LONDON (Reuters Breakingviews) - United Technologies isn’t staying fully grounded in its quest for scale. The U.S. industrial conglomerate is paying $30 billion including debt for aerospace supplier Rockwell Collins. The strategy makes sense but, with a weak return on investment, United Technologies is paying up for the privilege of getting bigger.
The deal, whose $23 billion equity value is a roughly 18 percent premium to the price of Rockwell Collins stock before news of a possible sale emerged a month ago, was widely anticipated last week. Breakingviews' estimate (reut.rs/2vG4ox3) of the likely cost savings came in close to the $500 million of annual synergies touted in Monday's official release.
Taxed at 30 percent and capitalized on a multiple of 10, these are worth $3.5 billion – just a hair more than the deal premium, before allowing for transaction costs and the four years it will take to realize the savings in full. That makes financial sense. The overall return, though, isn’t so compelling.
Analysts on average expect Rockwell to make $1.7 billion in earnings before interest and tax in the coming 12 months, according to Thomson Reuters data. Add the cost savings and tax the total profit, and the return on the full price, including $7 billion of Rockwell net debt, barely tops 5 percent. That’s well short of Rockwell’s weighted average cost of capital of 8.4 percent, as calculated by Morningstar.
United Technologies chopped more cost out of its last big acquisition, of Goodrich for $16.5 billion in 2012, than it originally promised. Yet justifying the Rockwell Collins purchase needs more. Pricing power with customers like Boeing and Airbus could be one source of value, but if that’s a real factor the deal will face stiff opposition from those companies. So might cross-selling more systems and parts, although revenue synergies like that are much more easily hoped for than delivered.
Another way to keep shareholders happy might be a future carve-up, and adding bulk in aerospace could make that easier. Carving out the climate-control and elevator arms of United Technologies would be a logical step, though executives didn’t sound in any hurry to do that on Tuesday. A 4 percent drop in the $90 billion company’s stock in morning trade underlines the need for elusive revenue benefits or a lucrative breakup to prove the deal’s potential.
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