Industrial conglomerate Illinois Tool Works (NYSE:ITW) announced August 16 that it was selling 51% of its decorative surfaces business, which includes Wilsonart International, to Clayton, Dubilier & Rice for $1.05 billion in cash. While retaining a 49% equity interest in the segment, ITW plans to use the cash to buy back shares. I'll take a look at what this means for investors.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Streamlining

In the press release announcing the deal, CEO David Speer suggested the divestiture would allow ITW to focus its resources on its core platforms. Further, it planned to speed up the pace of its divestitures. Activist investor David Batchelder, CEO of San Diego investment manager Relational Investors, badgered the company throughout the second half of 2011 to unload some of its 825 businesses to become more efficient and streamlined. ITW had a total of eight reportable segments at the end of 2011, including its decorative surfaces unit, its smallest, with annual revenue of $1.1 billion and operating income of $132.4 million.

SEE: Zooming In On Net Operating Income

In January, ITW and Batchelder agreed to work together, and Relational was given an option to take a seat on the board anytime up to the 2013 annual meeting. At the end of June, Relational owned 14.6 million shares that are worth $867 million as of August 16. Not thoroughly familiar with ITW's business, I hazard to guess what else is on the chopping block. However, if I were to make an educated guess, I'd assume the likeliest candidate would be the businesses clustered together in the "All Other" segment. Its revenues were $2.9 billion in 2011 with $532 million in operating income and identifiable assets of $2.6 billion, almost seven times those of the decorative surfaces unit. In addition, it attempted to sell its finishing businesses to Graco (NYSE:GGG) for $650 million in 2011 but was initially denied by the Federal Trade Commission. Eventually, it was able to close the deal in early April. In addition, it intends to sell its consumer packaging businesses, also part of the "All Other" segment. Those two divestitures, along with the decorative surfaces sale announced August 16, will likely result in pre-tax proceeds in excess of $2 billion. With more divestitures possible and its total debt-to-capitalization ratio at less than 33%, share repurchases are one of its best options.

SEE: History Of The U.S. Federal Trade Commission

Use of Cash

ITW uses its free operating cash flow to pay dividends, to make small to medium-sized acquisitions and to buy back stock. On the dividend front, it pays out approximately 30% to 45% of the average of the last two years' free operating cash flow. In the first six months of 2012, that amounted to $346 million. In the first and second quarters, it made a total of $587 million in acquisitions, 22% less than in the first half of 2011; it's slowing down its appetite. Finally, it spent $1 billion on share repurchases in the first six months of the year at an average cost of $55.56 a share. That's not a great buy, paying within 5% of its six-month high of $58.27. However, as I said earlier, its debt levels are reasonable, it's limiting its acquisitions, and a special $2 dividend would have delivered just 4% additional yield. I suppose management could have hung on to the cash, but that's no solution either.

SEE: Analyze Cash Flow The Easy Way

Bottom Line

Large industrial companies these days are selling or spinning off all extraneous parts. Much of the cost cutting has been done, and now the best way to deliver value is by divesting businesses that aren't part of the long-term plan but possess value to strategic buyers. Despite protestations by David Batchelder that ITW was underperforming its peers, the company's long-term record is one of success. Batchelder might have moved the process along, but my gut tells me this would have happened without the interference. ITW shareholders should be delighted with the news. Change is good.



At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Stock Analysis

    The Top 5 Micro Cap Alternative Energy Stocks for 2016 (AMSC, SLTD)

    Follow a cautious approach when purchasing micro-cap stocks in the alternative energy sector. Learn about five alternative energy micro-caps worth considering.
  6. Stock Analysis

    Analyzing Porter's Five Forces on Under Armour (UA)

    Learn about Under Armour and how it differentiates itself in the competitive athletic apparel industry in light of the Porter's Five Forces Model.
  7. Stock Analysis

    The Biggest Risks of Investing in Qualcomm Stock (QCOM, BRCM)

    Understand the long-term fundamental risks related to investing in Qualcomm stock, and how financial ratios also play into the investment consideration.
  8. Stock Analysis

    The Biggest Risks of Investing in Johnson & Johnson Stock (JNJ)

    Learn the largest risks to investing in Johnson & Johnson through fundamental analysis and other potential risks. Also discover how JNJ compares to its peers.
  9. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  10. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
RELATED FAQS
  1. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  2. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  3. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  4. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  5. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
  6. What is the formula for calculating earnings per share (EPS)?

    Earnings per share (EPS) is the portion of a company’s profit that is allocated to each outstanding share of common stock, ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center