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Why far-flung 3M isn't likely to follow in H-P's breakup path

FILE - This April 25, 2011 photo shows 3M Post-it notes at Office Depot in Mountain View, Calif. 3M reports quarterly earnings on Thursday, April 24, 2014. (AP Photo/Paul Sakuma, File)

Run a finger down the list of Dow Jones Industrial Average members and you’ll hit several corporate empires that appear ripe for a breakup in the vein of Hewlett-Packard Co.’s (HPQ) recent split.

Nelson Peltz’s Trian Fund Management has formally advocated a split of Dupont Co. (DD), of course. Cisco Systems Inc. (CSCO) is viewed by some as the next Old Tech leader in need of disaggregation.

International Business Machines Corp. (IBM) – which has been unbundling itself piecemeal for years - and even Johnson & Johnson (JNJ) have heard similar chatter from investors from time to time.

Yet there isn’t much talk of breaking apart perhaps the quintessential multi-industry blue chip, 3M Co. (MMM), even though at first look the company famous for Post It notes and Scotch tape would appear to be ripe for such treatment.

The 112-year-old company, formerly known as Minnesota Mining & Manufacturing, has such enormous breadth that its official corporate description is almost comically generic: “3M is a diversified technology company serving customers and communities with innovative products and services.”

The company operates through five discrete divisions – industrial, safety and graphics, electronics and energy, health care and consumer - each of which will have more than $4.5 billion in revenue this year. In theory, any one of those units, which themselves include hundreds of products, could be a separate large-cap company on its own. (Despite its Post It and Scotch tape fame, the company is far more reliant on invisible industrial, chemical and healthcare end markets.)

Yet 3M has avidly hewed to this diverse approach, casting its breadth and ability to allocate resources across sectors as a strength. Indeed, rather than looking for ways to chisel hunks of the company off the core, 3M this year has moved to consolidate itself further by acquiring the 25% stake in its Japan subsidiary formed in 1961 - from Sumitomo Electric Industries for $865 million.

While it might seem popular and clever to suggest that 3M would be better carved up as “6M or “9M,” the company in fact can make a pretty good case for maintaining its current bulky silhouette. 

-For one thing, the company and its stock have performed quite well, leaving no obvious leverage for, say, an activist investor to complain that shareholders have suffered under the current structure. 

The company, with a $90 billion market value, consistently converts mid-single-digit percentage revenue gains into high-single-digit earnings growth. Its operating profit margin, above 21% last year, is double that of some other big conglomerates and is closer to the likes of dominant consumer names such as Coca-Cola Co. (KO) than to industrial suppliers.

This is the kind of steadiness and impressive profitability that has won it a place in such growth-stock portfolios as Jensen Quality Growth (JENRX) mutual fund – not the sort of fund that typically holds mismanaged activist targets.

3M’s stock has handily outperformed the Dow, the Standard & Poor’s 500 and peers such as General Electric Co. (GE) over the past two, five and 10 years – and unlike H-P it can’t be plausibly called undervalued. At nearly 20-times trailing per-share earnings and more than 17-times forecast year-ahead profits, it trades at comfortable premiums to competitors and the broad market.

As for sharing its cash bounty, 3M has arguably beaten potential rabble-rousers to the punch, recently ramping its dividend payout pace and increasing share-buyback plans over the next few years. 

The company, which has paid dividends without interruption for 98 years, is set to pay out $3.42 a share this year, up 35% from the 2013 dividend level. 

3M chief financial officer Nick Gangestad emphasized at an investor conference last month that as the company seeks to repurchase close to $5 billion in shares this year, it will employ a disciplined approach taking account of share price and “evolving cash sources.” 

-Another key distinction between 3M and H-P is that 3M is not a collection of decades worth of big, often messy acquisitions.

The company is not even, in a sense, a conglomerate given that most of its business lines came from its own research labs. It has made very few acquisitions of more than $1 billion. (In fact, the company has perhaps been too timid in this regard, and its CEO Inge Thulin has been telling Wall Street he might hunt for larger game in coming years.) 

While 3M can be accused of being a bit too taken with its own history of homegrown innovation, this pride is mostly justified. Its lush profit margins come from having been first-to-market and maintaining leading positions in so many product areas.

Its early-20th century CEO William McKnight encouraged employees to spend 15% of their time focused on projects of their choosing, decades before the Google guys made such a policy a signature of enlightened idea-cultivation. 

So 3M could, with some validity, claim not to be an unfocused conglomerate but rather that rare large company whose main products are innovation, incremental improvement and smart capital allocation.

Until management falls short of its own standards, then, 3M will likely remain free of pressure to break apart. The stock might not be a bargain, but the premium it commands also serves as well-deserved insulation against the bust-up trend.