Initiating Coverage on Honeywell (HON US: Model Available)

Date of Initiation: 4/14/2025

Current Price: $200.25

Price Target: $260.15

Conviction: 5/10

Holding Period: 2.25 Year Hold

Model: Honeywell.xlsx

Supplemental Writing: Evaluating Spinoffs and the Conglomerate Discount.docx

Honeywell is a large American industrial conglomerate that sells a wide range of products to various end markets. Me and the Special Situations team in Brigham Capital pitched Honeywell on April 14th, 2025 and I wanted to publish my research on the stock. Both Honeywell and the BC Special Situations team group their operations into Advanced Materials, Automation, and Aerospace. I believe that Honeywell is good large cap exposure for me (which I have none of) and that the underlying businesses are undervalued relative to the sum of their parts. Normally a SOTP valuation is not an intellectually honest method for valuing a conglomerate, but Honeywell has announced spinoffs into three separate publicly traded companies. They will first spinoff Advanced Materials in late 2025 and then Honeywell Aerospace in late 2026 with Honeywell Automation becoming the remainco. My team and I are particularly excited about Honeywell Aerospace and have tentatively advised the fund to hold Aerospace and reevaluate the prospects of Honeywell Automation in late 2026.

I've taken a 2% weight in Honeywell and plan to hold this smaller relative weight in an effort to manage my U.S. exposure. I'm working on an article about how I'm handling the current tariff/macroeconomic uncertainty, and much of my strategy will be in allocating capital outside of the U.S. Something for the readers to look forward to in the coming week!

I believe Honeywell is currently undervalued by the market because it has a large conglomerate discount which will soon be removed. While spinoffs fall apart all the time, I believe this spinoff is particularly likely to take place because of the involvement of Elliott Management. Elliott took a $5 billion position in Honeywell in November of 2024, their largest position by dollar amount to date. I don't believe Elliott will walk away from Honeywell until they've achieved a return they feel satisfied with because settling for anything less could damage the firm's reputation and ability to frighten management teams in the future.

Thesis 1: Conglomerate Discount

Our team spent most of the semester trying to determine what makes some spinoffs successful and other spinoffs unsuccessful. This is a question that Bain Capital Principals Jeff Haxer, Dustin Rohrer, and Sam Rovit attempted to answer just a few years ago. Their article in HBS highlights that a majority of spinoffs destroy shareholder value two years after the spinoff has occurred. Only 25% of spinoffs create significant shareholder value in the same time period. The Special Situations team believes that this is likely a function of management speak. No management team will openly tell the market the asset they are spinning off isn't a good asset, yet many of these spinoffs are management's method for ridding themselves of a bad asset. It is our job as investors to determine if the spinoff will create value and if the business would be more valuable if it operated separately.

I believe this to be the case with Honeywell because there are very little similarities across their 3 major business units. In the Supplemental Writing linked above, I explore the differences between Honeywell's Aerospace and Building Automation segments to show that there is very little crossover between the two. The following is an excerpt from that paper:

Aerospace Technologies

End Market: Commercial Aviation OEMs like Boeing and Airbus, Commercial Aviation parts aftermarket, and Defense and Space companies like Lockheed Martin, NASA, and the U.S. Department of Defense.

Products: Engines, electric power systems, avionics, and flight management and navigation systems.

Building Automation

End Market: Commercial and residential buildings like the Marriott School of Business, malls, hospitals, and office buildings.

Products: Fire alarms and smoke detectors, gas detectors, video surveillance and alarm systems, and energy efficiency products.

These two business units share essentially no common products or end markets and I believe they would operate more efficiently with a focused management team. Peter Lynch, one of my favorite investors, uses the term "diworsification" to describe acquisitions or expansions which detract from the core competencies of the original business. I believe Honeywell is sufficiently diworsified and would benefit greatly from the separation of their business units.

Thesis 2: Aerospace Dominance

This is a much smaller part of the thesis, but I wanted to add a comment about how strong Honeywell's underlying Aerospace business is. I've had the opportunity to become familiar with companies like TransDigm and Heico over the last 10 months. I feel there is a pedigree of companies in this aerospace industry generating great returns on capital, growing both organically and inorganically, and commanding hefty multiples thanks to sustainable competitive moats. Honeywell Aerospace will become the largest pure play aerospace company after they spin out. The following table shows margin and EBITDA profiles for some of the top players in this industry and Honeywell is clearly very comparable. I see no reason they can't garner a similar multiple with their dominant market share in avionics and navigation systems.

Conclusion

I've added a 2% weight in Honeywell with the belief that the conglomerate discount will be realized upon the spinoff of Advanced Materials and Honeywell Aerospace. I also believe that Honeywell, and particularly their aerospace division, is incredibly strong and could become a darling in the eyes of the market once it's a pure play competitor. This should be a rather sleepy position and I look forward to learning about spinoffs and how applicable finance theory is in real market settings.