A.O. Smith Gets Out While The Getting Is Good

It looks like ABB (NYSE: ABB) has managed to shake up the electrical motors business. In the press release announcing a deal whereby A.O. Smith (NYSE: AOS) will sell its motors business to Regal-Beloit (NYSE: RBC), AOS tacitly acknowledged that industry consolidation, and this recent deal between ABB and Baldor Electric (NYSE: BEZ), has made it too difficult to continue on with their own efforts. Facing up to reality and making the best of the situation, AOS is getting a pretty decent going-away prize for this business.

The two companies announced that Regal-Beloit would buy AOS's motors business for $875 million in a combination of cash ($700 million) and stock ($175 million). That is a healthy multiple (1.4x trailing sales) for a business that was the #4 player behind Emerson (NYSE: EMR), Regal-Beloit, and Beldor and relied heavily upon replacement sales (75%) for its business. By comparison, Beldor sold out for about 1.9x sales - Beldor was far larger, more diversified, more leveraged to growth opportunities, and filled a key gap in ABB's motors business.

A.O. Smith management was a little cagey about their plans for the proceeds - talking about using the capital to expand the water products business into new markets and perhaps acquire other products/technologies in that sector. That's almost certainly not enough money to acquire Franklin Electric's (Nasdaq: FELE) water pumps business, but maybe the company would think of taking a run at a large target like Badger Meter (NYSE: BMI) if management felt especially ambitious. What is much more likely, though, is that AOS would target one or more of the numerous small private companies that are involved in heaters, boilers, or tanks - particularly those that have a good business in emerging markets like China or Brazil.

I give AOS management a lot of credit for having the humility and rationality to realize that ABB was putting them in a box that would make their business increasingly nonviable and unlikely to earn attractive returns on capital. That does not mean that it's an awful deal for Regal-Beloit. Quite the opposite actually. Regal-Beloit has the scale that AOS lacked (especially with this deal) and does not seem to be overpaying for what should be a leveragable business. I would expect RBC to able to integrate this deal fairly easily and make it accretive in relatively short order.

Win-win deals are not that common, and certainly seldom come from a major rival getting more active in the space. Nevertheless, ABB's efforts to grow its North American motor business may just end up helping these two companies out if A.O. Smith can put the capital to good use and Regal-Beloit can avoid the footfalls of the new giant.