Stock Spinoffs

Ingersoll Rand and Gardner Denver To Put Their Whole Selves In, Reverse Morris Trust It All Around

Inelegant Investor

That’s what it’s all about. How do you sell off part of your business and not pay taxes? The answer, of course, is a reverse Morris Trust transaction. Ingersoll-Rand(IR) is an Ireland-based industrial conglomerate with a $30 billion market cap and 49,000 employees. Ingersoll Rand is no stranger to these pages, having spun off its security business as Allegion(ALLE) in 2013.  The company will now be spinning off its industrial assets and retaining its HVAC and transport refrigeration assets. These assets “will become a pure play global leader in climate control solutions for buildings, homes and transportation (“ClimateCo”).” A new name will be coming for ClimateCo, hopefully one of the existing brands in the portfolio(i.e. Trane or ThermoKing), but more likely an overpriced branding consultancy will come up with something like Climatoolicious designed to invoke feelings of cold and aspirations to shape ones climate for the benefit of humanity.

The spinoff will immediately merge with Gardner Denver(GDI) in a reverse Morris Trust transaction and will retain the Ingersoll Rand name. The companies expect this will take place by early 2020. The key benefit of a reverse Morris Trust transaction is that there is no taxable gain. In order to qualify, shareholders of the company spinning off a business must retain a majority stake in the combined business. In this case, Ingersoll Rand shareholders will own 50.1% of the new Ingersoll Rand stock, with Gardner Denver shareholders receiving 49.9%.  ClimateCo will also receive $1.9 billion in cash from the new company, funded by debt.

Under the terms of the agreement, which has been unanimously approved by the Boards of Directors of Ingersoll Rand and Gardner Denver, at the time of close, ClimateCo will receive $1.9 billion in cash from Ingersoll Rand Industrial that will be funded by newly-issued debt assumed by Gardner Denver in the merger. Upon close of the transaction, existing Ingersoll Rand shareholders will receive 50.1% of the shares of IndustrialCo on a fully diluted basis, valued at approximately $5.8 billion 4 . Existing Gardner Denver shareholders will retain 49.9% of the shares of IndustrialCo on a fully diluted basis. The transaction is expected to be tax-free to Ingersoll Rand and Gardner Denver’s respective shareholders for U.S. federal income tax purposes.

Naturally, there’s excitement all around about this deal. The headline on Ingersoll Rand’s website, shown above, calls it “a compelling transaction”. We mean, we enjoy reading Form 10s as much as the next guys, but maybe compelling is a bit hyperbolic.

“This transaction will create a global leader in mission-critical flow creation and industrial technologies, and accelerate both companies’ strategic priorities of deploying talent, driving growth, expanding margins through increased efficiencies and allocating capital effectively,” said Vicente Reynal . “Gardner Denver and Ingersoll Rand’s Industrial business have a combined history of over 300 years, and are both renowned for our commitment to operational excellence, innovation and quality.”

Vicente Reynal added, “Together we believe we will create meaningful value for shareholders through our increased scale and reach, unmatched portfolio of iconic brands, highly compelling service and aftermarket platform, exposure to diverse and attractive end markets and geographies and the expected realization of significant synergies. We look forward to combining the strengths and talents of our teams, and providing our customers with more comprehensive solutions and broader, industry-leading product, service and aftermarket offerings.”

“Ingersoll Rand has a long track record of top-tier financial performance,” said Mike Lamach . “This transaction presents a compelling opportunity to unlock significant value for all of our stakeholders through the formation of two global leaders in their respective sectors. In addition to owning one hundred percent of the ClimateCo, our shareholders will also benefit from majority ownership of IndustrialCo and the significant synergies expected to be unlocked as a result of the combination.”

Mike Lamach added, “As a pure play global leader in the climate control solutions markets, we will leverage our leading brands, outstanding sales and service channels and our proven business operating system to capitalize on global sustainability megatrends that play directly to our strengths: reducing energy demand and greenhouse gas emissions and improving efficiency in buildings, homes and transportation. With greater focus, more targeted investments and a simplified business model, we believe our new company will continue to drive above GDP growth and deliver value for shareholders, customers and employees.”

One interesting note that we don’t recall seeing in similar announcements- all employees in the new Ingersoll Rand will be granted equity awards. In total, $150 million will be awarded. This is a nice gesture, and its inclusion in the deal press release is telling.

Following the close of the transaction, IndustrialCo intends to grant all employees of the combined company – who are not already equity eligible – with an equity award in IndustrialCo. The total amount of these awards will be approximately $150 million .

“In the same spirit in which we granted stock to our employees during Gardner Denver’s IPO, we feel strongly that all employees of IndustrialCo should be owners of their business,” said Peter Stavros . “We believe in fostering an ownership mentality, and that this drives motivation and engagement, something that has been clear in Gardner Denver’s strong performance. We look forward to offering this equity award to all eligible employees of the combined company and working together to drive the business forward to create value for all of our shareholders.”

The companies also provided detailed rationale for the transaction:

Key Strategic & Financial Benefits

For IndustrialCo 5

IndustrialCo brings together two highly complementary, premium industrial companies with strong operating platforms and exposure to attractive secular growth trends and diverse end markets. IndustrialCo is expected to benefit from:

  • An experienced management team and the combined talents and skills of Ingersoll Rand and Gardner Denver team members with a continued strong focus on culture and employee engagement;
  • 2019E pro forma revenue of approximately $6.6 billion and adjusted EBITDA of approximately $1.6 billion (including identified cost synergies to be realized);
    • Ingersoll Rand Industrial valued at approximately 11x 2019E adjusted EBITDA pre-synergies ;
  • Generation of long-term shareholder value through significant expected synergies and revenue growth opportunities;
    • Annualized cost synergies of approximately $250 million expected to be achieved by the end of year three following the close of the transaction through efficiencies in manufacturing, supply chain and procurement and structural overhead;
    • Meaningful opportunity to drive incremental revenue growth by leveraging a broader portfolio of technologies, service capabilities and geographic expertise;
    • Opportunity to enhance customer value and accelerate margin expansion through increased efficiencies by leveraging Gardner Denver’s execution excellence practices and Ingersoll Rand’s business operating system.
  • More comprehensive solutions and an industry-leading product, service and aftermarket portfolio;
  • Greater scale and reach through leading brands with strong global footprint across North America , Europe , Asia Pacific andLatin America ;
  • Exposure to diverse and attractive end markets ;
    • Balanced industrial portfolio with 90% of revenue having a GDP+ growth profile and 10% of revenue driven by upstream energy activity;
    • Continued execution on successful Club Car growth strategies in low-speed, electric vehicle end markets linked to sustainability trends.
  • Approximately 40% recurring pro forma revenue and long-term growth opportunities , driven by highly compelling services and aftermarket platforms;
  • Strong cash flow generation, supporting a balanced and effective capital allocation strategy:
    • Pro forma net leverage ratio of approximately 1.9x, inclusive of approximately $250M cost synergies expected to be achieved by the end of year three following the close of the transaction, allows for continued balance sheet flexibility 6 ;
    • Low capital intensity of ~2% capex as a percentage of sales facilitates enhanced opportunities to strategically allocate capital and generate strong free cash flow conversion.

For ClimateCo

With a strong portfolio of market-leading brands including Trane and Thermo King well positioned to capitalize on global sustainability megatrends, the industry-leading ClimateCo is expected to benefit from:

  • Revenue of approximately $12.9 billion 7; and adjusted EBITDA of approximately $2 billion 8.
  • A complete portfolio of energy-efficient equipment, controls and services, continuing to generate top-tier growth and high recurring revenue streams;
  • A strong global footprint, with leadership positions in key markets in North America , Europe , Asia Pacific and Latin America , and leading brands including Trane, a world leader in HVAC and Thermo King , a world leader in refrigerated transportation;
  • Proven business operating system designed to deliver strong top-line growth, incremental margins and powerful free cash flow;
  • An experienced management team, exceptional global talent and continued strong focus on winning culture and employee engagement ; driving high levels of commitment, innovation, productivity and customer satisfaction.
  • Above-GDP growth driven by global sustainability megatrends;
  • Strong EPS growth and free cash flow generation , driven by healthy leverage;
  • Continued dynamic capital allocation strategy , with expected deployment of 100% of excess cash over time for debt reduction, dividends, share repurchases, M&A and other corporate uses;
    • Dividend post-closing expected to remain at $2.12 annualized , highly competitive and growing over time;
    • $1.9 billion in cash proceeds from the deal , with $600 million to $1 billion expected to be utilized for debt repaymentand $900 million to $1.3 billion available for share repurchases and M&A .
  • Unlocked shareholder value through ClimateCo’s continued focus on profitable growth, more targeted investments and a simplified business model; and majority ownership of the combined Industrial company with estimated annualized cost synergies of approximately $250 million expected to be achieved by the end of year three following the close of the transaction.

This is yet another example of the move away from conglomerates that have marked the last few years. That said, we wouldn’t be surprised to see one or both of the resulting companies find itself back as part of a conglomerate in the next decade.

Disclosure: The author holds no position in any stock mentioned

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