Stock of the week: United Technologies

Summary:

• United Technologies (UTX.US) announced completion of the Rockwell Collins acquisition

• Following the acquisition United is likely to bolster its position as dominant aircraft parts supplier

• Industrial conglomerate plans a spin-off of its major business segments

• Company’s stock underperformed at the beginning of the week but found bottom near the previous low

United Technologies (UTX.US), the US industrial company from Dow Jones Industrial Average index, attracted a lot of attention recently thanks to two major events. Record aerospace industry acquisition is the first one while significant shift in the company’s structure is the other. In this analysis we will take a look at both events and try to assess implications for shareholders.

Both United Technologies and Rockwell Collins managed to boost their revenue and earnings in the past dozen or so years. However, when it comes to United growth in both metrics was rather stagnant in the past couple of years. Source: Bloomberg, XTB Research

United Technologies is the US company producing aircraft engines, aerospace systems, elevators as well as air conditioning systems. Over a year ago the company announced that it would acquire Rockwell Collins, the US aircraft cabin interior and avionics systems manufacturer. Given the size of two companies the deal required receiving clearance from some of the World’s major antitrust authorities. With the Chinese approval secured on Monday the last hurdle was out of the way. This came as a relief as there were concerns that the United-Rockwell merger may be subject to trade war political play. However, in the recent interview Gregory Hayes, Chairman and CEO of United Technologies said that China just wanted to wait until a similar clearance is received from the US Department of Justice to ensure both rulings will be on the same terms. United Technologies announced that it completed the acquisition on 27 November. What is more, it was not the only big news concerning the company released this week.

United Technologies saw its revenue drop in comparison to earlier years of this decade. On the other hand, Rockwell managed to boost its revenue significantly thanks to acquisition of B/E Aerospace in the first half of 2017 (the acquired company was shifted into Interior Systems segment). Source: Bloomberg, XTB Research

Simultaneously to announcing completion of the acquisition the company revealed that it will split into three independent entities. The move was rumoured on the street for some time now and the announcement came in as a final confirmation that it is happening. While the management of the company was mulling the split, it looks like investors’ opinion played a key role. Spare for pressures from activist investors, Hayes said in a interview following the announcement that shareholders were quite reluctant towards investing in a conglomerate stock saying that if they want to invest in aerospace industry they would like to buy aerospace industry stock rather than a bundle combined with elevators or HVAC business. Moreover, the acquisition of Rockwell Collins granted United Technologies scale that is said to make it harder to maintain operational efficiency as a single entity. In turn the company’s Board decided to split the conglomerate into three entities: United Technologies, Otis and Carrier. Otis will operate elevators business while Carrier will be in charge of HVAC business. United Technologies will maintain its Pratt & Whitney segment (aerospace) and newly acquired Rockwell Collins operations and begin to operate as “pure” aerospace company.

Rockwell Collins enjoyed higher operating and net profit margins than United Technologies throughout the past decade with Q4 2015 being the only exception. In that year United Technologies experienced significant gain in non-operating item (discontinued operations to be precise) that resulted in its net profit margin exceeding the operating one. Source: Bloomberg, XTB Research

Now, let’s take a look at some figures concerning those events. The deal was announced in September 2017 and the two firms agreed that United Technologies will pay $140 for each share of Rockwell. This sums up to around $30 billion and is the biggest aerospace industry deal up to date. Two-thirds of this amount will be paid in cash while the remaining part will be paid in the United stock. The company estimated the cost of splitting into three entities at $2.5-$3 billion. According to CEO of the United Technologies around $0.5 billion will be subject to costs concerning setting up proper IT and tax systems. Moreover, structuring companies towards tax minimization will cost about $2 billion. This latter process is also said to be the longest in an upcoming split taking as much as 18 months to complete. This is the main cause why company’s management estimates that the process will be completed by the end of 2020. Apart from that, receiving clearance from the European, Chinese and US authorities required promising some divestitures. In turn, United Technologies will have to sell part of its aerospace business. However, as United Technologies’ major business segments - Aerospace, Otis and Carrier - were to huge extent operated individually the overall cost of a split is said to be much lower than it was in the case of, for example, General Electrics.

United Technologies was raising its dividend payout throughout the past three decades. The abnormal spikes in 1996, 1999 and 2005 were due to stock splits and stock dividends being paid. The company plans to maintain its current dividend policy in the quarters preceding split completion. Source: Bloomberg, XTB Research

In the aftermath of the acquisition and a split United Technologies will bolster its position as the World’s dominant supplier of the aircraft parts outpacing its major rival GE Aviation by a huge margin. The stock is viewed to continue to be major supplier to Airbus or Boeing as addition of Rockwell Collins to United’s portfolio means that the company is now able to supply more than a half of all parts needed to build a plane. Moreover, both Rockwell Collins and United Technologies regularly made it to the top100 of the US federal contractors in the past few years therefore it is likely that the combined entity will continue to receive significant orders from the US government. When it comes to the direct impact on long-term shareholders, management of United Technologies is keen on keeping up with its current dividend policy until the split. The company said that investors will continue to receive at least 75 cents of dividend in each of the upcoming quarters. However, once the split is completed each of the separate companies will have a say in setting up its own dividend policy. The other pleasing factor for the shareholders may be the more direct exposure to the underlying businesses. In the past it happened that losses at one division were subsidized with profits from the other segment. However, the company’s management said that each segment is able to keep up with its own revenues and expenses now and in turn there is no longer a need to subsidize one division with the other.

United Technologies (UTX.US) opened significantly lower on Tuesday when it turned out that split costs will be higher than some market participants expected. Nevertheless, the price managed to find bottom at previous low around $119.20 for now. The stock is trading around 15% below its ATH around $143.80. Source: xStation5