Thursday, November 7, 2013

United Technologies-Raytheon Merger Builds Scale for Scale’s Sake: Merging the companies will create an aerospace and defense behemoth, but efficiency gains are a leap and the deal is messy

The Wall Street Journal
By Jon Sindreu and Lauren Silva Laughlin
Updated June 10, 2019 8:32 p.m. ET

United Technologies isn’t making things simple. The industrial conglomerate is buying Raytheon to create the U.S.’s second-largest aerospace-and-defense company by sales, while concurrently working on a spinoff.

Shareholders of both firms were mildly positive on the deal based on early-stock price reactions. If the former DowDuPont ’s merger-spin is any example, though, shareholders have a messy haul ahead. Meanwhile, the logic that changes in the aerospace business will favor a larger company has flaws.

Commercial aviation and defense will each make up roughly 50% of revenue for the combined firm once other businesses are shed. UTC is contributing Collins Aerospace, which manufactures engine parts, landing gear and the like, and its engine-making division, Pratt & Whitney. Raytheon specializes in radars and missiles, and 68% of its sales are to the U.S. government.

The logic of such a deal would be that together, the companies would be able to gain pricing leverage versus suppliers and clients at a time when the U.S. defense budget is expected to stop growing and a period of unprecedented appetite for commercial planes could be nearing its end.

It may be more a case of size for the sake of size, though. The respective market shares won’t necessarily grow. Analysts at Bernstein Research estimate a revenue overlap of less than 14% for the aerospace businesses, mostly related to sensors and other reconnaissance systems. The companies claim that synergies will save the new corporation $1 billion a year four years after the deal is done—peanuts relative to a likely joint market value of at least $100 billion.

Ensuring a smooth transition depends on Raytheon’s Tom Kennedy and United Technologies’s Greg Hayes, who will jointly integrate the company until Mr. Hayes takes over as chairman and CEO two years after the deal closes. The vast complexity of the aerospace industry makes it hard to efficiently run many businesses at once. This is why Boeing and Airbus have so far only timidly ventured into the hugely profitable market for post-sale services.

There is also the danger that corporate shuffling will delight bankers while distracting management and leaving less value for shareholders at the end. Raytheon shareholders will get stock in a smaller United Technologies after its Otis elevator and Carrier building-systems businesses separate. While it is being billed as a merger of equals, shareholders likely won’t know what they are receiving until the value of the independent company is clearer, likely closer to when the spinoffs occur.

The messy deal resembles the one former DowDuPont just completed. Chemical giants Dow and DuPont said they would merge back in December 2015 and then later decided to split up. It wasn’t until earlier this month that those plans were finally completed. In the two years leading up to its final stages, the company lost roughly a quarter of its value.

It isn’t as if UTC was lacking complexity even without a deal. Beyond spinning off Otis and Carrier, it completed the acquisition of Rockwell Collins just at the end of last year. It also faces problems with its new Geared Turbofan engine, which powers narrow-body planes like the popular Airbus A320neo, and running the math on whether to build engines for Boeing’s midsize jet project.

The company could have considered more useful and less-complicated mergers. Buying U.K. manufacturer Rolls-Royce, for example, would truly give it more heft in engines by taking it into the market for bigger planes. Now this seems less likely. As for Raytheon, its margins are coming under pressure mainly in its missile division, which has been besieged by delays and technological problems. The merger will only disguise these problems.

The proposed merger should at least be easy for regulators to swallow with little overlap between the two. However, that is just one reason investors should be skeptical.

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