I’m always interested in companies with potential to deliver value for shareholders by way of a spin-off, or other divestment strategy. I don’t mean distressed companies selling assets out of desperation. I’m talking about sound businesses, capable of performing well as they are, but with options to divest subsidiary assets or divisions to maximise the value of the parent company.
Industrial technologies conglomerate Smiths Group (LSE: SMIN) is one such FTSE 100 stock on my radar right now. Here, I’ll look at how it’s performing, its potential for unlocking value by divestments, and why I think its shares are undervalued by 50%+.
Hidden value highlighted
Smiths Group has made steady progress in sharpening its portfolio of businesses since a change of management in 2015. It caught my eye last September after news it had turned down an offer for its Smiths Medical division, reportedly in the region of £2.5bn-£2.8bn.
This highlights there may be considerable hidden value in the group. The table below shows some key numbers for its five divisions from its last financial year.
| Revenue (£m) | Underlying operating profit (£m) | Underlying operating margin (%) | |
| Smiths Medical | 885 | 156 | 17.6 |
| John Crane | 881 | 202 | 22.9 |
| Smiths Detection | 793 | 134 | 16.9 |
| Flex-Tek | 354 | 67 | 18.9 |
| Smiths Interconnect | 300 | 42 | 14.1 |
| Total | 3,213 | 601 | 18.7 |
Smiths Medical accounted for 27.5% of group revenue and 26% of group underlying operating profit. How much might the whole group be worth? On the basis of that £2.5bn-£2.8bn reported offer — 26% of group operating profit — we might value the whole group at between £9.6bn and £10.8bn (2,425p to 2,728p per share). Yet its market capitalisation is currently just £6.5bn, with the shares trading at 1,640p.
A comparative valuation
Could Smiths really be worth so much more than its current valuation? Intertek, a highly rated FTSE 100 peer, has a similar underlying operating margin to Smiths. And I consider they share some broad drivers for long-term growth, as well as similar near-term forecast earnings growth rates, according to City analysts.
Smiths currently trades on 15.8 times forecast 12-month earnings, while Intertek’s multiple is 25.9. If Smiths were to be afforded the same multiple as Intertek, it would be valued at a little under £10.7bn (2,697p a share) — within, and at the top end of, the valuation range I derived from the rejected offer for Smiths Medical.
Unlocking the value
In November last year, two months after rejecting the offer, the company announced its “intention to separate Smiths Medical.” By March this year, this had become an “intention to pursue a demerger of the Smiths Medical business and separately list it in the UK.” Management said it anticipates completing the process during the first half of calendar 2020, subject to the approval of shareholders.
As my colleague Kevin Godbold has discussed, the separation into two companies promises to give each “greater and more-focused entrepreneurial drive.” As such, I expect shareholders to strongly approve of the demerger.
In the meantime, there’s always the possibility of another (higher) bid for Smiths Medical, or some other value-outing event, as “the board will continue to evaluate all opportunities for value maximisation as the process goes forward.”
Based on my valuation calculations, I think investors at today’s share price should enjoy strong returns, as events unfold. I expect significant value to be unlocked in due course. I rate the stock a ‘buy’.
