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Morningstar | Rumors Surface That Ingersoll Rand’s Industrial Segment Is Merging With Gardner Denver

Ingersoll Rand’s stock opened the April 29 trading day up 5% following a Wall Street Journal report that claimed a merger between Ingersoll Rand’s industrial segment and Gardner Denver is imminent. Per the report, Ingersoll Rand shareholders will receive a mix of cash and Gardner Denver stock, and a Reverse Morris Trust structure will allow Ingersoll Rand to avoid taxes on the divestiture.

Sources told The Wall Street Journal that the combined business will have an enterprise value of approximately $15 billion. Gardner Denver’s enterprise value prior to this report was approximately $7 billion, so this tells us that the deal values Ingersoll Rand’s industrial segment at $8 billion, or approximately 12 times our estimate of the segment’s 2019 EBITDA. A forward 12 times multiple for this business is fair, in our view, and is commensurate with the one-year average forward EV/EBITDA multiple for peer Atlas Copco, which has generally boasted better financial performance. Neither Ingersoll Rand nor Gardner Denver have publicly commented on this report. However, Ingersoll Rand is set to report its first-quarter results April 30, so if this report is indeed true, it could be officially confirmed then. We’re maintaining our $103 per share fair value estimate for shares of Ingersoll Rand until the merger is confirmed with more clarity around the deal terms. We don’t expect to change our narrow moat rating.

If not for Ingersoll Rand’s $1.5 billion pending acquisition of Precision Flow Systems, a leading manufacturer of fluid management systems, which was announced on Feb. 11, we wouldn’t have been surprised by this rumor. Conglomerate break ups are in vogue, and some of Ingersoll Rand’s closest competitors in the heating, ventilation, and air-conditioning industry (United Technologies and Johnson Controls) have opted for a more simplified business model. However, we saw the PFS acquisition as Ingersoll Rand’s commitment to its industrial segment.

That said, we can certainly see why Ingersoll Rand would divest its industrials segment for the right price. For one, the segment’s financial performance has lagged narrow moat rated Atlas Copco, and we have long thought it would be difficult for Ingersoll Rand to close that gap. The business case for this rumored deal likely considers increased economies of scale and other synergies as opportunities to boost financial performance as a combined entity.

Furthermore, the industrial segment’s performance over the last decade has shown that it’s a more cyclical business than Ingersoll Rand’s climate business. Whereas climate operating margins improved each year from the 2009 trough of approximately 6% to almost 15% in 2018, industrial segment operating margins improved from 9% in 2009 to near 16% in 2013 before sinking to below 11% in 2016 amid a pullback in industrial activity (industrial operating margins have since improved to near 14% in 2018). The divestiture of the industrial segment will likely soften Ingersoll Rand’s decline in sales and profit margins during the next recession.

If Ingersoll Rand does indeed rid itself of the industrial segment, the firm would revert to a pure-play HVAC and refrigeration business. The pure-play model will become the norm for the industry over the coming years as Johnson Controls completes the sale of its power solutions business (slated for no later than June 2019) and Carrier spins off from United Technologies (currently a first-half 2020 event). Lennox already operates as a pure-play HVAC and refrigeration manufacturer, although it has rid itself of some underperforming domestic and foreign refrigeration businesses.