Raytheon-United Technologies Merger Proposal Spurs Controversy, Questions

Posted: Jun 18, 2019 6:55 AM

The Raytheon-United Technologies merger proposal aimed at amassing advanced technologies and products in defense and aerospace is drawing controversy and questions about whether the combination will reward shareholders sufficiently.

The all-stock merger of equals is aimed at producing annual cost synergies of more than $1 billion by year four and new revenue from technologies of the defense industry’s Raytheon Company (NYSE:RTN), of Waltham, Massachusetts, and United Technologies Corporation (NYSE:UTX), a Farmington, Connecticut, aerospace firm. The companies jointly announced they planned to return $18-$20 billion in capital to their shareholders during the first 36 months following completion of the merger, but some prominent investors are publicly blasting the proposed deal.

United Technologies still would carry out its planned separation into three independent companies, which would involve the sale of its Otis elevator and Carrier systems-building business units in the first half of 2020. The merger is expected to be tax-free and close by the end of first-half 2020, following the separation of the Otis and Carrier businesses from United Technologies.

Raytheon-United Technologies Merger Would Create $74-Billion Company

The combined company will have approximately $74 billion in pro forma 2019 sales. Raytheon and United Technologies’ leaders said the unified company would boast a strong balance sheet and robust cash generation, as well as give Raytheon enhanced resources and financial flexibility to support significant research and development (R&D), along with capital investment through business and political cycles that affect funding for U.S. defense programs.

The merger agreement, which was approved unanimously by each company’s board of directors, calls for Raytheon shareowners to receive 2.3348 shares in the combined company for each of their existing shares. Upon completion of the merger, United Technologies shareowners will own approximately 57 percent of the combined company, while Raytheon shareowners will own the other 43 percent, on a fully diluted basis.

The timing for the decoupling of Otis and Carrier is not expected to be affected by the proposed merger and remains on track for completion by the end of first-half 2020. The merger is intended to qualify as a tax-free reorganization for U.S. federal income tax purposes.

Raytheon-United Technologies Merger Proposal Receives Mixed Reviews

“We loved RTN as a standalone company, so seeing management settle for a slightly nebulous deal is a bit of a letdown,” said Hilary Kramer, a Wall Street money manager who leads the Value Authority, GameChangers, Turbo Trader, High Octane Trader and Inner Circle advisory services for individual investors.

Third Point, a New-York-based hedge fund led by its founder and Chief Executive Officer Dan Loeb, is opposing the deal due to concerns it undervalues United Technologies. As a holder of 0.8% of United Technologies shares, according to the hedge fund’s most recent quarterly regulatory filing, Third Point seemed positioned to reap the benefits of billionaire Loeb’s May 2018 call for the aerospace company to sell the Otis and Carrier businesses to unlock an estimated $20 billion in value.

However, United Technologies announced its merger proposal with Raytheon unexpectedly and barely more than six months after receiving final regulatory approval in November 2018 of its $30-billion acquisition of Rockwell Collins. That purchase became one of the largest mergers in the history of the aerospace manufacturing industry, with Rockwell Collins renamed Collins Aerospace, while United Technologies also took ownership of Pratt & Whitney.

Hedge Fund CEO Blasts Raytheon-United Technologies Merger Plan

Bill Ackman, founder and CEO of the Pershing Square Capital Management hedge fund company, also is objecting to the merger, and he sent a sharply worded June 9 email voicing his reasoning to Greg Hayes, the CEO of United Technologies. Ackman advocated finding enhanced value though the separation of the Otis and Carrier businesses that then would turn United Technologies into a pure play aerospace company, after ridding the company of acquisition-related amortization that artificially reduced its earnings and market value.

We can see why strategic investors like Bill Ackman are less than overjoyed,” Kramer said. “After all, UTX has shuffled its side of the deck so much over the last two years that we just don’t know exactly what this offer is worth or what RTN shareholders are getting in exchange for giving up their independence. We’re getting 2.3 shares of UTX after Carrier and Otis spin out. Maybe that’s the equivalent of $200 to $230 for every RTN share today but there are simply too many moving parts involved to narrow that range any further.”

Kramer added that she had a “fairly high conviction” that Raytheon was on its way back to at least reaching $210 a share on its own, so much depends on United Technologies having the “dynamism” to hold up its end of the combined company better than the market currently expects. United Technologies is offering the legacy Pratt & Whitney business unit, as well as Rockwell Collins, she added.

Chart Courtesy of TradeStation.com

“Even valuing that end of the company at something like par and factoring out the spinouts implies that Pratt & Whitney brings roughly $30 billion more to the market cap math,” Kramer said. “That’s not really enough to give us our $210 a share under the current terms. For that to happen, UTX would need to be trading above $220 a share on its own, which is possible but not a sure thing.

“Until management really lays the inner workings of what’s left behind after Carrier and Otis are gone, it looks like a great deal for UTX shareholders and a roll of the dice for RTN shareholders. Naturally, we prefer deals that go the other way. If there’s no premium in giving up our independence, scale isn’t a goal in itself. How much legacy debt will the new company take over from UTX and how much will be pushed to the spinouts? How much growth will the new UTX contribute to its union with RTN? These are questions the press release should have answered.”

Another consideration could be that the United Technologies stock has significantly underperformed during the past five years, Kramer said. Shareholders are impatient and want something done, and this merger could add value through “financial engineering,” she added.

Raytheon-United Technologies Merger Proposal Offers Technical Trading Play

“Both Raytheon Co. and United Technologies are at technical levels where the securities will typically fall into corrective mode, swinging more widely on the daily and weekly charts, but without much incentive for longer-term bulls or bears either way,” said Toni Hansen, president and head trader at Trading from Main Street, a provider of market analytics and trading education. “It looks to stabilize heading into 2020, so opportunities based on the anticipated merger are likely to offer short-term plays but drive investors batty by failing to easily commit to a larger bias.”

A “bull’s trap,” in which a false signal is shown as a declining trend reverses temporarily, is seen with the recent daily gap, especially in Raytheon, and may draw increased buyers in the short term, Hansen said. But those buyers will want to pay “very close attention” to momentum, she added.

Chart Courtesy of TradeStation.com

“Even though it may seem decent compared to the rally in the first quarter, any correction lasting longer than those that took place within that rally will be viewed with disappointment and make it easier for a larger bull trap to develop, such as the one I’ve hypothesized on the daily chart shown below,” Hansen said.

Chart Courtesy of TradeStation.com

“The proposed merger is another example of consolidation in sectors, especially those that involve a lot of investment in technology. It’s not clear what the benefits of the merger will be to shareholders,” said Bob Carlson, who heads the Retirement Watch investment advisory service. “The two companies have little overlap in their products and defense contracts. Yet, executives say the merger will create cost savings through economies of scale. That’s a rationale for mergers that often isn’t fulfilled. It’s a tough promise to deliver on when the two companies have limited overlap.”

The companies also face a long road ahead to have the merger approved, Carlson cautioned. Defense Department officials are concerned about too much consolidation among defense competitors and some large contractors, such as Boeing, might object to the merger of two competitors, he added.

Even President Trump told CNBC that he would be concerned about the merger possibly reducing competition for federal defense contracts.

Chart courtesy of stockcharts.com

Chart courtesy of stockcharts.com

Raytheon-United Technologies Merger Proposal Could Prove Beneficial

I think this news is good for UTX, especially if the feds allow it to happen, which I think they will,” said Jim Woods, editor of Intelligence Report and Successful Investing. “The new company adds more defense business to UTX, so combined the company will be a mighty force in the field. I am watching this one closely to see what transpires further, but I like what I see so far.”

The leaders of Raytheon and United Technologies said the combination would create long-term value for shareholders that could not be matched if the companies stayed independent. They touted the merit of forming a balanced and diversified aerospace and defense organization to establish a broad and complementary portfolio of high-growth business segments, while reducing risk by becoming less concentrated than if they remained separate.

The combined operation would pump $8 billion annually in research and development spending, support seven technology Centers of Excellence and employ more than 60,000 engineers to develop new, critical technologies faster and more efficiently than in the past, the leaders announced. Areas of joint advancement would include “hypersonics” and future missile systems; energy weapons; intelligence, surveillance and reconnaissance (ISR) in contested environments; cyber protection for connected aircraft; next generation connected airspace; and advanced analytics and artificial intelligence for commercial aviation.

Financial Gains Promised from Raytheon-United Technologies Merger

Raytheon plans to consolidate its four businesses into two businesses that will be named Intelligence, Space & Airborne Systems and Integrated Defense & Missile Systems. The new businesses will join Collins Aerospace and Pratt & Whitney as the four key businesses of the unified company that will be called Raytheon Technologies.

Net debt for the combined company at the time of closing is expected to be approximately $26 billion, with United Technologies likely to contribute approximately $24 billion. The united company will seek an ‘A’ credit rating at the time of the deal’s closing.

Raytheon Technologies’ combined board of directors will be comprised of 15 members, consisting of eight representatives from United Technologies and seven from Raytheon. The lead director would come from Raytheon. Tom Kennedy, Raytheon’s CEO, would be appointed executive chairman and Greg Hayes will be named CEO of Raytheon Technologies. Two years after the transaction’s closing, Hayes will assume the role of chairman and CEO.   

Raytheon Technologies will be headquartered in the greater Boston metro area and will retain a corporate presence in its existing locations. The timing of the deal’s closing will depend on receipt of required regulatory approvals and the support of Raytheon and United Technologies shareowners, along with completion by United Technologies of the spin-off of its Otis and Carrier businesses.

Aside from its defense business, Raytheon serves the civil government and cybersecurity markets, as well as gives sensing and mission support for customers in more than 80 countries. It is possible that United Technologies’ management sees untapped potential in Raytheon and its cybersecurity business that hedge fund leaders Loeb and Ackman are missing, but nonetheless, investors should not feel rushed to buy either RTN or UTX amid continuing criticism and questions about their planned merger.

Paul Dykewicz, www.pauldykewicz.com, is an accomplished, award-winning journalist who has written for Dow Jones, the Wall Street JournalInvestor’s Business DailyUSA Today, the Journal of Commerce, Seeking Alpha, GuruFocus and other publications and websites. Paul is the editor of StockInvestor.com and DividendInvestor.com, a writer for both websites and a columnist. He further is the editorial director of Eagle Financial Publications in Washington, D.C., where he edits monthly investment newsletters, time-sensitive trading alerts, free e-letters and other investment reports. Paul previously served as business editor of Baltimore’s Daily Record newspaper. Paul also is the author of an inspirational book, “Holy Smokes! Golden Guidance from Notre Dame’s Championship Chaplain,” with a foreword by former national championship-winning football coach Lou Holtz. Follow Paul on Twitter @PaulDykewicz.

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