There is some big M&A news in the aerospace & defense sector as Raytheon (RTN) and United Technologies (UTX) enter into an agreement to combine in an all-stock merger of equals. Raytheon is a major defense contractor (missiles, radar systems) while United Technologies is a major aerospace company (comprised of Collins Aerospace and Pratt & Whitney). The combined company will be named Raytheon Technologies.
Recall that last fall UTX announced some major news of its own. It was more of an industrial conglomerate back then. It decided to separate into three separate companies:
- The United Technologies segment (comprised of Collins Aerospace Systems and Pratt & Whitney). Of note, Collins Aerospace was formed through the combination of UTC Aerospace Systems and Rockwell Collins. This acquisition, one of the largest in aerospace history, closed last fall.
- Collins Aerospace supplies electrical, mechanical, and software across all major segments of the aerospace industry.
- Pratt & Whitney focuses on aircraft propulsion with a number of engine programs including which UTX sees as a revolutionary commercial engine, called the Geared Turbofan. It also supplies military engines.
- Otis is the world's largest manufacturer of elevators, escalators, and moving walkways. This business has significant recurring revenue from long-term maintenance contracts.
- Carrier is a provider of HVAC, refrigeration, building automation, fire safety etc.
While Otis and Carrier are still currently part of UTX, they will not be included in this new transaction. Otis and Carrier are expected to be separated from UTX in 1H20. There is no premium built into this deal. UTX shareholders will own 57% of the combined company and Raytheon shareholders will own 43%. The deal is expected to close in 1H20 after the Otis and Carrier separations are complete.
The resulting Raytheon Technologies will be a massive company with $74 bln in pro forma 2019 sales. With this deal ,the companies aim to create a "balanced and diversified aerospace and defense portfolio that is resilient across business cycles."
It's clear that the two companies feel bigger is better. The increased scale should allow the company to cut costs pretty aggressively and benefit from economies of scale. The larger size should allow the new Raytheon to negotiate better prices from its suppliers.
While defense spending has increased of late, next year is an election year and a new administration could slow defense spending so it's smart of Raytheon to diversify beyond defense into the broader commercial aerospace market, which is experiencing robust demand even with the 737 MAX troubles.
These are some big changes for UTX, going from an industrial conglomerate to aerospace-only company to joining with defense giant Raytheon. There were some comments from President Trump this morning on CNBC that he may be troubled by this deal reducing competition. We think this is more bluster than anything. There is very little overlap in terms of products which means we don't expect much of a problem on the regulatory approval front. Finally, both stocks popped higher on the open but have pulled back since then. We think investors will come around to like this combination.