By Kris Rosemann
Despite expectations that M&A activity would remain subdued due to the high level of volatility in the markets, Johnson Controls (JCI) and Tyco (TYC) have announced the first major merger in 2016, creating a leader in building products and technology.
Under the terms of the deal, Johnson Controls shareholders will own ~56% of the combined company and receive an aggregate cash consideration of $3.9 billion while current Tyco shareholders will own the remaining 44% of the company. The current terms of the deal represent an 11% premium to Tyco’s January 22 closing price for Tyco shareholders. Immediately prior to the merger, Tyco will undergo a reverse stock split that will result in Tyco shareholders receiving a fixed exchange ratio of 0.955 shares for each of their existing Tyco shares.
Shareholders of each company will then receive one share for each of their current shares, but Johnson Controls shareholders will have a choice of the share or receiving $34.88 in cash per share, which represents Johnson Controls’ five-day weighted-volume average share price. This choice is subject to proration in order to ensure the amount of cash paid is in line with the ~$3.9 billion agreed upon.
The deal is expected to close by the end of Johnson Controls’ fiscal 2016, which ends September 30, and will be tax-free to Tyco shareholders but taxable to Johnson Control shareholders. The businesses will be combined under ‘Tyco International plc’ and will be renamed ‘Johnson Controls plc.’ The newly formed company is expected to trade under the ‘JCI’ ticker on the New York Stock Exchange and will maintain Tyco’s Irish legal domicile in Ireland. As a result, it is expected that the combined company will create at least $150 million in annual tax synergies.
In addition to the material tax synergies expected, the combined company expects to generate at least $500 million in annual operational synergies over the first three years after closing. Increasing efficiency, eliminating redundancies, integrating the global branch networks, and leveraging the combined scale of a $20+ billion building business platform will be the main sources of the annual operational synergies.
The combined company–and after accounting for the spin-off of Johnson Controls’ remaining automotive business–is expected to have approximately $32 billion in fiscal 2016 pro forma revenue and ~$4.5 billion in pro forma EBITDA before synergies. The spin-off of Johnson Controls’ automotive business, to be called Adient, into an independent, publically-traded company was announced last July and is expected to be completed in early fiscal 2017. All shareholders of the new Johnson Controls will receive shares of Adient, and the newly-formed company is expected to receive between $2.5-$3.5 billion from the transaction.
Both of these moves are consistent with Johnson Controls’ strategy to become a multi-industrial company with a leading position in core growth platforms of buildings and energy storage. The transformation began with the divestiture of its lower-margin Automotive Electronics and Interiors and Global Workplace Solutions business and continued with the acquisition of Air Distribution Technologies and the formation of a joint venture with Hitachi. Tyco has transformed in recent years as well. The firm now has a focused and leading fire and security portfolio that will complement the building platform at Johnson Controls. Tyco’s core portfolio strengths are its security and fire systems integration, commercial security monitoring, and its fire, security and life-safety products.
Given the recent struggles of both companies and the expected operational synergies, we generally like the deal for both sides, though it is still very early in the process. $500 million in annual synergies is an attractive number, and management will have its work cut out for it in extracting these synergies. Johnson Controls’ strategic shift away from its lower margin automotive operations is another move we applaud, as the firm sees greater opportunity for material profitable growth in its buildings platforms. We tend to agree with this notion, especially when considering the increasing amount of connectivity in homes, buildings, and cities.
The combination of the two leading industrial companies’ portfolios will allow the new company to expand its global investments as it continues to develop new innovative solutions for customers. The combined company expects to pay a competitive dividend, and both Tyco and Johnson Controls registered a strong Dividend Cushion ratio as of their latest updates. Johnson Controls has been trading below our fair value range for most of 2016, and Tyco shares have consistently been in the lower half of our fair value range for multiple months. We expect to update our reports for both companies pending additional details.