Honeywell (HON) announced Tuesday morning it has agreed to acquire privately held Sparta Systems for $1.3 billion in an all-cash transaction from New Mountain Capital.
Sparta Systems is a leading provider of enterprise quality management software (QMS), including a next-generation software as a service (SaaS) platform for the life sciences industry. Sparta currently has more than 400 customers, including 42 of the top 50 pharma companies and 33 of the top 50 medical device companies, according to the fact sheet here.
The deal's price tag may look a little rich (like nearly all software deals do at first glance) and this could explain some of the weakness we are seeing in trading Tuesday, but analysts at Deutsche wrote in a note this morning that they believe this deal makes strategic sense.
"Management has previously noted the importance of life sciences as a breakthrough growth initiative, and this acquisition bolsters HON's software, control and analytics capabilities in this space. Sparta's QMS offering will combine with Honeywell Forge to provide greater value to life science and pharma customers," the analysts wrote in a research note.
Sparta Systems will fit into Honeywell's Performance Materials and Technologies (PMT) segment, which is traditionally known for its exposure to oil and gas markets. So what we also like about this deal is how it increases the segment's exposure to the less cyclical, more secular growth in the life sciences industry. A deal like this represents a step in the right direction of turning into a steady compounder.
Shares of Honeywell have had a strong 2020, gaining roughly 18% year-to-date and about 26% since the end of October compared to the S&P 500's move of roughly 14% and nearly 13% over the same two time periods at the time this was written. This stretch of outperformance has put HON's trading multiple under the microscope, with one recent knock being that its price-to-earnings multiple of roughly 26-times consensus 2021 EPS has gotten slightly too rich relative to the company's historical average. We think investors should not worry about HON's elevated multiple for two reasons.
First, we think the earnings estimates could prove to be conservative a few different ways. The clearest path is through a stronger than anticipated recovery in the economy with Honeywell driving better than expected operating leverage. But balance sheet deployment can also create upside, either through prudent share repurchases or more strategic M&A activity. Honeywell has the cleanest balance sheet in its peer group and management has previously said it has the capacity to deploy $30 billion to $36 billion in capital from 2021 to 2023. This firepower is very significant and should not be overlooked.
Secondly, we do not want to get hung up on HON's current multiple relative to historically averages, because Honeywell of today is very different from the Honeywell of old. The transformation kicked off in 2018 when it completed the spinoffs of its turbo charger business (Garrett Motion) and its residential comfort and security businesses (Resideo Technologies), and these two moves helped Honeywell become less cyclical and more focused (less end markets) with businesses that offer multiple platforms for growth and margin expansion.
The company has also developed the Honeywell Forge, which CEO Darius Adamczyk has previously said "underpins our Honeywell Connected Enterprise as an asset-light recurring revenue solution addressing a $100 billion market in the industrial Internet of Things."
The Honeywell Forge is an Enterprise Performance Management (EPM) SaaS-based offering that helps customers harness their data, improve operational performance, and deliver key outcomes for its customers like 20% to 40% productivity gains, 20% to 30% yield optimization, 90%-plus operations enabled remotely, and a 25% reduction in carbon footprint, according to the presentation here.
As you can see, over the past few years Adamczyk and his management team have undertaken significant portfolio measures aimed at transforming Honeywell into a less cyclical and more digitally focused, software company. This acquisition is a continuation of this journey that we believe justifies the recent re-rating in the stock.