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The problem for industrial conglomerate Johnson Controls (JCI ) was that the market had always thought of it as a slow-growth auto parts supplier. That’s been true over the course of its long history. However, in recent years, JCI has begun a transformation that has moved it away from the slow growth of car dashboards and batteries towards becoming a building automation giant.
Well, the market isn’t confused now.
Its latest move drives that notion out of the park. The firm is planning on buying rival Tyco (TYC) and integrating its businesses into its fold. The buy out makes a ton of sense and moves JCI from the “boring dividend stock” category into the “exciting dividend stock” arena.
All in all, there’s a lot to like about the deal and the potential for long-term returns.
The resounding merger story over the last year has been the idea of corporate inversions. The basic idea behind the move is that a U.S. company will buy a foreign company and “move” its corporate headquarters to the international destination. The reason for doing this is taxes. The corporate tax rate in the U.S. is around 35%, the highest in the developed world. In a place like Ireland, it’s only 12.5%. For some megacorporations, that annual tax savings can be profound and has spurred a frenzy in recent years to find and acquire Irish-domiciled firms.
Luckily for JCI, after moving from New Hampshire to Bermuda to Switzerland, Tyco is now based in Ireland.
After buying TYC, Johnson Controls would use the backdoor inversion and base itself out of Ireland, thereby realizing the lowest tax rate in the developed world. The combined firm would see about $650 million in cost savings and synergies over the next three years. The tax portion of that savings would be about $150 million a year and would start to be felt almost immediately.
Now, many of the recent presidential candidates have sounded off about the inversions, such as Pfizer (PFE ) trying to buy its Irish peer Allergan Plc (AGN), but the practice is still legal.
Aside from the tax savings, the deal makes a ton of sense for JCI in other ways. The company is no longer just about car parts; it has expanded heavily over the last few years into building automation and energy efficiency products. The company offers a complete suite of products that help both new and old buildings operate more efficiently and use less energy during operation. Smart HVAC units, LED lighting fixtures and building control software are quickly becoming its bread and butter. And with cost savings in the millions of dollars, even more if you include tax breaks, property operators have been jumping at the opportunity to retrofit old and construct new buildings with their technology.
It’s become such a big part of JCI’s revenues and profits that the firm is now planning on spinning out its automotive parts businesses and only focusing on the energy efficiency side of things.
That’s where Tyco comes in.
Following some cutting of its own by spinning out its health care business as Covidien (COV) and its parts businesses as TE Connectivity (TEL ), TYC is now 100% focused on commercial fire and security systems. Those industries plug right into JCI’s automation offerings and provide a services aspect to its retrofits and build outs. JCI can now save a property owner money on energy, heating/cooling costs and keep the building safe and secure.
With the buy out and the spin off of JCI’s car parts businesses, investors are going to have the play on building management. And that’s a good place to be. The newly combined JCI/Tyco should generate around $49 billion in revenue this year. Both JCI and TYC are already solidly profitable as reaffirmed by their latest earnings releases.
The tax and cost savings as well as the additional revenue from the combined firms should help drive dividend growth far into the future. JCI already has a long history of dividend growth and currently yields 3.29%, while TYC pays about 2.41%. Additionally, Tyco’s low debt makes the deal even sweeter as it shouldn’t impact JCI’s credit rating or significantly hurt cash flows at all.
All of this means that dividend investors are getting a great buy in the newly merged company. The time to buy Johnson Controls is now.