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On January 23, 2019, United Technologies (UTX) released its Q4 and FY2018 results and provided the investment community with a progress report on its Rockwell Collins integration and the work being carried out on the Otis and Carrier spin-offs which should be completed in 2020.

Summary

  • UTX released Q4 and FY2018 results on January 23 which exceeded analyst expectations thus resulting in a bump in UTX’s share price.
  • While the total estimated cost of the Otis and Carrier spin-offs is significant, the long-term benefits should outweigh these one-time expenses.
  • The Rockwell Automation acquisition closed November 2018. Integration is proceeding as planned and UTX’s management is now more confident in its ability to deliver ~$0.5B in cost synergies in the first 4 years.
  • Management’s focus is to de-leverage the balance sheet in the near term and to strengthen UTX’s credit rating.
  • Despite the recent bump in UTX’s share price, shares are still currently fairly valued.

Introduction

On October 23rd I wrote this United Technologies (UTX) article in which I indicated that I decided to acquire another 300 shares @ ~$126 on October 22nd for one of the ‘side accounts’ of the FFJ Portfolio. These shares are in addition to the UTX shares I acquired for undisclosed accounts in mid-April 2008 and all the reinvested dividends.

Now that UTX has released its Q4 and FY2018 results and has provided the investment community with more details regarding the spin-off of Otis and Carrier I am taking this opportunity to revisit UTX.

The Case For Spin-Offs

The heightened level of competition has resulted in the restructuring of many companies. In multiple cases, this restructuring has included corporate spin-offs.

I have reviewed several spin-offs (eg. Synchrony from GE, Zoetis from Pfizer, PayPal from eBay, AbbVie from Abbott Laboratories, Agilent Technologies from Hewlett-Packard) and have found that spin-offs often significantly enhance shareholder wealth.

The list of companies reflected above were mature companies which spun-off subsidiaries whose growth prospects were masked to some extent by the slow growth of the parent company. By ‘creating’ a smaller company through a corporate spin-off, the idea was that the company’s valuation would improve because people in the spun-off company suddenly have powerful incentives to succeed (think stock, deferred share units, and stock options for the senior executives of the spun-off company).

Another reason for spin-offs is that they can help the parent company to focus on the core operations because there is less internal competition for corporate funds.

On a personal note, I have benefited from the spin-off of Broadridge (BR) in 2007 and CDK Global (CDK) in 2014 from Automatic Data Processing (ADP).

I am now hoping that of the spin-off of Otis and Carrier from UTX in 2020 will be just as rewarding.

Portfolio Separation

In my January 30th and October 23rd articles I touched upon the Rockwell Collins acquisition (closed in November 2018) and UTX’s evaluation of strategic options for the company’s future.

On November 27th, UTX announced its intention to separate into 3 separate companies; Otis and Carrier would be spun-off from UTX in 2 separate tax-free transactions for US federal income tax purposes.

A key benefit to be derived from the spin-off of these two entities is flexibility in capital allocation and structure.

One-time costs, particularly in the area of non-US tax expense to effect these transactions, in the range of $2.5 - $3B were expected to be incurred. This range included anticipated one-time costs related to debt refinancing charges and other typical items associated with large portfolio shaping activities across multiple jurisdictions.

The plan is that at separation each business will maintain an investment grade credit rating.

Furthermore, the expectation is that the sum of the 3 companies’ dividend per share at the outset will be no less than UTX’s dividend at the time the spin-offs are completed.

When the spin-off was announced, management indicated that during the 18 – 24 month transition period it was highly unlikely that significant share buybacks would be executed. The focus was to de-leverage the balance sheet in the near term and the long-term objective was to strengthen the aerospace business credit rating (see Credit Ratings section of this article for current ratings).

While smaller scale mergers and acquisitions were not being ruled out, the focus was to de-leverage and sustain shareholder returns. (cont’d.)

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Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long UTX.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.