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Why Rockwell is Right to Reject Emerson's Takeover Attempts

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After Emerson Electric Co.’s (EMR - Free Report) third takeover bid for automation products manufacturer — Rockwell Automation Inc. (ROK - Free Report) — was spurned by the latter last week, we believe it might be prudent for Emerson to completely abandon its suit. In fact, Emerson’s shares had risen 2.5% in the aftermath of the rejection, as investors’ concerns about an expensive deal that would overstretch Emerson’s finances eased.

Let’s discuss the reasons why a deal between the two would, more likely than not, be a debacle, after we touch upon the relatively few arguments in favor of the same.

“For” the Deal

Emerson is seeking to bolster its offerings by adding the leading supplier of software and controls for assembly-line operations. Doubtlessly, the deal would have added heft after Emerson’s CEO slashed almost a third of the company’s sales during its two-year restructuring process. To that end, it has been making smaller, bolt-on acquisitions, including a $3.15-billion acquisition of Pentair’s valves and controls business in April.

Similar to the rationale for buying Pentair’s valves and controls unit, Emerson believes acquiring Rockwell Automation would help equip it better to bid for larger-scale automation projects. Emerson’s process automation prowess, and Rockwell Automation’s leadership in discrete automation would, no doubt, result in a truly hybrid, global player, and also a leader in the $200-billion global automation market.

Emerson also believes the deal will create $6 billion in capitalized synergies, of which about a third would come from sales synergies, with the rest coming in the form of cost synergies.

Rockwell Automation’s stock price has raced much ahead of Emerson in the past year. While Emerson has risen 13.2%, Rockwell Automation’s shares have soared a whopping 46.7% during the same time frame.

Emerson has also underperformed the industry during the same time frame, with the industry gaining 15.9% over the past year.

Rockwell’s Reality Check for Emerson

Automation firmly believes Emerson's sweetened bid of $29 billion doesn’t outweigh the risks involved in integrating the two industrial automation giants. It maintained that the unsolicited proposal undervalued the company, and also expressed concerns about the large amount of Emerson’s stock in the deal.

Emerson's poor track record of integrating acquisitions was another nail in the coffin for its ambitions to create an industrial automation giant. Also, Moody's Investors Service estimates that the proposed deal implies leverage of five times the combined company's EBITDA — which is more than twice the median for major North American industrial companies (according to Bloomberg reports).

Rockwell Automation said that the proposed merger would stunt its growth and hurt its competitiveness in the evolving market. The company noted that unlike Emerson, Rockwell Automation does not see this proposed deal as essential for its growth and expansion in the industrial automation and information market. Clearly, the company has great confidence in its strategic direction and ability to continue delivering superior levels of growth and value creation. It has witnessed bullish momentum this year, and its profit levels and margins are impressive.

The company maintained that it is better off alone, riding on the success of the company’s Logix product which offers customers a single software platform to build on instead of learning multiple ones. Integrating it with Emerson's multiple offerings could be costly and could create grave customer disruptions.

Summing Up

While both companies have impressive long-term track records, Emerson has arguably been lagging in shareholder and operational returns over the past decade. Its shares have been largely inert, while shares of Rockwell Automation have virtually tripled over the time period.

Rockwell Automation boasts superior margins and revenue growth, while Emerson is beset by repercussions of poor M&A decisions of the past. Emerson might have strategic rationale behind the deal, however a large multiple, high leverage, lack of earnings accretion, and a questionable track record, all hint toward abandoning the deal being a better choice.

Both Emerson and Rockwell Automation currently carry a Zacks Rank #3 (Hold).

Stocks to Consider

Better-ranked stocks in the broader space include Terex Corporation (TEX - Free Report) and Caterpillar, Inc. (CAT - Free Report) , both sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Terex generated four outstanding beats over the trailing four quarters, for an outstanding average positive surprise of 135.9%.

Caterpillar has a striking earnings surprise history for the same time frame, having beaten estimates all through for an average beat of 53.1%.

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