Honeywell and Vertiv announced a joint effort on Thursday to help data centers reduce energy consumption.
Honeywell International is acting more like a software company than an industrial conglomerate. The company announced a techlike collaboration this past week with another firm that should enhance both partners’ long-term outlooks.
That’s a small bit of good news for Honeywell (HON) investors. But it could be a very big bit of good news for the company Honeywell joined with: Vertiv Holdings (VRT).
Honeywell and Vertiv announced a joint effort on Thursday to help data centers reduce energy consumption. Honeywell’s Building Technologies division provides management systems for data centers that run things such as air conditioning and sprinklers. Vertiv makes power-management systems for data centers.
Power is a big deal for data centers, which consume 1% of the world’s total energy output. Reduced consumption can save big dollars. “Our offerings complement each other to provide greater value to data center operators,” said Vertiv CEO Rob Johnson in the company’s news release.
Data centers were booming even before Covid-19 made the term “work from home” ubiquitous and increased the need for businesses to house and host key processes in the cloud.
The power-management products Vertiv provides are a critical component of a data center. “You can’t just plug a server into the wall,” Vimal Kapur, the CEO of Honeywell Building Technologies, or HBT, tells Barron’s. Data centers require uninterruptible power and sophisticated systems to manage voltage and current. After the servers, power-management systems are a data center’s second biggest expense.
Kapur’s unit, which includes data centers, accounted for about 16% of Honeywell’s total sales in the second quarter of 2020. Data-center products account for a majority of Vertiv’s sales.
Industry analysts, even before Covid, expected data centers to handle about 175 zettabytes of data by 2025, up from about 21 zettabytes by the end of 2021. (Zetta is one with 21 zeros behind it. It’s a big number.)
That’s about 70% average annual growth, yet Vertiv, a key supplier to the industry, trades for only about 16 times estimated 2021 earnings of $1.15 a share, a discount to the roughly 21 price/earnings ratio of the S&P 500 index. Stock in data-center operator Switch (SWCH) trades for about 65 times estimated 2021 earrings.
We aren’t suggesting Vertiv should trade for 65 times earnings. It’s largely an industrial hardware business, which goes through cycles related to IT spending and the health of the overall economy.
Still, the outlook for the company looks bright. And the Honeywell partnership offers another way for Vertiv investors to win: by being bought.
“We see this relationship as…[a] natural extension for HBT into a large and growing addressable market,” wrote Baird analyst Peter Armnet in a Thursday research report. “Longer-term, if the partnership shows success, [Vertiv] could become an attractive fit inside HBT as an acquisition candidate given its growth opportunity, share gain, and margin expansion likelihood as SaaS [software-as-a-service] offerings grow.”
Honeywell has its own software aspirations. It generates roughly 14% of total sales from software solutions. And Vertiv isn’t all about hardware. Its Services unit, which include software products, account for about 30% of sales.
Acquisition timing—and pricing—is hard to predict. Fortunately, Vertiv has another thing going for it. It’s perfect on Wall Street. Eight out of eight analysts covering the company rate shares Buy. The average Buy-rating ratio for stocks in the Dow Jones Industrial Average is about 58%. The average analyst price target for Vertiv stock is about $21 a share, up about 15% from a recent level of $18.34.
Wolfe analyst Nigel Coe calls Vertiv a growth and value story. He sees sales and earnings growing an average 7% and 20% a year, respectively, between 2020 and 2023, driven, in part, by the secular tailwinds in the data-center space. But with a below-average P/E multiple and an opportunity to improve profit margins, he believes value investors should look at Vertiv as well. Coe’s price target is $23, 25% higher than recent levels.
Vertiv reports earnings on Nov 4. Honeywell will report on Oct. 30. Investors can expect to hear more about potential benefits for joint product offerings then. Goldman Sachs analyst Mark Delaney expects Vertiv’s sales growth to be solid but adds “investors should be mindful of historical digestion periods in this end market.” Still, he rates the shares Buy. His price target is $19 a share.