[fm]: Tyco shows how to achieve growth in a no-growth environment

Johnson Controls (JCI) agreed on Monday to acquire Ireland-headquartered Tyco International (TYC), combining the companies’ building-control businesses. This $3.9 billion deal marks the latest move by an American company to lower its tax bill through an inversion, which allows U.S.-based corporations to acquire foreign-domiciled companies and reduce their tax rates by shifting their headquarters. The $160 billion acquisition of Allergan (AGN) by Pfizer (PFE), announced in November, is the most high-profile and recent tax inversion deal.

But Tyco’s 11.7% spike on Monday, in a pressured market, is emblematic of a broader trend: Companies searching for earnings power in a low-growth macro environment. After all, fourth-quarter GDP growth is expected to clock in at just 1.4%.

Given an absence of organic growth, companies have become inventive in extracting value, using strategies employed by investment bankers. In addition to tax efficiency strategies, “Wall Street wizards" have advocated business break-ups.

And many of these splits have led to eventual mergers, contributing to the record-setting $3.8 trillion spent on mergers and acquisitions in 2015 and likely fueling the pending 2016 M&A activity as well.

Breaking up aint hard to do when it leads to a merger

Corporate break-ups have dominated headlines in recent years across all sectors -- with names ranging from eBay (EBAY) and Paypal (PYPL) to Hewlett Packard Enterprise (HPE) and HP Inc. (HPQ) to Twenty-First Century Fox (FOXA) and News Corp. (NWSA). De-conglomeration has been a growing trend among industrial companies, as well -- even General Electric (GE) has shed its financial business. Splits have spanned sectors from oil and gas, including Marathon Oil (MRO) and Marathon Petroleum (MPC), to healthcare names like Abbott Laboratories (ABT) and AbbVie (ABBV), to food companies like Dean Foods (DF) which spun off WhiteWave Foods Company (WWAV). Other giants have been pressured to break up, including Pepsi (PEP) and Johnson & Johnson (JNJ).  Investors have applauded companies that are easier to value with management teams that can focus on specific businesses.

Sometimes the broken-up pieces of the company become acquisition targets themselves. This is the case with Tyco. In 2007, Tyco, known as one of the “original conglomerates,” split into three publicly independent companies—its healthcare business, Covidien; its electronics business, TE Connectivity (TEL); and its engineered products and services, Tyco International. Tyco International was then further broken down when it spun off its home security business ADT (ADT) and sold its flow-control company to Pentair, leaving the core business focused on fire and security products.

Johnson Controls, currently in the process of spinning off its auto parts business, aims to combine its core building efficiency business with Tyco's buildings platform. Johnson expects the move will save $500 million in the first three years after the deal closes.

Pure play to target

Tyco is just the latest example of a pure-play company that has become part of a value-creating merger.

Amercian Standard's break-up in 2007 is one well-known example of this phenomenon. In 2007, the company sold its plumbing fixture business and spun off its auto braking systems unit, WABCO (WBC), while the remaining core company, renamed Trane, was later acquired by Ingersoll Rand (IR).

The March 2015 announcement that Kraft would merge with Heinz (now called The Kraft Heinz Company (KHC)), in a deal backed by Berkshire Hathaway and 3G Capital, marked the last piece of a long series of breakups for the food manufacturer. In 2011, Kraft split into the domestic Kraft with brands like Jell-O and Velveeta and the international Mondelez (MDLZ) with emerging markets snack brands like Oreos and Ritz crackers. Kraft had originally been part of Philip Morris before it split its tobacco and food businesses in 2007.

In 2012, Sara Lee split into its packaged meats business, Hillshire Brands, and international coffee company, D.E Master Blenders, which was later bought by a European conglomerate. And Hillshire got not one, but two bids -- from Pilgrim's Pride (PPC) and the ultimate winner Tyson Foods (TSN), which paid a 70% premium for it in 2014.

Beam, the liquor company behind Jim Beam, Sauza tequila, and Maker's Mark, was acquired in early 2014 by Japanese spirits business Suntory for $16 billion, a 25% premium to its price before the announcement. Beam was the final result of an October 2011 breakup of Fortune Brands, which was once a golf business, a home and security business, and a liquor business.

And even Covidien, the former healthcare arm of Tyco which spun off its pharma division Mallinckrodt (MNK), was acquired by medical device behemoth Medtronic (MDT) in another tax-inversion deal.

The bottom line: The break-up-to-merge value-creation mechanism is a trend that stands to continue, boosting the stocks involved despite the market's negative pulls of oil and China.

By: Nicole Sinclair. 

Review: Emerging Market Formulations & Research Unit, Flagship Records.
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