Brookfield Business and CDPQ made the day of Johnson Controls’ Shareholders by acquiring Power Solution Business for $13.2bn

Johnson Control International PLC [JCI: NYSE] – Market Cap as of 21/11/2018 $30.754bn

Brookfield Business Partners LP [BBU: NYSE] – Market Cap as of 21/11/2018 $4.613bn

Introduction

On November 13^th, 2018 Johnson Control International announced its intentions to sell Power Solutions Business, one of its most profitable divisions. Generating $8bn of revenues so far this year, Power Solutions is a market leader for automotive batteries production. In the recent years, the company has been trying to turn into a provider of systems for smart homes and next-generation buildings. In order to do so, and to have a strong financial position to grasp strategic opportunities when they eventually pop up, Johnson Control has decided to sell the mentioned unit to Brookfield Business Partners LP and Caisse de Dépot et Placement du Québec.

Johnson Control International PLC

Headquartered in Cork since 2016, Johnson Control International is a globally diversified and multi-industrials leader in the development of intelligent buildings, efficient energy solutions, integrated infrastructures and next-generation transportation systems. The company’s main commitment is sustainability, while its main goal is to play a key role in the actualization of smart cities and communities. Looking at the past, Johnson Control was founded in 1885 in Wisconsin, its core business being the manufacturing and installation of automatic temperature-regulation systems. As time went by, the company enlarged the portfolio of activities, so as to include car batteries and automotive parts production. In 2016, a merger between Johnson Control and Tyco International finally resulted in the creation of Johnson Control International PLC, strategically located in Ireland.

JCI’s stock is traded on the NYSE, and the company is included in the Fortune Global 500, with a market capitalization of $30.94bn. It currently operates in more than 150 countries worldwide, counting approximately 120,000 employees and boasting $31.4bn in revenues from in the 2018 FY, up from $30.1bn in 2017 and $20.8bn in 2016. Net income as of September 30^th, 2018 was $2.1bn, showing a 34.2% increase year-over-year against 2017.

Brookfield Business Partners LP

Headquartered in Toronto, Canada, Brookfield Business Partners is a publicly traded limited partnership, operating in the private equity industry. Specifically, the company focuses on owning and operating high-quality businesses, which benefit from high entry barriers and low production costs. It was founded in June 2016 as a result of a spin-off from Brookfield Asset Management, a leading global alternative asset manager.

Today Brookfield Business Partners is listed on the NYSE and on the Toronto Stock Exchange, with a market capitalization of $4.485bn and has $15.8bn in AUM.

Caisse de Dépot et Placement du Québec

Headquartered in Québec City, CDPQ represents Canada’s leading institutional fund manager. The company invests globally in major financial markets, private equity, real estate, private debt and, above all, infrastructures; for this latter segment, the institution even gave birth to an ad-hoc branch, i.e. CDPQ Infra, which handles the main infrastructural investments countrywide. CDPQ was founded back in 1965, as a result of an act by the National Assembly. Its commitment and the scope of its activities are clarified by its mission statement: “The mission of the Fund is to receive money on deposit as provided by law and manage them with a view to achieving optimal return on capital, within the framework of depositors’ investment policies, while at the same time contributing to Québec’s economic development.” Through those words, it is straightforward to infer that CDPQ is, specifically, a long-term institutional investor, managing funds mainly for public and para-public pensions, and for insurance practices. As of the 30^th of June 2018, the company had CAD 308.3bn in net assets.

Industry Overview

The industrial sector globally is very large and diverse. It includes a significant variety of subsectors that drive the economy worldwide. Johnson Control’s business is focused on support services such as building technology and power solution. There is, however, a broad range of other services included within the industrials category such as: cables and wires, test and measurement, distribution, diversified, mechanical power transmission, power equipment, electronic components, flow control, industrial machinery, building technology, multi-application components, and electrical equipment.

It is a highly cyclical industry, and many companies experience their earnings to rise or fall depending on the macroeconomic drivers and economic profit-creation cycle. Some sub-sectors are more heavily impacted, other are consistently outperforming the peers. For instance, the Power Solution business of Johnson Control, which produces advanced batteries for vehicles, is robust and generates stable cash flows. Non-cyclical aftermarket sales comprise 75% of the business’ profits. Moreover, productions costs are low. This enables the unit to increase sales through all the business cycles. Other subsectors are less fortunate and more exposed to global economy. More details regarding the performance of each industrial subsector can be found on graphic below:

Source: McKinsey&Company

Rapid growth for the industry occurred in the period 2001-2007: Companies were boosting their profits either by margin expansion or by increasing capital productivity. In 2007 Industrials reached a total profit of nearly $52b, while during the crisis it dropped significantly: in 2009 total profit amount to a mere $9.9bn. However, already in 2010, the industry recovered and nearly reached the pre-crisis level, with profit up to $51.7bn. The last decline occurred in the years 2015-2016 and was related to prices of base materials such as steel or copper as well as oil and gas. On top of that, at that time a downtrend in industrial demand was observed. Overall, it resulted in a mild stagnation in industrial production. Since then, Industrials’ economic profits remain largely flat because companies were not able to increase their margins further. Currently, the sector is under a lot of pressure and face a great deal of uncertainty due to the trade war between US and China. Profits of many US Industrial companies sank in 2018 due to the imposed tariffs. Apart from that, however, the economic outlook for the industry is rather positive according to economists forecast. It is also expected that big Industrial’s conglomerates will pursue a strategy of divestures and will try to spin off less profitable businesses soon. Therefore, more deals in the sector are expected. Johnson Control itself has already spun off its automotive seat maker and safety equipment business last year.

Deal Structure

Johnson Control agreed to sell its Power Solution business at a value amounting to $13.2bn. Considering that for the fiscal year 2018, Power Solutions unit generated $8.0bn in revenue and $1.68bn in EBITDA, the agreed price represents a multiple of 7.9x trailing EBITDA.

The deal is a cash transaction which is going to be funded mostly with debt. Approximately $10.2bn out of total $13.2bn will be paid using long-term debt financing, and the remaining $3bn will be funded with equity. Brookfield Business Partners is going to cover 30% of the equity consideration from its existing liquidity. CDPQ should fund another 30% of the equity on closing, and the balance is expected to be funded by other institutional partners.

The deal is still subject to customary closing conditions as well as regulatory approvals. Still, already from the first quarter of fiscal year 2019 the Power Solutions operating result will be reported in the financial statement of Johnson Control as discontinued operations.

Deal Rationale

Since 2016, Johnson Controls has been ongoing a strategic transformation process that might have concluded last Tuesday, with the sale of its Power Solutions business. Indeed, since the merger with Tyco in 2016, Johnson’s aim was to focus entirely on its building technologies and solutions services, leaving aside its automotive business. To do so, the company spun off Adient Plc, a car-seat maker, in 2016 and sold its Scott Safety business to 3M for $2.0bn in 2017. Finally, the sale of the Power Solutions business, seems to be culmination of Johnson Controls’ makeover. The deal will enable the company to solely focus on buildings’ heating, ventilation and air conditioning systems, as well as building access control and fire detection systems.

The sale price was qualified as “very attractive” by George R. Olivier, Johnson Controls’ CEO, considering that the amount was 7.9x EBITDA and the net proceeds were close to $11.4bn (after transaction-related expenses and tax). Indeed, the focused portfolio will allow the company to capitalize on long growth trends and to provide a strong financial performance through improved free cash flow conversion, lower capital intensity and continued margin expansion.

Even though the business carried higher margins than the rest of the company, it was particularly capital intensive for the company current financial situation. As argued in Johnson Controls shareholders’ statement regarding the recent operation, the company has two major objectives: debt pay-down, to achieve a greater financial flexibility to strengthen the company’s balance sheet, and returning capital to shareholders. In line with the objectives of retaining its current investment grade credit rating, the company expects to allocate $3.0bn to $3.5bn of the net proceeds to debt pay down and retain the BBB+ investment grade credit rating. The remaining $7.9bn to $8.4bn will be returned to shareholders, most likely in form of a share buyback but special dividend is also being considered. More specific details regarding the deployment of the proceeds should be announced once the transaction is closed, by June 2019.

At the other end of the deal, Brookfield together with institutional partners, including Caisse de dépôt et placement du Québec, will benefit from a market leading business with a strong competitive position. The Power Solutions department has been able to present consistent growth and stable cash flows, mainly due to a solid 75% of non-cyclical aftermarket sales out of the total sales, for the last couple of years. Moreover, Brookfield argues that the business has a long-standing reputation for product quality and safety as well as extremely valuable relationships with customers.

Market Reaction

The deal was welcomed by investors as Johnson Controls International’s shares rose 1.7% to a month-high $34.78 per share on the day of the announcement. Indeed, the company’s announcement of returning capital to shareholders through the operation’s proceeds was very appealing to investors.

Brookfield’s share price gained 1.53% on the announcement day as its shares moved from $43.18 to $43.85 per share. Investors judged that the highly-leveraged buyout was a good acquisition of a competitive business that added value to the asset management.

Advisors

Centerview Partners and Barclays Plc served as financial advisers to Johnson Controls. As for Brookfield, financing and advising will be led by a syndicate of banks including Credit Suisse, JPMorgan Chase, BofA Merrill Lynch, BMO Capital Markets, CIBC Capital Markets, Citigroup, Deutsche Bank, Goldman Sachs, HSBC, RBC Capital Markets, The Bank of Nova Scotia, TD Securities and, finally, Barclays financing only.

Davis Polk & Wardwell LLP is acting as lead deal counsel to Brookfield.  In addition, Baker McKenzie is providing non-US legal advice, Cahill Gordon & Reindel LLP is providing compliance advice and Weil, Gotshal & Manges LLP is providing consortium advice to Brookfield. Kirkland & Ellis is acting as legal counsel to CDPQ.