Ramstad: Investors focused on AI and flashy tech may overlook important innovation

Investors and the media tend to overlook the innovation and efficiency that happens inside old-line industrial companies. They instead throw money and attention on flashy, fast-growth tech ideas like AI.

I got a fresh reminder not to make that mistake during recent visits to two of Minnesota's oldest industrial companies, Graco Inc. and Tennant Cos.

Both have rich histories, excellent financials and are on the leading edge of technological advances that will guide them for decades to come. They're also ready to buy other companies at a moment when corporate dealmaking appears likely to accelerate.

In 1926, brothers Russell and Leil Gray started a company to sell an air-powered lubricator that Russell developed at a Minneapolis gas station to grease auto parts in cold temperatures. Today, Graco sells more than $2 billion worth of sprayers, pumps and other fluid-handling equipment. (It's not affiliated with the similarly named baby-products brand owned by Atlanta-based Newell Brands.)

The excitement there these days is focused on how electric circuitry is replacing compressed air to pump fluids. With paints, for instance, electrically controlled sprayers turn on and off more precisely, reducing overspray and waste. It's a significant turning point for Graco.

"Air is really inefficient, and a lot of factories used compressed air to move their pumps," said Mark Sheahan, Graco's chief executive. "We've designed and developed a lot of pumps that are driven by electricity, which is much more efficient and reduces energy by a lot, depending on how often they're used. We're in the early innings and I think over time that'll be great for us."

George Tennant started a woodworking business in Minneapolis in 1870, then turned it into a provider of wooden flooring. His successors in the early 1930s added wood-floor vacuums to their offerings, putting the company on a course to become one of the nation's largest makers of industrial-scale floor-cleaning equipment. Today, it sells $1.2 billion of those machines each year.

The excitement at Tennant these days is about robotics. The innovations in sensors, batteries and software that produced consumer-grade vacuums like Roomba 20 years ago are now so advanced they can guide Tennant's half-ton (and bigger) cleaning machines around Walmart stores and factory floors.

"You've got this really interesting nexus where there's critically important work that has to be done and it's hard work and nobody wants to do it," said David Huml, Tennant's chief executive. "That's why we get excited about mechanization and robotics. That's why the space is so attractive to us, and we think that we've carved out a significant position."

In 2019, Walmart saw a concept from Tennant for a robotic version of the standup floor washing and scrubbing machine that it used in many stores — and then placed an order so large it sent Tennant's stock up 20% when news reached investors. It took the company more than a year to make all the machines, keeping its factories humming even after the pandemic arrived in 2020.

Now, Tennant has crafted a new strategy for mergers and acquisitions that revolves around opportunities in robotics and automation. Huml said the company will look at firms that make products or technologies that will fill gaps in its product lineup, as well as makers of technologies that enable robotics. It has a list of about 800 potential target companies.

"What we're doing is racking and stacking the 800 based on what we think is most attractive," Huml said. "And then we're out shopping ourselves, making sure people know we are in the market ... so that the lines of communication are open."

Tennant earlier this year took a sizable minority stake in a company that provides the key operating software for robotic machines, a move that Huml said the firm may repeat.

"I view it as deploying capital to create value for shareholders, just a little differently than a pure acquisition play," he said.

At Graco, free cash flow amounted to $466 million last year, by far a record and more than double its 2022 level.

"That's a pretty big powder keg for us to be able to utilize" for deals, Graco's Sheahan said. "We also are not afraid of taking debt if we need to. I think we could easily access $2 billion of external debt without jeopardizing the company in any way, shape or form."

Tennant has knocked down its debt and has around $1 billion of borrowing capacity, Huml said. Sheahan, who joined the Tennant board of directors this year, said the environment for companies like theirs is better now that money is more expensive than it used to be. In other words, the higher interest rates that came about to combat inflation took out some of the competition that established companies faced for deals.

"When money was free, you would have private equity go out and borrow at virtually 0% and they could bid up and prices would get pretty high," Sheahan said. "For strategic buyers like us, who have shareholders that demand 10% of their money every year, that math is really hard to compete against."

And what happens now that the Federal Reserve has started cutting interest rates?

"That pendulum might swing a little bit differently," he said. "But for the Gracos of the world, we don't have to go out and do huge, transformative deals. I think the [mergers and acquisitions] market is in good shape and we should be able to execute better than we ever have."