In September 2022, Danaher Corp. (NYSE:DHR) announced its intention to spin off its environmental and applied solutions segment into a separate publicly traded business in the fourth quarter of 2023. Called EAS for now until it gets an official name, the new company will include the water quality and product identification businesses.
According to Joel Greenblatt (Trades, Portfolio), spinoffs tend to generate an above normal rate of return, and GuruFocus research also indicates that historically, spinoffs as a group tend to outperform the market. Of course, there are exceptions, but in general, spinoffs tend to succeed in part because their narrower area of focus allows them to get rid of unnecessary bureaucracy, focus on their own areas of specialty and become fully valued by the market rather than suffering a conglomerate discount.
Danahers spinoff looks especially promising because it will become one of the few names on the market that is primarily focused on water quality and water management solutions in a world where water shortages are expected to become commonplace over the next couple of decades. According to estimates from The World Counts, Earth could run out of fresh water in as little as 17 years unless water use is drastically reduced, which means the services of companies that purify water and help manage water usage will be in increasingly high demand.
A water crisis in the making
According to a March 2022 United Nations report, global water usage is expected to continue increasing about 1% per year. Only part of this will be due to growth in household water usage as the world population increases, since household water usage makes up about 12% of global water usage compared to business making up 88% of water usage.
Since agriculture is also included under that 88% umbrella, population growth may actually have more of an impact than many people think. The good news is, there are ways to reduce agricultural water usage, such as growing more drought-resilient crops. As for industrial water usage, much of that comes from the growing prevalence of technology in our everyday lives, as well as the frequent consumption and disposal of retail goods.
That 1% per year adds up, especially since climate change and deforestation are drying up many previously abundant sources of water. For example, according to the U.S. Draught Monitor, 82% of the U.S. is between abnormally dry and exceptional drought conditions. The Mississippi River has never been so low in recorded history, and the Colorado River has dried up so much that the surrounding region is experiencing its worst draught in 1,200 years. Brazil has chopped down 20% of its rainforest, leading to a water crisis in the countrys breadbasket region.
Danahers EAS spinoff aims to solve these problems
The EAS spinoff is ideally positioned to capture growth in demand for water quality businesses. Its operating companies include Hach, ChemTreat, Trojan, OTT and McCrometer in water quality and Videojet, X-Rite Pantone, Esko and Linx in product identification.
Breaking down the water quality businesses, Hach manufactures analytical instruments and test kits for testing water quality, ChemTreat is in the business of industrial water treatment, Trojan provides water quality and efficiency solutions (including the worlds largest UV disinfection facility) and McCrometer develops precision flow meters.
Due to all of the above-mentioned contributing factors, Grand View Research estimates the global market for water treatment systems should expand at a compound annual growth rate of 8.8% through 2030.
As fresh water becomes a scarcer resource, there could also be further opportunities for developing or acquiring new and innovative water treatment technologies. Since Danaher is one of the leading names in the water treatment industry, it has the opportunity to leverage its existing economies of scale to distribute new technologies as it acquires them.
One downside is that we do not yet have much information on the strategy that the standalone companys management intends to pursue. Additionally, since Danaher has been reporting both the water quality and product identification segments as one, we will not actually know the revenue and earnings breakdown of these two segments until after the company is spun off and begins reporting independently.
While the product identification business does not have anything to do with water quality and mainly involves product marking and coding solutions for both retailers and the packaging supply chain, this will likely become a smaller percentage of its business moving forward as the water quality business grows. However, as long as there are products being produced for sale, someone will need to make both physical and digital labels for all of them.
Takeaway
Danaher as a whole has a three-year revenue growth rate of 20%, a three-year earnings per share growth rate of 43.6% and a PEG ratio of 1.1. The GF Value chart rates the stock as modestly undervalued. The wide variety of business under Danahers corporate umbrella include developers of leading-edge medical diagnostic tools, scientific research companies and businesses that focus on protecting global food and water supplies.
Danaher: A Future-Focused Spinoff Value Play
Spinoffs tend to unlock value for shareholders, and given the solid growth outlook for Danahers EAS spinoff, especially the water quality business, I do not think this case will be any exception.
