stake. All three of them are already 100 % leased to hyperscalers on 15-year deals with 3.6 % annual rent escalators. So it should help the company more than keep up with inflation when it comes to their rent. Two of them are supposed to be occupied and stabilized in the first half of next year, the third in the first half of 2028.

2:51Tyler Crowe:Matt, you're making a pretty compelling case here, but the market doesn't seem to agree because the stock's down about 5 % as we're recording. So why do you think the market may be a little less as on board with this idea as you are? Yeah, and it's a good question. There are a few different reasons why. So, I mean, for one, Digital Realty says this is going to be accretive to FFO, which is funds from operations, the real estate version of earnings. but not until these properties are fully occupied and stabilized, which won't happen for a while. In the near term, it's probably going to hurt the earnings numbers.

3:26Plus, as I mentioned, they're selling$2.3 billion of new stock. And not only that, but Blackstone is selling$2.3 billion of its own digital realty stake. So it's a dilutive deal. You're going to see a lot of stock hit the market at the same time. The FFO benefit is delayed. It's a fair price. It's a cap rate of 6.5 % in real estate, which is, that's okay. It's a fair price. It's not a bargain for top quality assets. And like I said, it's going to hurt the numbers in the near term. So it's not a perfect deal, but long-term, I like the strategy here.

3:56Lou Whiteman:Yeah, it's funny. I'll take the other side of that trade. The goal of private equity is to be ruthlessly unsentimental, to buy low and sell high. And for Blackstone, they're cashing out on an asset with massive continuing capex at a premium. I get it for digital reality. I'm not saying it's going to be a terrible deal for them, But I'd rather be sitting on Blackstone's side, and I do think that this is what private equity does well. But, you know, I don't want to be boring and just focus on one deal, so let's broaden it a bit. Tyler, Carlisle's bid for Owens Corning and then the Martin Marietta deal, too, they both intrigue me because they suggest that there are management teams out there who think it is time to be greedy when others are fearful.

4:37Lou Whiteman:There's been a ton of headwinds in construction, especially on the residential side. We'll see. They may be too early here, but the sort of animal spirits in construction slash residential construction, I feel like as an investor, even if I don't want to invest in those companies, it's a data point I should pay attention to that these management teams feel like it's time to stick their necks out.

5:01Tyler Crowe:Yeah, and this certainly isn't the first time we've been hearing this consolidation of the building products space going on in the past couple of years. I feel like this has been a continuing trend in a slow market, whether that's to grow the top line now while everything's weak or to your point of seeing the bottom. One of the companies that we like to discuss here, or at least the man behind a lot of companies, Brad Jacobs, he has his company QXO, which is basically a building products roll-up company. It recently acquired TopBuild, which was an insulation building products company. There is a lot of consolidation going on here.

5:42Tyler Crowe:And it's an interesting side note to me because a lot of these companies have been for much of the 2010s and into the 2020s. They were good quality companies doing really well that have hit the skids. And it's going to be fascinating to see when renovation, new build cycle starts again with these kind of beefed up companies, whether or not, you know, these acquisitions made them better or they just kind of made them bigger, right? Because sometimes acquisitions can go both ways.

6:16Lou Whiteman:We're still too early, but how too early are we here is kind of, and, you know, and the management's wherewithal to get things done. That's the interesting question. And we'll just take from this and sort of learn as they do.

6:27Tyler Crowe:You know, not to leave OnSemi and Synaptics out of the conversation too much here. This is a company where, you know, on semi, I don't want to be too diminutive when I say this, but they're kind of like the dumb chips, right? When we think of like what we use semiconductors for, these are kind of the chips that you see a lot of like automotive companies and anyone who is translating like electronic signals to physical motion, them, companies like NXP semiconductors, companies like that are doing a lot of this. And this Synaptic deal, at least in their words, is like combining a lot of machine learning, AI inference, a lot of that kind of the technology, the platform for which a lot of OnSemi wants their new chips to be running so that they can start implementing this into, you know, making, I mean, they're kind of dancing around it, but it's basically like a path towards robotics.

7:23Tyler Crowe:and you know at the current price it seems to make sense but again like we've been talking about shifts as like this hyper growth area but like the the physical motion actuator again a diminutive term the dumb chips have not been exactly the uh the hot thing like we've seen with a lot of the other parts of the business so coming up after the break we want to break down the honeywell and all of the associated parts that it is now is

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8:28Tyler Crowe:It's been about a year for Honeywell International to complete what has been a rather stellar portfolio transformation because this was a large conglomerate that has basically divided up. I won't say four, but I think if we were to back up even further, we could go five, six, seven companies over the past 10 years as to what Honeywell has done. But this week was kind of the end of the line here where we saw the biggest breakup. And I think where management says it's going to stop. So we've got the legacy Honeywell, which is going to trade with the old ticker HON. We've got Honeywell Aerospace with ticker H-O-N-A.

9:09Tyler Crowe:and then we've also got solstice advanced materials this actually was spun out i believe back in november of last year trading on the ticker sols and then i'm going to say this wrong quantinium or quantinum with two u's uh the ticker is qnt and this was like an ipo that honeywell kind of owned it was like their quantum computing division so i know i gave a little bit of like what they did. But Matt, can you kind of give me like a more of a breakdown of like what all these companies are going to be doing now that they're on their own and away from the Honeywell corporate blanket? Yeah, well, I'm going to refer to that last one as Quantinium.

9:50Lou's going to refer to it as Quantinium. And between the two of us, one of us will be right. Quantinium just sounds so much cooler. I'm sorry. It does. It does. I think I think I'm the right one, but yours is the cooler one. Yeah. So here's a quick roundup, just a little bit beyond what Tyler just said. As he mentioned, Honeywell itself is the industrial automation and process automation company. And out of the two that just spun off, you know, Honeywell Aerospace being the other one, it's actually the smaller by revenue. Honeywell Aerospace provides power units, avionics, mechanical systems, parts, services.

10:22It is now one of the largest pure play aerospace suppliers that is publicly traded in the world. That's significant for, you'll see why later in the discussion. Solstice Advanced Materials, Tyler's correct, it spun off in October of last year and is the specialty materials parts of the business. They make a specialized refrigerant, for example. Quantenum is an interesting one. That was technically an IPO, not a spinoff, and it's still majority owned by Honeywell. I think Honeywell and one of its other investors own a combined, I think, 82 % stake in the business. This is the full stack quantum computing business.

10:58It is a pre-revenue company, like any quantum computing pure play is. And their goal is to develop both hardware and software that kind of powers the next wave of computing, which is quantum computing, which at the most, you know, optimistic timetables will be a thing in 2030-ish.

11:18Tyler Crowe:This was obviously like a lot of different parts here. And there is always the debate of like, be separate, be together. And I feel like we've been having that discussion for who knows how long when it comes to business. So Lou, make the case, like, why, like, why were they doing this now? Or what was the case for any of these even being together in the first place?

11:40Lou Whiteman:Yeah, it's funny, you can go back to the 1950s in terms of like, just these cycles of coming together and breaking apart. But kind of where we were to get to here, Honeywell stock, first of all, has done nothing this decade, and kind of wasn't a great performer before then, just flat, which I would argue does not reflect the quality of the assets in the portfolio. Now, some of this was management either, you know, being bold or being silly. They loaded up with some debt to cobble together these assets. But a lot of it arguably is the so-called conglomerate discount. Conglomerates are companies that are basically in a bunch of different industries.

12:19Lou Whiteman:Think of it as a lot of businesses under one roof. There's some advantages to this structure, but ultimately each business has its own capital needs, its own M &A strategy. They operate in different cycles and the management team for each has to basically go to the parent, go to mom and dad to ask permission every time they want to do something. There's a constant battle for who gets the allowance. The theory in this breakup is freed from that extra layer of management. Each operating team can make decisions that are in the best interest of their unit. The aerospace business can use all of the cash they're making to invest in the business or, you know, maybe pay a dividend, something like that, instead of sending their cash upstairs for it to be distributed to shareholders or funneled to other parts of the business.

13:04Lou Whiteman:In this case, you know, Honeywell Aerospace is a well-run provider of cabin electronics and other systems, but it doesn't really have a lot of room for margin expansion or maybe not even growth. It's already the market leader where it is. So, you know, for this management team, maybe it's a capital allocation story. Buybacks, bolt-on deals. That's what's going to drive appreciation. The automation business, much earlier in its lifecycle, much more just investing in what they do. They're likely to use their cash kind of internally. These are just two management teams free to do what is best for their business instead of listening to what the parent needs.

13:43Tyler Crowe:It's not just Honeywell that has been kind of going through this come together, break apart cycle. Over the past, I want to say six to 10 years, we have seen a lot of, you could argue like iconic names of industrial conglomerates basically do these breakups. We had GE, General Electric was like, you know, the gold standard of like what a company should be. And, you know, all of the disciples that Jack Welsh created. And now all of a sudden it's created into three different companies now. We've got GE Aerospace, GE Vernova, and GE Healthcare Technologies. And interestingly enough, a lot of these companies that go through these spinoffs have gone through pretty disparate returns as a result.

14:26Tyler Crowe:Like Healthcare Technologies was supposed to be the crown jewels in sort of cash generation. While since the breakup, Aerospace and Vernova have been crushing it, while Healthcare hasn't. You had like UTX Technologies and Raytheon coming together. And then they split back up into RTX, Carrier, and Otis. Same thing. Everyone kind of thought like, oh, Raytheon, this RTX avionics defense business is going to be a mega grower. Otis is going to be this high return business. We don't know what to do with Carrier. Carrier ends up being the best performer of the group. Last one too, Dow DuPont, when they merged together and did a split, kind of like consolidating and deconsolidating.

15:07Tyler Crowe:everyone thought like this agricultural business, which is called Cortiva, was gonna be the worst performer. And then all of a sudden, we're several years after the split-ups. And while you know it, Dow stock is actually down since Dow Chemical, it's just called Dow Inc. now, is actually down since the split, and Cortiva is the best performer. And so what I'm getting at here is that sometimes the things that we think are going to be the great performers of these split-ups isn't necessarily the case. And so what I'm going to do is with all of that in mind, I want you guys to put a little bit of a predictions hat on.

15:45Tyler Crowe:I'm not going to say that Honeywell's, all their business are going to follow this pattern that we saw with GE, UTX, Dow DuPont, but recent examples. So of these spawn of Honeywell that are remaining, which one do you see most likely to be the carrier or the Vinova of the split that's going to do incredibly well? and the one that's maybe going to be the GE Healthcare or the Dow of this group.

16:10Lou Whiteman:So I, full disclosure, I bought Honeywell ahead of the split because I kind of wanted to own Honeywell and Honeywell Aerospace. So for the long term, I like both of those businesses. But as I said before, arguably, you're not going to see the same surge as all, like, say, after the GE breakup, just because of where we are in the cycle for these businesses. One of of them, it's kind of already played out some and one of them is still to come. I like them over five years, I think better than I like them over one year. As for the run and the litter, Tyler, I am going to cheat and I'm going to lean in on technicality because as you mentioned at the top, this is not Honeywell's first three way split.

16:47Lou Whiteman:In 2018, they spun out their auto business and their thermostat business, the old Honeywell, what we all think of when we think of Honeywell. That residential control business, Rosadio Technologies, was the one that I would have avoided back then. It's the one I'm avoiding today. Honestly, the auto business, Garrett Motion, was to be avoided until it went through bankruptcy. But it's funny. I think the first time Honeywell sort of took out the, I don't want to say take out the trash, but kind of took the underperformers. And this time, what was left was just a desirable group. I think what's left is pretty strong, but the ones back from 2018 came out with a lot of warts.

17:30Yeah, and I would even add the Comcast and NBCUniversal deal we saw the other day to the deconglomerate trend. There have been quite a few. You're right. Maybe Berkshire Hathaway's next. I know Lew would be a fan of that. Not as much as a dividend. Let's say it that way.

17:46Lou Whiteman:The problem with doing that is that so many of the operating businesses inside Berkshire seem to have just kind of rotted on the vine or aren't as competitive as they were when they were bought. So I'd almost be afraid to, it's almost like a puppy you can't let out into the wild some of these businesses, unfortunately.

18:03Tyler Crowe:There would be a lot of portfolio fixing if we were to actually start doing some Berkshire spin-outs. There could be a dozen of them in one company. And in most cases, I mean, the motivation with most of that list you mentioned has been to separate a high growth business or one with a lot of, you know, long-term tailwinds, in like a defense spending trend or something like that from either capital intensive or commoditized, you know, boring businesses. I see Honeywell Aerospace as being the GE vernova of this. It's a pure play. It benefits from one, a reliable revenue stream from its, you know, aftermarket business.

18:40It's the surge of global defense spending that, you know, companies like Boeing and Airbus are finally starting to normalize and work through their backlogs. That's a nice trend here. I mean, there have been several recent examples of where companies in the aerospace of defense businesses get a premium multiple when they become peer plays. But on the other side, I'll go with Solstice as my GE Healthcare. It's a capital intensive business. It started with about a billion dollars of debt and it's the most boring of the four. But it's also, it's impossible to classify Quantinam into either basket.

19:12With all the deconglomerate deals you mentioned, there weren't any speculative pre-revenue companies that were created. It's a binary outcome stock. It should be approached with caution and it could either be, it could be either one of the two baskets that you mentioned.

19:26Tyler Crowe:Something about solstice, it sounds incredibly boring. It's like chemical solvents that we use for refrigerants and fluorinating uranium for nuclear power and a lot of that stuff. And the more and more you squint at it, you're like, huh, refrigerants, data centers, that kind of makes like a weird sense. Nuclear power growth, being the only one that can fluorinate uranium as part of its conversion from yellow cake to actually enriched uranium. That sounds kind of interesting. There's part of me that wants to look at that and in part and be like, man, maybe this was just like a problem child at Honeywell.

20:02Tyler Crowe:But if you bring in a management team that can really like tie this together, there are a lot of long term catalysts that could be behind this business over the long term. So each of us kind of taking slightly different bets on what can do best at GE or at Honeywell. Sorry, I'm so used to talking about breakups with GE, but it is Honeywell this time. Coming up after the break, we'll hit a listener question.

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