United Technologies (NYSE:UTX) plans to acquire Raytheon (NYSE:RTN) – and investors aren’t sure how to react. United Technologies stock fell 7% in the first two sessions after the deal was announced. But UTX stock has regained about half of those losses, thanks in part to a few “buy the dip” notes from Wall Street analysts.
The uncertainty makes some sense. The UTX-Raytheon deal is big and complicated enough on its own. But United Technologies’ existing strategy adds another layer of complexity.
The company already plans to split up into three companies by spinning off Carrier heating & cooling and Otis elevator businesses. It’s not yet clear how the market will value those businesses. And so it’s difficult to estimate the value of the UTX stock being contributed to the combined company.
That complexity might be enough to push some investors to the sidelines. If it isn’t, history could be. Huge mergers have a poor track record when it comes to shareholder value. That track record is augmented by a more recent example that shows that aggressive financial engineering might have a limit.
The Case for United Technologies Stock
On paper, the merger of Raytheon and United Technologies does make sense. Raytheon’s defense-heavy business has little exposure to macro trends. United Technologies’ aerospace business, on the other hand, is highly cyclical. The combined company thus should be able to ride out almost any type of economy.
Raytheon has a thriving cybersecurity business. That marries well with the avionics business UTX picked up by acquiring Rockwell Collins in 2017. The merger positions the new company to be a leader in future growth markets like electrified aircraft engines and missile development.
Given the all-stock nature of the deal, post-merger debt will be manageable. Management initially sees room for $500 million in net annual cost synergies, with more possible. UTX has been a dividend standout, paying distributions every year since 1936. It should be able to drive more growth going forward.
Finally, it’s worth noting that United Technologies has a pretty good track record when it comes to M&A. The Rockwell deal looks like a winner. The $18 billion purchase of Goodrich in 2011 similarly has worked out well. At this point, UTX might well deserve the benefit of the doubt.
That said, not everyone is happy about the deal. Well-known investors Bill Ackman and Dan Loeb both own shares of United Technologies stock. Both have come out against the merger. Indeed, it’s not certain that the deal will receive shareholder approval from both companies, which would be required to move forward.
And while United Technologies has a good track record, the Raytheon deal is at another level. The $57 billion purchase is the largest ever in the aerospace industry. The total ~$120 billion transaction value is among the largest of all time – and those mega-deals generally have not performed well.
The AOL-Time Warner merger in 2000 is one of the biggest mistakes ever. Bayer (OTCMKTS:BAYRY) already regrets its $63 billion acquisition of Monsanto, which closed just last year; Bayer stock trades at a seven-year low. CVS Health (NYSE:CVS) has dropped since its purchase of Aetna.
Kraft Heinz (NASDAQ:KHC) is a mess. So is Anheuser-Busch InBev (NYSE:BUD) after buys of InBev and SABMiller. Bristol-Myers Squibb (NYSE:BMY) is at a multi-year low, in part due to its decision to acquire Celgene (NASDAQ:CELG).
Those deals all made sense on paper, too. None really have worked out. They all represent a cautionary tale for UTX stock.
Is United Technologies Stock Different?
To be fair, this deal may be different. Many of those deals came in challenged sectors where acquirers were either trying to buy growth and/or were hopeful that synergies could help margins. The aerospace and defense industries are much healthier than consumer staples, pharmaceuticals, or healthcare have been.
The lack of debt helps as well. United Technologies is picking up Raytheon stock at what seems like a reasonable price. To shareholders like Loeb and Ackman, who saw United Technologies I stock as undervalued, that price isn’t reasonable. But it’s not as higher debt is going to make UTX cut its dividend, as BUD and KHC have.
That said, there’s an interesting recent example of the type of financial engineering United Technologies is trying to execute. Dow (NYSE:DOW) and DuPont (NYSE:DD) merged in 2017 with the goal of splitting into three companies. Value investors – including Dan Loeb – saw the breakup as creating substantial value. It hasn’t.
UTX is different, admittedly, in that it’s splitting before the merger, not after. And its business should be less cyclical than that of Dow in particular, whose pricing is volatile.
Still, DowDuPont represents yet another cautionary tale for United Technologies. The financial engineering underway here might work – but if it does, it will be the exception rather than the rule.
As of this writing, Vince Martin has no positions in any securities mentioned.