Siemens is a 174-year-old conglomerate in the midst of a generation shift toward technology.
Jason Alden/Bloomberg
Siemens, a German industrial giant and one of Europe’s largest companies, gave investors what they wanted on Thursday: a €3 billion ($1.2 billion) share buyback program beginning next year and running until 2026.
But that’s not where investors’ attention should end. As part of its capital markets day—the first under the leadership of Roland Busch, its new chief executive—the group laid out plans for critical advances in two of its divisions. If both are executed successfully, it could lead to shares in the group rising as much as 50%.
The first step is to demystify Siemens ’ software division, which could change the way capital markets value the business; the second is increasing the profitability of the group’s division focused on infrastructure, which lags behind peers.
Philip Buller, an analyst at investment bank Berenberg, identifies these steps as “two clear levers which management should pull in order to drive value for shareholders, either of which would be positive for the share price, but together make the shares look particularly undervalued.”
Siemens is in the midst of a generational shift from aging industrial behemoth to focused technology company. The jewel in the group’s crown is the factory business it calls digital industries, which builds high-tech factories for the future, supplying automated manufacturing systems and, increasingly, industrial software.
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The company’s software division has €4 billion in annual sales and growing, but Siemens’ market valuation doesn’t appear to take into account that it contains such a valuable business. So far, the software business has been buried within the larger industrial group, obscuring the higher valuation that software companies fetch compared with industrial stocks.
As a capital goods company, Siemens’ stock currently trades at around 2-2.5 times its annual sales, but software groups are valued at closer to 10 times annual sales. Siemens’ purchase of Supplyframe—a U.S. software group—for $700 million in May supports this; Supplyframe notched sales of $70 million in the year prior.
While Siemens’ software business has grown through buying companies valued at 10 times sales, the group’s market valuation of two times sales remains unchanged. This leaves room for a substantial re-rating of the company that could add up to €30 billion to its market capitalization, adding 20% to 25% to the stock price, according to Buller, who said the way the software business is reported “drives mispricing.”
This “can be addressed relatively easily, primarily through improved disclosure, enabling the market to assign a more suitable value to this asset,” Buller said.
Announced on Thursday, starting in 2022, digital industries will begin a fundamental business-model transformation, the company said, transitioning most of its software business to a subscription model to make revenue more predictable and increase accessibility for smaller companies that can’t afford complex computer infrastructure.
The group will also begin reporting annual recurring revenue, which will give investors increased insight into how the division works. Changing the business model and financial reporting framework, as Siemens plans to do, is just the kind of clarity that Buller says capital markets need to take a second look at Siemens.
The second opportunity for Siemens to boost its share price is in its second-largest division by revenue: smart infrastructure for power grids and digitally connected buildings.
In concert with the capital markets day, Siemens has put new emphasis on profitability targets in the smart infrastructure division, aiming for margins of 11% to 16%, up from the 10% to 15% range it guided for that specific division at the end of 2020. Margins in the infrastructure business declined from 10% in 2019 to 9.1% in 2020.
Buller noted that margins are almost twice as high in Siemens’ closest competitors in this sector, Eaton and Schneider Electric.
“There is no structural reason why margins can’t expand at pace for Siemens and this should be the number one priority for the new CEO from an operational standpoint,” Buller said. “Not only would this drive strong earnings momentum but should also be deserving of higher multiples than are currently being assigned to this business,” he added.
Successfully bringing margins closer to peers’ could similarly add 20% to 25% to the price of Siemens’ shares, Buller said, so the stock could see as much as a 50% upside from executing on both software and infrastructure goals.
Busch, in an interview with Barron’s, outlined the steps that Siemens is taking to increase infrastructure margins: relying on its low-voltage business, a renewed portfolio, introducing cost savings, and consolidating research and development.
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Fine-tuning the infrastructure division will also help drive broader revenue growth at Siemens, which hiked targets for annual sales growth from between 4% and 5% to a 5% to 7% range.
But it may not be easy. Mark Fielding, an analyst with RBC Capital Markets, noted that Siemens’ revenue growth target appeared to be the “most ambitious” of its headline announcements ahead of the capital markets day.
And Denise Molina, an analyst at Morningstar research, noted that while Siemens remains a technology leader in healthy markets, it has been posting “anemic” profitability and “subpar” growth.
Moreover, Molina said that managing the group’s four core parts—industry, infrastructure, mobility, and health technology—is an unnecessary drag on costs due to a lack of synergies, which also opens the door for inefficient capital allocation.
But Busch envisions a Siemens that will define itself around applying dominance in key technologies—automation, 5G, and cloud computing and security—across the core parts of its business. That could solve the problem of synergies, and is integral to his plan to reinvent the 174-year-old technology company.
