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United Technologies Bit Off More Debt Than It Can Chew

Down-on-its-luck 3M might be a better play

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United Technologies (NYSE:UTX) announced Sept. 21 that it’s buying Goodrich (NYSE:GR) for $127.50 per share. The total value of the deal is $18.4 billion, including the assumption of $1.9 billion in debt. Paying a 47% premium to Goodrich’s Sept. 15 closing price, many analysts believe the acquisition is a great deal for both companies. Time will tell if they’re right.

I’m skeptical about large acquisitions because they usually never deliver the anticipated synergies. Shareholders likely won’t be able to judge whether the deal is a success until long after CEO Louis Chenevert has departed with a huge retirement package stuffed in his back pocket as thanks for a job well done. United Technologies shareholders beware — it’s easy to throw around money when it’s not your own. Sell now before things get ugly.

Debt to Capital

United Technologies is paying for Goodrich by issuing approximately 57.1 million new shares of its stock worth $4.1 billion as of the Sept. 28 closing price of $71.85 and $12.4 billion in debt. The deal temporarily dilutes earnings per share by 5% and raises total debt from $11.4 billion to $25.7 billion. Its debt-to-capital ratio moves from 32% prior to the deal to 92% after. At no time in the past 10 years has this risen above 42%.

For UTX to digest Goodrich, it’s suspending its share repurchase program, and making no buybacks in 2012 and half as much in both 2013 and 2014. Since most companies are notoriously poor buyers of their own stock, this is a positive when it comes to cranking up the leverage.

Free Cash Flow

CFO Greg Hayes suggests it will repay the additional debt in five years based on annual cash flow of more than $5 billion. Perhaps, but let’s have a closer look. United Technologies and Goodrich had combined free cash flow in 2010 of $5.3 billion. Together they paid $1.5 billion in dividends. United Technologies increased its dividend in each of the past 10 years and will do it again in 2011, paying $1.87 per share.

In 2012, I’m guessing UTX will pay out $2.06 in total dividends for a total outlay of $2 billion. In the past five years, it has  grown free cash flow by an average of 8% a year. Therefore, based on 2012 free cash flow of $5.7 billion, UTX will have $3.7 billion available for debt repayment. In 2013 and 2014, assuming United Technologies sticks to its plan on repurchases, it should have $1 billion less per year available for debt repayment and $2 billion less thereafter.

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