Personal Finance

This Hedge Fund Bought $3 Billion of ABB Ltd Stock: Should You Buy, Too?

EMR Chart

According to SEC filings, Swedish activist hedge fund Cevian Capital held more than 132 million shares of ABB Ltd. (NYSE: ABB) in September, worth around $3 billion at today's pricing. That's 6.2% of the of the utility, industrial and transportation-focused company's shares, and it signals Cevian's determination to unlock value from ABB's portfolio of companies.

While it's never a good idea to blindly follow hedge fund managers, Cevian's ABB position is a statement of intent from a well-respected investment manager, so let's take a look at the case for an individual investor to buy the stock.

EMR Chart

Data by YCharts

In Danaher's case, the remaining company comprises its higher-growth medical and technology segments, while the spun-off business, Fortive, is made up of a collection of highly cash-generative but cyclical industrial businesses.

Meanwhile, Johnson Controls' spin-off of Adient -- its former automotive experience unit (automotive seating and interiors) -- left the company with its power solutions segment (automotive batteries) and building products (heating, ventilation, and air-conditioning, plus Tyco's fire and security products).

In other words, investors and management have been granted two very different investment propositions in both cases. Danaher offers secular growth and healthcare exposure, while Fortive offers industrial exposure and high-cash flow generation. Johnson Controls offers exposure to commercial building and the growth potential in automotive batteries, while Adient offers exposure to automotive production, particularly in China.

The idea is that separation will enhance value in a way that the combination couldn't. It's also an idea that equally applies to apotential separation ofABB's power grids unit from its other three segments.

ABB EV to EBITDA (Forward) Chart

EV to EBITDA (Forward) data by YCharts

Clearly, ABB needs to do something and its management responded to Cevian's statements by opening a strategic review of the power grids business. Unfortunately for Cevian, the conclusion of the review was that the company should keep power grids, and make plans for acquisitions and investments in internal development in order to digitalize products in power grids while increasing higher-margin services sales. As a consequence of these actions, ABB's management upgraded its target 2015-2020 EBITA margin range for power grids to 10% to 14% from 8% to 12%, coming into effect in January 2018.

In fact, ABB has decided to follow another well-worn trail, one mapped out by General Electric (NYSE: GE) , whose embrace of the industrial internet and drive to increase services revenue is a key part of its growth strategy . In addition, just as GE made its Predix (platform as a service) available on Microsoft 's Azure cloud offering, so ABB has announced a strategic partnership to develop digital solutions on Azure.

What does it mean for investors?

In a sense, Cevian's activism has already made ABB a more investable company. The transformation of its power grids business may not be the solution Cevian (or other shareholders) wanted, but it's in line with what GE and others are doing. Moreover, the company always has the option of changing its mind on the strategic future of power grids and taking a path more akin to the ones followed by Danaher and Johnson Controls.

Meanwhile, ABB's valuation discount makes it the value play in the sector.

EV to Free Cash Flow (TTM) data by YCharts

Cevian is, directly or indirectly, helping to make it that way. Analysts and ABB management are forecasting double-digit EPS growth and margin expansion for the next few years, so this stock deserves a close look by value investors.

10 stocks we like better than ABB

When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor , has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and ABB wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of January 4, 2017

Lee Samaha has no position in any stocks mentioned. The Motley Fool owns shares of General Electric and Johnson Controls. The Motley Fool is short Johnson Controls. The Motley Fool recommends Emerson Electric. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story


Other Topics


The Motley Fool

Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

Learn More