10pg Case Analysis

How Dave Cote got Honeywell's groove back

May 14, 2012

The GE veteran and one-time cod fisherman has led a

remarkable turnaround at the industrial giant.

By Shawn Tully, senior editor-at-large

Dave Cote in a New Jersey lab where Honeywell is developing a new nylon copolymer that can

be used in food packaging. Around his office he typically wears jeans instead of a suit.

FORTUNE -- Dave Cote is feeling the beat. He takes a sip of Mountain Dew and bobs his head

in time to the throbbing bass of Jay-Z's "Hard Knock Life." The CEO of Honeywell

International, one of the world's largest industrial conglomerates, with $37.1 billion in sales, is

wearing his usual work attire -- a beat-up leather bomber jacket, baggy jeans, and clunky work

boots. Cote's office in the company's frozen-in-the-1960s headquarters in Morris County, N.J., is

nothing fancy. Boston Red Sox jerseys adorn the walls, and a 210-gallon fish tank he inherited

gurgles in the background. But for inspiration, he turns to his iTunes and hits SHUFFLE. "I've

got 10,000 songs on my server," he says. "The music never stops!"

Neither does Cote. While tunes like Billie Holiday's "God Bless the Child" and Neil Diamond's

"Forever in Blue Jeans" play in the background, Cote leaps from his personal history to business

insights as nimbly as the music changes genres. You can hear Cote's New Hampshire upbringing

in his voice as he recounts his youthful adventures as a cod fisherman in Maine. Moments later

he's explaining the technology of turbochargers. Then he veers into his service on the Simpson-

Bowles deficit commission in 2010. "What amazed me is how bad future deficits will be even if

we have strong growth," warns Cote.

Cote (pronounced CO-tee) is an increasingly rare commodity in the business world: an

independent thinker who's the antithesis of a slick, prepackaged CEO. The 59-year-old fills a

room not because he's an imperial type who prizes pomp, but because he's a rough-hewn leader

who demands accountability. Says Honeywell director Gordon Bethune, former CEO of

Continental Airlines: "He took us from a disaster to a hell of a company. And he never beat his

chest while he was doing it."

Indeed, Cote, who recently logged his 10th anniversary as CEO, has orchestrated one of the best

corporate comebacks in recent memory. Today Honeywell (HON) ranks as a top performer

among the diversified industrials, starting with how it has rewarded shareholders. Since the start

of 2003, Honeywell's stock has surged from $24 to $60. Investors have reaped a total return,

including dividends, of 215%. That puts Honeywell in second place among industrial

conglomerates -- just behind Danaher (DHR), which returned 229%, and ahead of United

Technologies (UTX), which has returned 210%. Honeywell's returns wax those of Emerson

Electric (EMR) (158%), 3M (MMM) (80%), and Cote's alma mater, GE (GE) (9.4%). In the

same period the S&P returned 88%. "Cote has transformed Honeywell into a technology

company with strong growth," says Jim Cramer, the CNBC host and former hedge fund manager

who also happens to be Cote's next-door neighbor in tony Summit, N.J. "This is one of the great

CEOs of our time, yet he's stayed below the radar."

Honeywell: No. 77 on the Fortune 500

How has Cote managed to recharge the failing institution that was Honeywell? The first

impression of a relaxed, hip-hop-loving raconteur is misleading. It masks a hard-core work ethic

that astounds his friends and lieutenants alike. "I'd call him for dinner in Washington the night

before a deficit commission meeting, and he'd say, 'I have eight hours of reading to prepare,' and

it would be 6 p.m.!" recalls Tim Collins, CEO of private equity firm Ripplewood Holdings. In a

decade Cote has relentlessly transformed Honeywell, making 70 acquisitions and shedding 40

businesses.

That process has shifted Honeywell's portfolio toward game-changing, technologically

sophisticated offerings that boast high margins and rapid growth. Honeywell's biggest pillar is

automation and controls, a business Cote has recharged with acquisitions including state-of-the-

art gas-detection device makers. Ranking second is aerospace. Honeywell is one of the world's

largest producers of jet engines for business aircraft, and of advanced avionics for every type of

plane. It's also a major innovator in the auto industry through a pet product of Cote's,

turbochargers.

The lineup reflects the big ideas that Cote has used to reshape Honeywell. "To run a diversified

manufacturer, you need unifying themes," he says. Cote's themes are energy efficiency, energy

generation, and industrial safety. "Energy is a conundrum," says Cote. "The economy as a whole

will use a lot more of it, but people driving cars and owners of commercial buildings and

refineries will want to conserve."

Cote's great accomplishment is unifying Honeywell's formerly fractured, dispirited culture, and

at the same time charting a fresh strategy based on those marquee ideas. Doing both required a

combination of personal magnetism and forward-looking, often contrarian thinking. The Cote

story is a step-by-step primer in an industrial revival that was anything but ordained, at a

company that on the day he arrived seemed headed for disaster.

To gauge Cote's accomplishment, it's crucial to understand the mess he inherited. Today's

Honeywell descends from a disastrous merger. In late 1999, AlliedSignal purchased Honeywell

for $14.4 billion, taking on the latter's more prestigious name. Both companies had big

reputations. Honeywell was a stalwart of American manufacturing, named for turn-of-the-

century plumbing entrepreneur Mark Honeywell and famous for its iconic round thermostat.

AlliedSignal was a scrappy, acquisitive conglomerate run with ruthless efficiency by the

legendary Larry Bossidy, the former vice chairman of GE.

Instead of meshing operations and paring costs, the new CEO, Honeywell veteran Mike

Bonsignore, and Bossidy, by then chairman, mainly fought. "Larry was always 15 minutes early

for meetings and hated to be kept waiting," recalls an executive who is still at Honeywell. "Mike

was always 15 minutes late. By the time the meeting started, Larry would be steaming."

By mid-2000 the merger's promise was collapsing, along with Honeywell's profits and share

price. Out of desperation the board accepted a takeover offer from GE's Jack Welch. GE teams

swooped down on Honeywell. GE executives took over budget planning and employee reviews.

But the biggest acquisition in GE history, and what Welch viewed as his crowning achievement,

wasn't to be. In June of 2001, Mario Monti, the European Commission's competition chief and

now Italy's Prime Minister, effectively killed the merger.

Bonsignore departed, and the board brought back Bossidy to help repair the damage. Bossidy's

priority was finding a successor who could handle the challenge. He took a chance on a

candidate who'd excelled but hardly proved a superstar at GE, and had served just a year as CEO

of TRW (TRW), an auto parts manufacturer half the size of Honeywell: Cote.

Cote's early life is an unlikely prologue for commanding an enterprise of 132,000 employees. He

grew up in a New Hampshire mill town named Suncook. His father had an eighth-grade

education and ran a garage. "I didn't know what success was, because it was hard to find anyone

in town you'd describe as successful," recalls Cote.

But his aptitude for numbers emerged early. "When Dave was 12, I'd put him on the bus to

Manchester with his big accordion and some cash," says his mother, Georgette Cote. "After his

music lesson he'd go all over town paying all the bills, for the department store, for our

insurance." Dave invariably returned with the correct change and all the receipts, Mrs. Cote notes

proudly. Today Cote describes himself as "New Hampshire cheap." Declares his mom: "I didn't

believe in allowances. When my children asked for money, I'd tell them, 'I don't charge you kids

for breakfast!'"

After graduating from high school in 1970, Cote put wanderlust before higher education. He

bought a 1963 apple-green Pontiac Catalina for $395 and drove to Michigan, where he labored as

a car washer and carpenter's apprentice. The next summer he signed up to join the Navy but

backed out of his pledge and decided to try college instead -- talking his way into the University

of New Hampshire in Durham even though it was past the official admissions date.

He later took a break from school that wasn't exactly a junior year abroad: Cote and a friend

bought a 33-foot lobster boat and spent a year running trawls for cod in Maine. "It taught me that

you can work very hard and get absolutely nowhere," he says. Around this time Cote got married

and his wife became pregnant. So he sold the lobster boat, and in 1976 he finally graduated from

UNH. (Cote is twice divorced and has three adult children and three grandchildren.)

Cote's friends today swear he's the same gregarious, up-for-anything kid from New Hampshire

outside the office. The CEO tools around the New Jersey suburbs on weekends on a Harley-

Davidson. Or, shotgun in hand, he stalks duck and pheasant in the Adirondacks with his friend

Tim Collins. "He's an incredible shot," marvels Collins. "Maybe not the best I've ever seen, but

the best for someone running a global corporation."

He also doesn't place too much emphasis on appearances. Cote goes to board meetings in jeans,

and encourages the directors to dress likewise. Not all his friends appreciate the look. "I'm a suit-

and-tie guy," says Cote's pal, Washington attorney Vernon Jordan. "I'd never come to work in

jeans. I tell Dave he looks like something out of Silicon Valley."

While at UNH, Cote had worked the night shift at a nearby GE jet engine plant as an hourly

laborer. In 1976 he landed a full-time job at another GE factory in Massachusetts as an internal

auditor, making $13,900. Cote rose to join the GE audit staff, then spent the mid-1980s as a

financial analyst at headquarters in Fairfield, Conn.

More: Where Honeywell makes its money

It was a chance encounter with chairman Jack Welch in 1985 that propelled Cote's career. Welch

heard that the company was dispatching exhaustive questionnaires about GE's business metrics

to obscure corners of the world like Mauritania. Regarding this as a colossal waste of time, a

furious Welch started calling everyone from the CFO on down, getting madder and madder when

he found the brass were absent, until he finally reached the wonk who was handling the project --

Cote. Cote kept his cool, explaining he was doing his best at a job he'd been assigned, then called

his wife and said, "I think I'm going to get fired."

But Welch was impressed with Cote's air of authority and his refusal to bad-mouth his superiors

-- especially when he later learned that Cote himself had argued against the project. Cote became

a Welch favorite. "At GE, if you moved up two levels it was great," says Cote. "Jack promoted

me three levels, which was incredible."

In 1996, Cote was put in charge of one of GE's major businesses -- appliances. "Prices were

falling, and the appliance field was brutally competitive," recalls Cote. To wring savings in

labor, Cote moved some manufacturing jobs to Mexico and threatened to move more. The tactics

didn't endear him to the unions. Asked about Cote, Charlie Smith, then head of the Electronic

Workers local, wrote to Fortune in an e-mail, "My father used to tell me that if you can't say

anything nice about someone, don't say anything at all."

Though Welch prized Cote, it was clear by 1999 that Cote didn't have a shot to be Welch's

successor. "Dave wasn't really in contention; he was a ways back," says Welch. So Cote joined

TRW as heir apparent, serving briefly as CEO before taking the far bigger job at Honeywell in

February of 2002.

For Cote, job one at Honeywell was halting a raging clash of cultures. Employees called it the

"red" and "blue" wars, taken from the traditional logo colors of the two companies. Red

represented the old Honeywell. Its folks were courtly and prided themselves on pleasing the

customer. But in practice that meant promising the customers anything, then, say, infuriating

aircraft manufacturers by delivering avionics equipment way behind schedule. Blue stood for the

former AlliedSignal. Its ethos was in-your-face confrontation, with an emphasis on "making the

numbers" at all costs.

To make matters worse, a third wayward culture needed taming. Around the time of the merger,

Honeywell absorbed a maker of fire and safety systems named Pittway. Its managers were

staunchly independent folks who'd started their own businesses and considered the red and blue

factions too incompetent to give them orders.

The feuding red, blue, and Pittway camps all bristled at taking direction from a new CEO. "I held

a town hall meeting in Brussels for the heads of the businesses in Europe," says Cote, "and about

one-third of the people I'd invited didn't show up." Pittway, meanwhile, had its own credit cards

and initially refused to switch to the brand used by the other employees.

Cote in an Agusta Westland AW139 helicopter. Honeywell is one of the world's largest

manufacturers of cockpit controls.

Early on Cote made two pivotal decisions that announced a new kind of leader. First, he ended a

long-standing tradition, inherited from both the former Honeywell and AlliedSignal, of

aggressive accounting, a practice highly in vogue at the time. Honeywell was capitalizing the

cash spent on providing free brakes, wheels, and other parts to airlines to win orders. It was also

capitalizing much of its outlays on aerospace R&D. "The system encouraged executives to give

away a lot of equipment and do research for its own sake, because those costs looked 'free,'" says

Tim Mahoney, chief of the aerospace business. Cote adopted conservative bookkeeping by

expensing both types of spending in the current quarter, even though the practice pounded short-

term earnings.

Second, Cote introduced a new strategy for tackling Honeywell's destructive legacy -- giant

asbestos and environmental liabilities. The former AlliedSignal had taken a stubbornly hard line

on asbestos suits, and investors dreaded what the future expense would be. "Dave realized we

couldn't litigate our way out," says general counsel Kate Adams. "He decided to take a

cooperative approach." Honeywell is establishing a trust for the claims and is working to scrub

the soil at old chemical plants. "The key change is that the future expense is now predictable,"

says Susan Kempler, a portfolio manager at TIAA-CREF, which holds 1.5% of Honeywell's

shares. Today the asbestos-plus-environmental expense consistently runs around $150 million a

year after-tax. That's a highly manageable number given last year's free cash flow of $3.7 billion.

To unite the company's warring factions Cote also introduced a series of disciplines covering

every business. A prime target was manufacturing. Cote saw that labor costs for everything from

aircraft power generators to fire alarms were far higher than those of competitors -- a situation he

couldn't abide. He added an extra dimension to create what's now the revered Honeywell

Operating System, or HOS. Cote demanded that his troops replicate Toyota's manufacturing

practices -- in Cote's mind, the best in the world. He dispatched 70 managers to Toyota's plant in

Georgetown, Ky., to master techniques for speeding output with the leanest workforce possible.

The rewards have been spectacular. Since 2002, Honeywell has increased its headcount just

21%, vs. an increase in sales of 72%. By keeping fixed costs like labor relatively flat, Cote

generates "operating leverage" that magnifies brisk revenue growth into outsize earnings. Since

2003, Honeywell has lifted sales 7% a year, while operating profits have grown by 12%.

During the recession, Cote demanded that Honeywell unite behind a highly unorthodox

campaign to save labor costs. He was unwilling to simply slash the workforce. "Dave was pacing

in my office, trying to decide what to do," recalls Mark James, head of human resources. "Then,

as is so often the case, he surprised me by saying, 'We need to preserve our industrial base for the

recovery, and huge layoffs will destroy it.'" So Cote required that Honeywell's employees take

unpaid furloughs of between two and five weeks during 2008 and 2009. "There was lots of

complaining," says James, "but it worked."

Cote also introduced a disciplined blueprint for M&A. The old Honeywell and especially

AlliedSignal had made a number of poor acquisitions, and Cote pledged to avoid the same errors.

"We studied every deal from 1992 to 2002," says Anne Madden, who directs M&A for the

company. "We found that half the mergers failed, usually because we overpaid or didn't integrate

the acquisitions." Today every acquisition must meet Cote's highly specific checklist. Forget

mega-deals. Of the 70 acquisitions, none costs more than $1.4 billion. "I believe in placing lots

of bets on lots of businesses," says Cote. "A big deal that goes bad can ruin a company."

Honeywell's shopping spree has been wildly successful. On average, Honeywell paid around 12

times earnings for the 70 acquired companies and tripled their profits. That improvement owes a

great deal to the CEO's relentless focus on integration. For all deals over $50 million he reviews

the integration plan's progress after closing for the following 30, 60, and 90 days, and quarterly

thereafter for at least a year.

The integration sessions provide a window on the Cote style. "If there is a loose thread in a

presentation, Dave will find it, and keep pulling until the whole thing unravels," says James. The

Cote approach is to pepper his lieutenants with endless detailed questions, bordering on

interrogation. He's incredibly focused on headcount, circling the figure with a red pen if he

deems it too high. Many of his comments are cloaked in icy humor. "You must have been a lot

busier than I was if you didn't think I'd ask that question" is a typical line.

Every few months, Cote sets aside a day to sit alone in his office reflecting on Big Ideas. He

turns up the iTunes and doesn't take phone calls. It was during these solitary sessions that he

decided to concentrate on the three grand themes of energy efficiency, energy conservation, and

safety. He also brainstorms about products that best fit each strategy. One of his favorites is

turbochargers.

A turbocharger is a device that resembles a metal pipe coiled into the shape of a snail. This

surprisingly small machine, no bigger than 18 inches in diameter, attaches to an internal

combustion engine and operates much like a jet engine. It captures the auto's exhaust and uses

that energy to force air into the cylinders at extremely high pressure. The process enormously

enhances the engine's power without a big increase in fuel consumption. Putting a turbocharger

on a four-cylinder gasoline engine generates six-cylinder horsepower, while raising miles per

gallon by as much as 20%.

Despite its obvious advantages, until recently turbo gained little traction in passenger cars except

in Europe. In the U.S., the reliability problems with the Chrysler K-cars of the 1980s had left

turbo with a poor image. But when Cote arrived, he calculated that a global revolution was

brewing. He later sold Honeywell's slow-growth consumer auto businesses -- such as spark plugs

and anti-freeze -- and poured some of the proceeds into enhancing Honeywell's turbo technology.

Cote felt that the strict fuel standards being imposed in the U.S., China, Russia, and other major

markets would make turbo the global industry's technology of choice. "I always thought that

improving the old internal combustion engine was the only way to meet those standards," says

Cote. That could create a go-go growth industry inside the mature auto business: Even if auto

sales rose slowly, turbo sales would explode as they were installed in more and more cars. That's

precisely what's happening.

As the world's largest producer of turbochargers, Honeywell now stands to benefit handsomely.

Today it's generating around $3.2 billion in turbo sales. But that figure could rise sharply. Using

data assembled with Global Insight, Honeywell predicts that turbo penetration in the U.S. will

jump from around 20% today to more than 80% by 2020, and quadruple in China to 60%. All

told, two-thirds of the world's new cars would carry turbochargers in just eight years, compared

with around 33% today.

Back in his office, Cote is riffing on another energy-themed product idea: auto and jet fuel made

from harvesting and refining algae. "We're partners in a plant in Hawaii that's making it right

now," he says enthusiastically. "The U.S. military even used it to fly an F-18 Green Hornet!"

Then he turns his attention from algae to the bubbling fish tank, filled with exotic species Cote

can't name. "It's supposed to be relaxing," he says. "Except that I don't do relaxation." John

Coltrane's "Giant Steps" comes over the speakers. Dave Cote is planning his next mighty stride.

This story is from the May 21, 2012 issue of Fortune.