United Technologies (UTX 120.33, -7.65, -5.98%) made a major announcement
yesterday after the close: the industrial giant intends to separate its
commercial businesses, Otis and Carrier (formerly CCS), into independent
The separation, which was announced alongside the completion of UTX’s enfolding of Rockwell Collins (lately COL), will result in three companies.
- United Technologies, to be comprised of Collins Aerospace
Systems and Pratt & Whitney ($39 bln in 2017 revs combined): This will be a
major systems supplier to the aerospace and defense industry. Of note, Collins
Aerospace was formed through the combination of UTC Aerospace Systems and
Rockwell Collins; as of its closing yesterday, this acquisition represents one
of the largest in aerospace history.
- Collins Aerospace will supply electrical, mechanical, and software solutions for clients across all major segments of the aerospace industry.
- Pratt & Whitney will focus on aircraft propulsion with a number of engine programs, including one which UTX sees as a revolutionary commercial engine, called the Geared Turbofan. It will also supply military engines.
- Otis ($12.3 bln in 2017 revs): The world's leading manufacturer of elevators, escalators, and moving walkways, this business will continue to have significant recurring revenue from long-term maintenance contracts.
- Carrier ($17.8 bln in 2017 revs): This company will serve as a provider of HVAC, refrigeration, building automation, fire safety, and security products and technologies and will continue to hold leadership positions across its portfolio.
UTX is confident that operating these businesses as three
independent and separate companies is the best way for each business to grow
and be innovative. Each business will be better positioned under this arrangement
to develop a financial strategy suited to its respective industry and risk and
return profile, and enjoy greater flexibility with its own share price.
Each independent company is expected to have a strong balance sheet and to maintain an investment grade credit rating. The three companies together, post-separation, are initially expected to pay a quarterly dividend that sums to at least $0.735 cents per share. The separation is expected to be completed in 2020.
At Briefing.com, we are generally supportive of companies breaking up into smaller independent businesses. (Hopefully PepsiCo will do this, but we digress.) There is something to be said about the synergistic savings of combining companies. Businesses can save a lot of money by combining back-end operations (accounting, finance, HR, IT, legal, etc.) across multiple businesses. However, these companies are so large that the benefits of any savings can ultimately register as pretty immaterial. The benefits of separating outweigh the benefits of staying together.
From a broader perspective, perhaps the rationale for and allure of combining into and maintaining huge industrial conglomerates is losing some luster. General Electric (GE) is struggling and is selling off pieces. In fairness, GE is doing this out of necessity while UTX is splitting from a position of strength. Otis and Carrier are solid companies with good long-term potential. These companies were both acquired in the late 1970's, so UTX has owned them for a long time, and spinning them off is a big decision.
One of the key benefits of separating is that each business can be appropriately valued by the market and its own stock price. Growth businesses tend to garner higher P/E multiples while mature businesses tend to attract income investors seeking nice dividends. So each business is different, and it's good to allow each of them to get priced efficiently. Another key benefit is that each company can focus on its own business and make operational and financial decisions that are in the best interest of the individual company rather than the parent company.
UTX is trading lower on the news, but we think the separation makes sense in the long run. These three businesses are pretty different from one another, and so there is not a strong necessity to keep them together nor a major amount of benefit lost in parting them. In particular, the aerospace market has been quite strong, and spinning off Otis and Carrier should allow the aerospace unit to trade at better multiples. With GE breaking up and now UTX, it will be interesting to see if other conglomerates follow their lead.