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- [00:00]
A
Foreign we're talking matchups and breakups today on Motley Fool. Hidden Gems Investing. Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe. And today I'm joined by longtime fool contributors Matt Frankel and Lou Whiteman. So we just got to the end of the Honeywell kind of breakup phase that's been going on for a year. So we're going to dive deep into that today. And of course we're also going to hit the mailbag like we always do. But we wanted to start today with, you know, it's July 4th weekend coming up and apparently Wall street bankers want to clear their plates before the July 4th weekend because there's been a ton of deals that have happened in the last couple of days. Yesterday, John Quast, host and company, they covered the Comcast split and the Rocket Lab acquisition. Matt, I think you were part of that discussion there. And since then we've seen even more deals come through. I've read four of them within the past 24 hours. And what I want to do today is we're going to go through all four of them and then I want you guys to tell me, which one of these do you actually like the most? We had Digital Realty buying data centers from Blackstone for about 3.5 billion. We have Carlisle Companies, a building supply company, doing an unsolicited bid for Owens Corning. So not done yet, but looks like something's going to happen. You've got a materials company, Martin Marietta Minerals, buying a limestone supplier for 13.5 billion. And then on Semiconductor is buying synaptics for about 7 billion. So, Matt, I feel like somebody who loves REITs is going to go in a certain direction here, Am I right?
- [01:33]
B
Yeah. I mean, I like playing the AI boom with stocks that I understand like the picks and shovels plays, the infrastructure plays like data center REITs. Digital Realty has been probably one of the top two or three longest running dividend stocks in my portfolio. The the deal is interesting to me. The Stock is down 5% after the deal. The company is purchasing Blackstone's roughly two thirds interest. When you combine all of them in three data centers in Northern Virginia for $3.5 billion, $1.2 billion is coming in cash. The other $2.3 billion, Digital Realty is issuing new shares. They're going to need about $1.4 billion of additional CapEx to complete the development of these. None of them are occupied or operational yet. And Digital Realty is assuming some debt as part of the deal. As well. So they were already the minority owner of these three properties. Just to be clear, they're just buying out Blackstone's majority stake. All three of them are already 100% leased to hyperscalers on 15 year deals with 3.6% annual rent escalators. So it should help the company more than keep up with inflation when it comes to their rent. Two of them are supposed to be occupied and stabilized in the first half of next year, the third in the first half of 2028.
- [02:51]
A
Matt, you're making a pretty compelling case here, but the market doesn't seem to agree because the Stock's down about 5% as we're recording. So why do you think the market may be a little less as on board with this idea as you are?
- [03:07]
B
Yeah, and it's a good question. There are a few different reasons why. So, I mean, for one, Digital Realty says this is going to be accretive to ffo, which is funds from operations, the real estate version of earnings, but not until these properties are fully occupied and stabilized, which won't happen for a while. In the near term, it's probably going to hurt the earnings numbers. Plus, as I mentioned, they're selling $2.3 billion of new stock. And not only that, But Blackstone's selling $2.3 billion of its own Digital Realty stake. So it's a dilutive deal. You're going to see a lot of stock hit the market. At the same time the FFO benefit is delayed. It's a fair price. It's a cap rate of 6.5% in real estate, which is. That's okay. It's a fair price. It's not a bargain for top quality assets. And like I said, it's going to hurt the numbers in the near term. So it's not a perfect deal, but long term. I like the strategy here.
- [03:57]
C
Yeah, it's funny. I'll take the other side of that trade. The goal of private equity is to be ruthlessly unsentimental, to buy low and sell high. And for Blackstone, they're cashing out on an asset with massive continuing capex at a premium. I get it. For Digital Realty, I'm not saying it's going to be a terrible deal for them, but I'd rather be sitting on Blackstone's side. And I do think that this is what price private equity does well, but, you know, I don't want to be boring and just focus on one deal, so let's broaden it a bit. Tyler, Carlyle's, bid for Owens Corning and then the Martin Marietta deal too. They both intrigued me because they suggest that there are management teams out there who think it is time to be greedy when others are fearful. There's been a ton of headwinds in construction, especially on the residential side. We'll see. They may be too early here, but the sort of animal spirits in construction, slash residential construction. I feel like as an investor, even if I don't want to invest in those companies, it's a data point I should pay attention to that these management teams feel like it's time to stick their necks out.
- [05:02]
A
Yeah. And this isn't, certainly isn't the first time we've been hearing this consolidation of the building products space going on in the past couple of years. I feel like this has been a continuing trend in a slow market. Whether that's to grow the top line now while everything's weak or to your point of seeing the bottom. One of the companies that we like to discuss here or at least the man behind a lot of companies, Brad Jacobs, he has a his company qxo, which is basically a building products roll up company, recently acquired Top Build, which was an insulation building products company. There is a lot of consolidation going on here and it's an interesting like side note to me because a lot of these companies have been for much of like the 2000 and tens and into the 2000 and twenties they were good quality companies doing really well that have hit the skids. And it's going to be fascinating to see when renovation new build cycle starts again with these kind of beefed up companies. Whether or not these acquisitions made them better or they just kind of made them bigger. Because sometimes acquisitions can go both ways.
- [06:16]
C
We're still too early, but how too early are we here is kind of. And the management's wherewithal to get things done. That's the interesting question. And we'll just take from this and sort of learn as they do not
- [06:28]
A
to leave ONSEMI and Synaptics out of the conversation too much here. This is a company where onsemi. I don't want to be too diminutive when I say this, but they're kind of like the dumb chips when we think of what we use semiconductors for. These are kind of the, the chips that you see a lot of like automotive companies and anyone who is translating like electronic signals to physical motion them companies like NXP Semiconductors, similar companies like that are doing a lot of this in this synaptic deal at least in their words, is like combining a lot of machine learning, AI inference, a lot of that kind of, kind of the technology, the, the, the, the platform for which a lot of onsemi wants their new chips to be running so that they can start implementing this into, you know, making. I'm going, I, I mean, they're kind of dancing around it, but it's basically like a path towards robotics. And, you know, at the current price, it, it seems to make sense. But again, like, we've been talking about chips as like this hypergrowth area, but like the, the physical motion actuator, again, a diminutive term, the dumb chips have not been exactly the, the hot thing like we've seen with a lot of the other parts of the business. So coming up after the break, we want to break down the Honeywell and all of the associated parts that it is now is.
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D
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A
It's been about a year for Honeywell International to complete what has been a rather stellar portfolio transformation. Because this was a large conglomerate that has basically divided up, I won't say four, but I think if we were to back up even further, we could go 5, 6, 7 companies over the past 10 years as to what Honeywell has done. But this week was kind of the end of the line here where we saw the, the biggest breakup and I think where, where management says is going to stop. So we've got the legacy. Honeywell which is going to trade with the old ticker hon. We've got Honey Honeywell Aerospace with Ticker hona. And then we've also got Solstice Advanced Materials. This actually was spun out, I believe back in November of last year trading on the ticker Sols. And then I'm going to say this wrong. Quantinium or Quantinum with two U's. The ticker is qnt. And this was like an IPO that Honeywell kind of owned. It was like their quantum computing division. So I know I gave a little bit of like what they did, but Matt, can you kind of give me like a more of a breakdown of like what all of these companies are going to be doing now that they're on their own and away from the Honeywell corporate blanket?
- [10:19]
B
Yeah. Well, I'm going to refer to that last one as Quantinum. Lou's going to refer to it as Quantinium. And between the two of us, one of us will be right.
- [10:26]
C
Quantinium just sounds so much cooler. I'm sorry.
- [10:28]
B
It does, it does. I think I'm the right one, but yours is the cooler one.
- [10:32]
C
Yeah.
- [10:33]
B
So here's a quick roundup just a little bit beyond what Tyler just said. As you mentioned, Honeywell itself is the industrial automation and process automation company. And out of the two that just spun off, Honeywell Aerospace being the other one. It's actually the smaller by revenue. Honeywell Aerospace provides power units, avionics, mechanical systems, parts services. It is now one of the largest pure play aerospace suppliers that is publicly traded in the world. That's significant. You'll see why later in the discussion. Solstice Advanced Materials. Tyler's correct. It spun off in October of last year and is it's the specialty materials parts of the business. They make a specialized refrigerant, for example. Quantum is an interesting one that was technically an ipo, not a spinoff and it's still majority owned by Honeywell. I think Honeywell and one of its other investors own a combined, I think 82% stake in the business. This is the full stack quantum computing business. It is a pre revenue company. Like any quantum computing pure play is and their goal is to develop both hardware and software that kind of powers the next wave of computing, which is quantum computing, which at the most, you know, optimistic timetables will be a thing in 2030ish.
- [11:50]
A
This was obviously like a lot of different parts here and there is always the debate of like be separate, be together. And I feel like we've been having that discussion for who knows how long when it comes to business. So Lou, make the case, like why? Like why were they doing this now? Or what was the case for any of these even being together in the first place?
- [12:12]
C
Yeah, it's funny, you can go back to the 1950s in terms of just these cycles of coming together and breaking apart, but where we were to get to here, Honeywell stock first of all has done nothing this decade and kind of wasn't a great performer before then, just flat, which I would argue does not reflect the quality of the assets in the portfolio. Now some of this was management either being bold or being silly. They loaded up with some debt to cobble together these assets. But a lot of it arguably is the so called conglomerate. Discount Conglomerates are companies that are basically in a bunch of different industries. Think of it as a lot of businesses under one roof. There's some advantages to this structure, but ultimately each business has its own capital needs, its own M and a strategy. They operate in different cycles and the management team for each has to basically go to the parent, go to mom and dad to ask permission every time they want to do something. There's a constant battle for who gets the allowance. The theory in this breakup is freed from that extra layer of management, each operating team can make decisions that are in the best interest of their unit. The aerospace business can use all of the cash they're making to invest in the business or you know, maybe pay a dividend, something like that, instead of sending their cash upstairs for it to be distributed to shareholders or funneled to other parts of the business. In this case, you know, Honeywell Aerospace is a well run provider of cash and cabinet electronics and other systems. But it doesn't really have a lot of room for margin expansion or maybe not even growth. It's already the market leader where it is. So for this management team, maybe it's a capital allocation story. Buybacks, bolt on deals, that's what's going to drive appreciation. The automation business, much earlier in its life cycle, much more just investing in what they do, they're likely to use their cash kind of internally. These are just two management teams freed to do what is best for their business instead of listening to what the parent needs.
- [14:15]
A
It's not just Honeywell that has been kind of going through this come together, break apart cycle over the past, I want to say six to 10 years we have seen a lot of, you could argue like iconic names of industrial conglomerates basically do these breakups. We had ge, General Electric was like, you know, the gold standard of like what a company should be and you know, all of the disciples that Jack Welch created and now all of a sudden it's created into three different companies. Now we've got GE Aerospace, GE Vernova and GE Healthcare Technologies. And interestingly enough, like a lot of these companies that go through these spinoffs have gone through pretty disparate returns as a result. Like Healthcare Technologies was supposed to be the crown jewels in sort of cash generation while since the breakup Aerospace and Vernova have been crushing it while Healthcare hasn't. You had like UTX Technologies and Raytheon coming together and then they split back up into rtx, Carrier and Otis. Same thing. Everyone kind of thought like oh Raytheon, this RTX avionics defense business is going to be a mega grower. Otis is going to be this high return business. We don't know what to do with. Carrier. Carrier ends up being the best performer of the group. Same last one too, a Dow dupont when they merged together and did a split, kind of like consolidating and deconsolidating, everyone thought like this agricultural business which is called Cortiva was going to be the worst performer. And then all of a sudden we're several years after the split and while you know it, Dow stock is actually down since Dow Chemical, it's just called Dow Inc. Now is actually down since the split and Cortiva is the best performer. And so I what I'm getting at here is that sometimes the things that we think are going to be the great performers of these split ups isn't necessarily the case. And so what I'm going to do is with all of that in mind, I want you guys to put a little bit of a product, you know, a predictions hat on. I'm not going to say that Honeywell's all their business are going to follow this pattern that we saw with ge, utx, Dow, dupont. But you know, recent examples. So of these spawn of Honeywell that are remaining, which one do you see most likely to be the carrier or the Vernova of the split that's going to do incredibly well and the one that's maybe going to be the GE Healthcare or the Dow of this group.
- [16:42]
C
So I full disclosure, I bought Honeywell ahead of the split because I kind of wanted to own Honeywell and Honeywell Aerospace. So for the long term I like both of those businesses. But as I said before, arguably you're not going to see the same surge you saw like say after the GE breakup just because of where we are in the cycle for these businesses. One of them, it's kind of already played out some and one of them is still to come. I like them over five years, I think better than I like them over one year. As for the runt and the litter, Tyler, I am going to cheat and I'm going to lean in on technicality because as you mentioned at the top, this is not Honeywell's first three way split. In 2018 they spun out their auto business and their thermostat business. The old Honeywell. What we all think of when we think of Honeywell, that residential control business, Rosadio Technologies was the one that I would have avoided back then. It's the one I'm avoiding today. Honestly. The auto business Garrett Motion was to be avoided until it went through bankruptcy. But it's funny, I think the first time Honeywell sort of took out the. I don't want to say take out the trash, but kind of took the underperformers and this time what was left was just a desirable group. I think what's left is pretty strong. But the ones back from 2018 came out with a lot of warts.
- [18:01]
B
Yeah. And I would even add the Comcast and NBCUniversal deal we saw the other day to the. The deconglomerate trend. There have been quite a few. You're right. Maybe Berkshire Hathaway's next. I know Lou would be a fan of that. Not as much as a dividend, let's say it that way.
- [18:18]
C
The problem with doing that is that so many of the operating businesses inside Berkshire seem to have just kind of rotted on the vine or aren't as competitive as they were when they were bought. So I'd almost be afraid to. It's almost like a puppy. You can't let out into the wild. Some of these businesses, unfortunately, there would
- [18:34]
A
be a lot of portfolio fixing if we were to actually start doing some Berkshire spin outs.
- [18:41]
B
There could be a dozen of them in one company. And in most cases the motivation with most of that list you mentioned has been to separate a high growth business or one with a lot of long term tailwinds due to a defense spending trend or something like that from either capital intensive or commoditized boring businesses. I see Honeywell Aerospace as being the G.E. vernova of this. It's a pure play. It benefits from one a reliable revenue stream from its aftermarket business. It's the surge of global defense spending. Companies like Boeing and Airbus are finally starting to normalize and work through their backlogs That's a nice trend here. There have been several recent examples where companies in the aerospace and defense businesses get a premium multiple when they become pure plays. But on the other side, I'll go with Solstice as my GE Healthcare. It's a capital intensive business. It started with about a billion dollars of debt and it's the most boring of the four. But it's also, it's impossible to classify quantum into either basket. With all the deconglomerate deals you mentioned, there weren't any speculative, speculative pre revenue companies that were created. It's a binary outcome stock. It should be approached with caution. And it could either be, it could be either one of the, the two baskets that you mentioned, something about Solstice.
- [19:59]
A
It sounds incredibly boring. It's like chemical solvents that we use for refrigerants and fluorinating uranium for nuclear power and a lot of that stuff. And the more and more you squint at it, you're like, huh, refrigerants, data centers. That kind of makes like a weird sense. Nuclear power growth being the only one that can fluorinate uranium as part of its conversion from yellow cake to actually enriched uranium. That sounds kind of interesting. There's part of me that wants to look at that and in part and be like, man, maybe this was just like a problem child at Honeywell, but if you bring in a management team that can really like tie this together, there are a lot of long term catalysts that could be behind this business over the long term. So each of us kind of taking slightly different bets on what could do best at GE or at Honeywell. Sorry, I'm so used to talking about breakups with ge, but it is Honeywell this time. Coming up after the break, we'll hit a listener question.
- [21:01]
D
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- [22:22]
A
As always, if you want to get your question answered on air, email us@podcastsool.com that's podcasts with an S ool.com three requests as always, keep it foolish, keep it short enough we can read on air, and please avoid trying to ask for any sort of personalized advice. We have to keep it as impersonal as possible. So Question today comes from Timothy Dombey, and it's related to a lot of new ETFs that we've been seeing. My question relates to the emergence of investment products that are income generating. A few tickers, for example spyi, qqqi, chpy, and btci. These are all covered call strategy ETFs that basic, you know, try to track a index while also writing premiums or writing options on those to generate income. His question is, can you explain the purpose of these products? They appear to cap upside, provide little downside risk, and provide a sold call mechanism. Is there a market scenario where these products actually make sense?
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C
Louis Absolutely. Especially for the issuer. Okay? For the buyer, I'm not so sure. I'm not a big fan. But look, there's a product for everyone. As the listener notes, you are capping your upside in return for monthly income. And not to be a snet mat, but to me that's what REITs are for. But look, my real issue here with these products is the fees with spyi and qqqi, two of them they mentioned you're paying a 0.68% expense ratio, which is really high. The bitcoin ones, the specialized ones are almost 1%. So you're capping your upside. You're paying through the nose for basically an artificially generated income stream. Not, you know, that the net asset value on these things tend to be horrible. So you better get that income stream. I come back to this all the time. But you know, a lot of products on Wall street were built to be sold were built for the fees, not necessarily built because they really, really work for the buyer. And for me at least these fall into that category.
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B
Yeah, I mean, technically, Lou, you could buy just the S&P 500 ETF and sell your own covered calls and avoid the fee entirely and generate some income that way. Yeah, you could.
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C
That's a lot of work.
- [24:45]
B
It is. And that's what these people are being paid for. That's the point. Generally these funds use covered calls that are just out of the money. Enough to produce those high single digit return percentages, which is what most of them target, which also helps them retain some upside potential. The options they provide income, they hedge a little bit against downside risk, but only somewhat. A sharp decline in the S&P 500 on one of these would more than offset any options premium they're collecting. They can be a decent option for retirees and other income oriented investors. Maybe if I were 70, I would feel a little bit different. Who want current income without having to sell the stocks that they own. There are some drawbacks. Lou correctly mentioned the fees, which are on the very high end for essentially index funds. There are also tax implications that you can run into as distributions that come from options premiums are generally not considered qualified dividends. So they can be considered ordinary income and hit your taxes more than you think. They can be a good way to generate income and benefit from volatility. During volatile times, the yields on these tend to rise significantly. But there are those big trade offs to keep in mind. If anything, retirees can use them as part of an income bucket. Like Lou said, that's what REITs are for. You can create a whole income bucket, but not as a core income strategy.
- [26:05]
A
I want to ask one follow up here. And it's to kind of Tim's whole part of this is thinking about the market conditions. In what market conditions do these types of products work and when are they basically going to. When are you going to take a bath on them? So like when people are thinking about these sort of things, like what should they be looking out for and when is it like, okay to perhaps own one of these sort of things?
- [26:29]
B
These work the best when you have kind of an outlook for low volatility and are mildly bullish on the stock market. They perform best when the market or whatever the underlying asset is is slowly rising. Not fast enough. So they're, you know, getting called out of positions or having to roll covered calls or anything like that, but that they're not going down and offsetting that option, that options premium they're generating in the first place. If the S and P rises by like 5% a year, these are golden. But it's really hard to predict when that's going to happen.
- [27:00]
C
Yeah, but he said you've capped your upside, so you don't want the market to have too much upside.
- [27:05]
A
Considering how well the market has done this year, it's almost like that might be taking on a little bit more risk than we may want. As always, people on the program may have interest in the stocks they talk about, and the Motley fool may have formal recommendations for or against. So don't buy or sell stocks. Basically on what you hear all pretty personal finance content follows Motley fool editorial standards and is not approved by advertisers. Advertisements are sponsored content provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. Thanks for producer Dan Boyd and the rest of the Motley fool team for Lou, Matt and myself. Thanks for listening and we'll chat again soon.