United Technology Corp. (UTX:NYSE) – market cap as of 16/09/2017: $90.33bn
Rockwell Collins Inc. (COL:NYSE) – market cap as of 16/09/2017: $21.30bn
Introduction
On September 4, 2017, United Technology Corp. announced the definitive agreement to acquire the aviation system and cabin equipment maker Rockwell Collins Inc. for a total transaction value of $30bn ($140 per share, in cash and UTC stocks). This deal is the third largest in the consolidating aircraft suppliers sector and will enhance the aerospace capability and technology systems for one of the world’s biggest manufacturer of components to companies such as Boeing and Airbus.
Although the new entity is expected generate cost synergies in excess of $500m, providing greater value to shareholders and customers, concerns have been voiced by the mentioned clients. In fact, while the merging companies are reassuring against the reduction in competition, it still seems like much power will be concentrated in the hands of a single supplier.
About United Technology Corp.
Founded in 1934 and headquartered in Farmington, Connecticut, United Technology Corporation provides high technology products and services to the aerospace and construction industries globally. As of today, the company has 201,600 employees worldwide and operates through 4 business segments: Otis, UTC Climate, Controls and Security, Pratt and Whitney, and UTC Aerospace Systems. The Otis segment produces elevators, escalators and moving walkways. The UTC Climate, Controls and Security segment provides heating, ventilating, air conditioning, and refrigeration solutions. Pratt and Whitney offers aircraft engines for the commercial, military, and general aviation markets. Finally, UTC Aerospace Systems comprises aerospace products and aftermarket services for business and military customers: the division is going to be combined with Rockwell Collins.
As of FY2016, UTC reported revenues for $57.2bn, which represents a 2% increase compared to the FY2015 figure. The strongest division in terms of sales was UTC Climate, Controls & Security which contributed to 29.5% of total sales, followed by Pratt & Whitney and UTC Aerospace Systems, which respectively accounted for 26% and 25% of total revenues. Finally, Otis business segment consisted of 21% of total sales. Gross margin as a percentage of sales decreased by 0.3% in 2016 with respect to 2015, reaching 27.6%. This was primarily due to lower gross margin in the Pratt & Whitney segment, driven by unfavorable contract performance. Overall, net income stood at $5.06bn, up 26.7% over the 1-year period.
About Rockwell Collins Inc.
Founded in 1933 and headquartered in Cedar Rapids, Iowa, Rockwell Collins Inc. designs, produces and supports communication and aviation systems for commercial and military aircraft manufacturers. As of today, the company retains around 30,000 employees worldwide. Rockwell Collins-brand aircraft electronics are installed in nearly every airline in the world and its communication systems transmit nearly 70 percent of US and allied military airborne communications.
Last year, Rockwell Collins acquired another major player within the industry: B/E Aerospace, a leading manufacturer of aircraft cabin interior products and services, for $8.6bn including debt. The rationale behind this acquisition was mainly related to cost saving opportunities and portfolio expansion.
Sales in FY2016 were $5.26bn, compared to $5.24bn in FY2015. Although total sales remained stable, US focused sales increased by $118m due to high government spending, whereas sales from outside the US decreased by $103m. COGS represented 60.3% of total sales. Overall, reported net income was $728m, consisting of 13.8% of sales.
Industry Overview
After several years of revenue expansion with a slightly declining trend, the Aerospace and Defense sector experienced in FY2015 and FY2016 a drop in global revenue, mainly driven by cuts in military spending, especially in the United States. However, thanks to a stable GDP growth, relatively lower commodity prices, including crude oil, and a strong passenger travel demand, driven by global demographics and wealth creation in Asia and the Middle East, the sub-sector of commercial aerospace is recovering and is expected to experience a 0.3% increase in revenues at the end of FY2017.
Besides, there has been a significant rise in orders for new aircrafts. The major aircraft manufacturers, Airbus and Boeing, are escalating production rates for 2017 and 2018 and are targeting to add 96 additional aircrafts to their existent fleets. This scenario will increase the attractiveness of the market, impacting deeply on the supply chain. In fact, higher volumes have been used to win price concessions from equipment suppliers, who have traditionally enjoyed higher margins than the aircraft makers. The consolidation of components, aero-structures, electronics and interiors suppliers was expected as a prompt response and it is likely to continue for the next few years, given the companies’ focus on gaining stronger economies of scale.
Moreover, the rise of global security threats and of geo-political tensions together with the growth of defense spending boosted revenue of the defense aerospace sub-sector for FY2017. A remarkable increase was due to President Trump’s policies in the US, the largest market for defense equipment and systems in the world, but also the uprising spending by major powers such as Japan and India have supported the optimism of a further industry’s ascension. Currently, after a record in transaction values in 2015 and a not equally strong 2016, the A&D industry is experiencing a fast-consolidation in the fragmented aerospace-parts manufacturers sector.
The combination between UTC and Rockwell is the third large transaction after the French aero-engine maker Safran purchase of French aerospace equipment maker Zodiac for €8.7bn (you can read about it here) and after Rockwell acquisition of B/E Aerospace, which supplies cabin interior systems. The deal-making trend is the result of increasing pressure from airframe manufacturers to reduce cost and boost production rates, to support the demand of new narrow-body jet lines.
Deal Structure
UTC’s agreement to acquire Rockwell Collins sets a price of $140 per share, of which $93.33 in cash and $46.67 in shares of UTC. The offer embeds a bid premium of approximately 18.2% over Rockwell Collins’ closing share price of $118.44 on August 3, 2017, the last trading day before any news was released, and a premium of approximately 7.2%, given Rockwell Collins’ closing share price of $130.61 on September 1, 2017, the last trading day before the announcement.
The transaction is expected to be accretive to EPS from 2018 thanks to predicted run-rate pre-tax cost synergies of approximately $500m which should be generated by 2021. Synergies are expected to be realized mainly from sharing best practices, exploitation of better negotiating leverage and purchasing economies, and capitalization on enhanced cash flows to reduce interest costs. Pro-forma sales are expected to be c. $67bn, of which c. $59bn coming from UTC.
The transaction is projected to be closed by the third quarter of 2018, subject to approval by Rockwell Collins’ shareowners, as well as other customary closing conditions. Upon completion of the transaction, Rockwell Collins and UTC Aerospace Systems will be integrated to create a new business unit named Collins Aerospace Systems.
Deal Rationale
The transaction combines two long standing industry leaders that together will enhance customer value in a rapidly evolving aerospace industry by making aircrafts more efficient and more connected.
From UTC’s point of view, the deal will allow the company to add tremendous capabilities to its aerospace businesses and strengthen its complementary offerings of technologically advanced aerospace systems. From Rockwell’s perspective, the deal represents an opportunity to compete more effectively for future business through continued investments in innovation, world-class integrated product offerings and the ability to retain top talents in the industry. Moreover, as part of UTC, Rockwell Collins will be able to gain from the upside of the whole business, and to capitalize on economies of scale to achieve substantial cost synergies. Moreover, the two combined companies would benefit from the adoption of cross-functional teams and leverage on each other’s capability to exploit the market positive momentum in the airline industry.
UTC’s M&A track record is proof of the company’s ability to successfully integrate large acquisitions into the business: “Once we have completed the integration of Rockwell Collins and made progress towards reducing leverage back to historical levels, we will have an opportunity to explore a full range of strategic options for UTC” stated UTC Chairman and Chief Executive Officer Greg Hayes.
Market Reaction
On the day of the official announcement, shares of United Technologies experienced a fall of about 4.5%, pushing the Dow Jones industrial average down by 0.8%. Rockwell Collin’s shares experienced a 0.8% increase.
However, over the last month shares of Rockwell Collins have risen around 9.8%, confirming numerous market talks about a possible deal, whereas United Technologies’ have fallen by 2.9% in the same period. As the company is planning to finance the purchase via a $14bn debt issue, Moody’s Investor Service reacted by placing the company’s ratings under review for a downgrade.
Advisors
Morgan Stanley is acting as financial advisor to United Technologies. JPMorgan and Citigroup are advising Rockwell Collins.
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