Activist investor Engine Capital calls on Smiths to explore breakup
By Michele Maatouk
Date: Friday 17 Jan 2025
(Sharecast News) - Activist investor Engine Capital has called on Smiths Group to explore a breakup.
In a letter sent to the board on Friday, US-based Engine Capital - which holds a 2% stake in Smiths Group - said the diversified engineer should launch a strategic review.
"We believe that Smiths has significant value that is currently unrealised due to its conglomerate structure, and that it is time for the board to announce a strategic alternatives process to maximise value for shareholders," it said.
Engine Capital said a sale of the entire company or its four businesses could deliver a significant premium to the current share price.
It argued that Smiths has "persistently" traded at a "conglomerate discount" to its sum of the parts and its segment-level peers, despite strong financials and a strong operating performance.
"Smiths' undervaluation is not a new phenomenon," the investor said. "For years, the company has traded at a significant discount to its sum of the parts (SOTP) valuation. Management and the board have been unable to close this gap to Smiths' intrinsic value and its segment-level peers despite producing strong financials and operating performance - leading us to conclude that structural issues have held the company back from being fairly valued in the public market.
"With several recent breakups that have created tremendous value for investors in the industrial sector, we see a significant and timely opportunity for the board to unlock meaningful value for shareholders by optimising Smiths' corporate structure."
In the letter, Engine Capital also warned the board and new chief executive Roland Carter against pursuing material acquisitions while maintaining its conglomerate structure.
"To acquire a high-quality company of scale in any of Smiths' end markets will likely require Smiths to pay a multiple well in excess of where it currently trades, which adds significant risk and will most likely result in value destruction as Smiths' higher cost of capital within the conglomerate structure is applied to the target's assets after the acquisition," it said.
"Two recent examples of this dynamic in Smiths' end markets are kSARIA (acquired by ITT) and CIT (acquired by Amphenol Corporation). Both target companies transacted at EBITDA multiples in the 12x-14x EBITDA range and are representative of what Smiths would likely have to pay for high quality at scale businesses."
Engine Capital said that paying such multiples when Smiths trades for a sub-10x multiple "would be a disaster for shareholders" and will not help re-rate the shares.
"While we have no issues with the board approving small tuck-in transactions at low multiples, as it has done recently, we strongly caution the board against pursuing medium or large transactions that will most likely require paying a higher multiple," it said.
In a brief response to the letter, Smiths said it "welcomes" feedback from all shareholders and "continues to have a clear focus on creating shareholder value".
"Smiths is performing strongly, with an upgrade to guidance in Q1 FY2025, and a second upgrade in guidance to 6-8% organic revenue growth and 40-60bps margin improvement announced on 14 January 2025," it added.
At 1340 GMT, the shares were up 5.3% at 1,859.26p.
In a note written before Engine Capital's letter was officially released, Berenberg said it thinks that historically there have been a number of liabilities within the group that have hampered a potential break-up - chiefly the pension liabilities, which has become less of a challenge since the company's pension position has improved and with the Smiths Medical sale going through in 2022.
"There are some liabilities remaining within specific businesses (eg John Crane asbestos provisions, the Titeflex provision in Flex-Tek, and unfunded German pensions in the working-capital-intensive Smiths Detection business), which might limit some options or lead to an elongated process to carve up the group (these separations can take several years, even without some of these challenges); however, with a net-cash balance sheet and an investment in ICU Medical that could be monetised, we think that the group has the resources to do this," it said.
The bank said it expects investor pressure would likely lead to Smiths entertaining strategic options and, therefore, that it could see the shares reacting positively.
Berenberg rates Smiths at 'hold' with an 1,850p price target.
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