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Honeywell International is in the news after an activist investor called for its breakup.
Should this happen, bright lights will shine on a standalone aerospace business that is a shell of its former self after being “cash cowed” by its parent company for several decades. How did this happen? And what is next for this major aerospace supplier?
Much like the tale of Boeing’s decline, Honeywell’s story begins with the merger of two major companies—AlliedSignal and Honeywell—in 1999, which created the first “supersupplier,” with aerospace revenue of $10.5 billion. A failed merger with GE and the onset of a deep industry recession in the early 2000s left the company in a funk, and two factions emerged. One was “Honeywell red” (mostly electronics); the other was “AlliedSignal blue” (mostly mechanical components and engines).
In 2002, new CEO David Cote took the helm. Like former GE CEO Jack Welch, Cote had a laser focus on shareholder value and believed that growth could be balanced with significantly higher profits. He established the “Honeywell Operating System,” which heavily emphasized productivity, facility rationalization and movement of value chain activities to low-cost countries. The system centered on a fixed overhead, which meant that as the company grew, its support function expenses remained frozen. This led to the creation of a very complex matrix organization, which made it challenging to fund R&D and enormously frustrating for customers to locate decision-making authority. By 2007, Honeywell Aerospace revenue hit $12.2 billion with an 18% profit margin—up from 14.8% in 2002.
In the booming 2010s, Honeywell extracted cash from aerospace to boost shareholder returns and invest in its non-aerospace businesses. The dearth of aerospace investment, risk-taking and mergers and acquisitions (M&A) manifested itself in falling original equipment market share in key businesses. Once a leader in wheels and brakes, Honeywell fell to fourth place by not investing in carbon-carbon technology. Its engine business lost market share to more nimble competitors, such as Williams International and Pratt & Whitney Canada. In avionics, it ceded territory to Rockwell Collins, Thales and Garmin. It undertook no major acquisitions as its competitors bulked up and consolidated the supply chain.
Fast forward to today: Honeywell’s commercial product revenue is 28% lower than in 2007 despite the industry’s doubling in size since then. Its $13.6 billion in aerospace revenue has remained flat through aggressive aftermarket price increases—extracting value from airlines and maintenance, repair and overhaul providers—while its forward-fit positions diminished. It finishes at or near the bottom of customer satisfaction surveys. At any industry event, the anger about Honeywell’s lack of performance is palpable. Employee morale has also suffered as the workforce has endured multiple unpaid leaves of absence to fatten the bottom line. The company’s growth story is focused on advanced air mobility (AAM), which is likely to disappoint investors.
Honeywell retains islands of strength in auxiliary power units, business jet avionics and compact navigation systems. Its product management philosophy is disciplined. And it is among the most profitable aerospace suppliers, with a pretax margin of 27%—nearly double what it was when Cote took over. In exchange for this level of profitability, however, the company gave up investment, growth, employee morale and customer satisfaction. It turns out that the Honeywell Operating System and growth were not compatible.
Where does Honeywell go from here, should it become a standalone aerospace company? The first option is to maintain the status quo, emphasizing shareholder returns and aftermarket price increases. That would lead to the same results, customer vitriol and, eventually, a contracting business.
The second option is to reverse course and become a growth-oriented aerospace company again by investing in innovation, taking better care of employees, closing performance gaps and pursuing M&A. That would require courageous leadership, as it would disappoint Wall Street when investment grew and profitability came down.
The third option is to sell and/or break up the company—perhaps returning to the original “red” and “blue” factions. The “blue” engine and auxiliary power unit businesses likely would be more valuable in the hands of a major aeroengine OEM like GE Aerospace than part of the current structure.
Let’s hope Honeywell chooses change. After an unfortunate two-decade journey into the “shareholders first” cul-de-sac, our industry deserves better.
Contributing columnist Kevin Michaels is managing director of AeroDynamic Advisory in Ann Arbor, Michigan.
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