Johnson Controls Shores Up Competitive Advantage

Brian Bernard: Johnson Controls merged with Tyco International on Sept. 2 and is expected to spin off its automotive seating business, Adient, to shareholders on Oct. 31. We believe these two transactions will result in a more profitable and less cyclical business, one with much less exposure to the volatility of the auto OEM market and more exposure to higher margin, recurring service revenue. 

We think Tyco's suite of security and fire-protection products and services complements Johnson Controls' HVAC and building automation business, and the combination should drive synergies and enhanced market penetration. We believe Johnson Controls will emerge from these transformative transactions as a true multi-industrial company, free from the stigma associated with automotive parts companies.

Given the new company's drastically reduced exposure to automakers, the addition of the narrow-moat Tyco business (which benefits from customer switching costs and intangible assets), and the continued market dominance of Johnson Controls' lead-acid battery business, we will upgrade narrow-moat Johnson Controls moat trend to stable from negative once the spin-off is executed on Oct. 31. Our preliminary fair value estimate for the new company is $51 per share which represents a 15% upside to current prices. If the company is able to realize its synergy run-rate target of approximately $1 billion by 2020, our fair value estimate increases to $54 per share. Shareholders of record as of Oct. 19 will also receive one share of Adient for every 10 shares owned of the new Johnson Controls.