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Honeywell: "In the Credibility Penalty Box"


David M. Cote hasn't exactly had the wind at his back since taking the helm of Honeywell International Inc. (HON) in February, 2002. Many of the $22.3 billion industrial giant's big airline customers are staggering, slamming Honeywell's huge aerospace unit. Manufacturing is in the pits, which hurts the automation and controls business. And the new CEO has had to wrestle with a massive asbestos liability and plunging morale following his company's failed merger with General Electric Co. (GE)

But if Cote was dealt a tough hand at Honeywell, some of his headaches have been of his own making. His biggest misstep: He lowered earnings forecasts to Wall Street twice last year, warning that the company would suffer from the weak economy. But with concern mounting about whether Cote's forecasts are still too rosy and worries about how he'll execute his turnaround plan, some analysts are cutting estimates for 2003. Since Cote took over, the stock, recently at about 22, is down 31%, vs. an 18% decline for the Standard & Poor's 500-stock index.

Clearly, investors have plenty of doubts about Cote. "He's in the credibility penalty box," says Brian T. Hannon, senior portfolio manager at Delaware Investments, which held 3.5 million Honeywell shares at the end of 2002. It doesn't help that Cote earned $32 million in salary, bonus, and other compensation last year. It was the 13th-highest pay package in America, twice that of GE Chief Jeffrey R. Immelt.

The risk for Cote now is that too many disappointments -- and a further weakening of Honeywell's stock price -- could make the company a takeover target. After all, Honeywell nearly merged with United Technologies Corp. in 2000, only to see those talks scuttled by a GE deal -- which also fell apart. Investors say that if Honeywell continues to struggle, UTC might even make another run at the now-cheaper company. That could mark the second consecutive quick exit for Cote: He was CEO for less than a year at TRW Inc. before bolting for the bigger job at Honeywell. Shortly afterwards, Northrop Grumman Corp. bought the debt-laden auto-parts and aerospace company.

Cote, in his first major interview in over a year, pins many of Honeywell's problems on the economy. "I had a lot of company last year when it came to lowering earnings guidance," he says. He doesn't believe he has lost a lot of credibility on Wall Street. Still, he adds, "nobody likes a miss." Cote says his strategy is to make selective acquisitions while boosting productivity and internal growth. As for his pay, he says that much of it was to make up for stock and options he gave up at TRW.

Clearly, Cote has had a hard time getting his arms around Honeywell's businesses. His assumptions about such factors as air travel, which affects its aerospace units, may be too optimistic, says analyst John G. Inch of Merrill Lynch & Co. Inch expects Honeywell sales to fall 1.5% in 2003, to $22 billion, with net income of $1.4 billion. That's better than last year's $220 million loss, when the company reserved funds for its asbestos liability, but still only $1.58 a share, vs. Cote's guidance of $1.60 to $1.70.

It's not that Cote isn't trying. Analysts say he may sell low-growth businesses with nearly $2 billion in sales, including the $1 billion nylon operation. Cote has strengthened the balance sheet by speeding up the collection of receivables and improving inventory turns. Some manufacturing is moving from the U.S. and Europe to low-cost sites in Singapore and Romania. And Cote wants to create a "growth culture" that more closely ties research to marketing: "There is only so much restructuring you can do. At some point you have to invest for the future."

Investors approve of the overall strategy -- it's the execution that worries them. They expected more, based on Cote's GE pedigree. He spent 25 years there and ran the appliance business from 1996 to 1999, garnering high marks for boosting efficiency. Cote left GE for the No. 2 spot at TRW in 1999, later becoming CEO.

Cote's best bet at Honeywell may be to just dump some businesses. But that won't be easy. Merrill's Inch warns that Honeywell may end up trying to sell nylon, for instance, just as two other big players, DuPont and Solutia Inc., also look to exit that business.

Adding new, faster-growing businesses also may prove tricky. Says Mark Demos, an analyst at Fifth Third Bank: "Acquisitions should be a secondary effort. They've got enough to fix in-house." Cote has made only one big deal so far. Last summer, he agreed to pay $416 million for the sensors business of British engineering firm Invensys PLC, a price some investors say was too rich.

Others would be happy if Cote just used some of Honeywell's $2 billion in cash to buy back shares. Cote won't comment, saying that money is needed as a cushion in a shaky economy. Fair enough. But somehow Cote has to show that he can put it to work in a way that rewards his beleaguered shareholders. By Amy Barrett in Philadelphia


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