United Technologies Corporation (UTX) and Raytheon Company (RTN) have recently announced a proposed merger of equals. Regulatory approvals are still required but because the companies are complementary in nature with less than 1% overlap in sales, management is optimistic the transaction can close in the first half of 2020.
- United Technologies Corporation and Raytheon Company have just announced a decision to merge thus creating Raytheon Technologies Corporation.
- The proposed merger of equals has yet to receive regulatory approvals but management is targeting the close of this transaction in the first half of 2020.
- The newly formed entity will have combined aerospace and defense segments revenue of ~$69B placing it behind Boeing and Airbus from an annual revenue perspective.
- Management is targeting an ‘A’ credit rating category for the new entity.
- Pro-forma Free Cash Flow (FCF) of ~$8B is projected for FY2021 with strong FCF growth expected to support investment and return of ~$18 – $20B in capital to shareowners through share repurchase and dividends in the first 36 months following closing.
- I intend to add to my existing UTX positions in the FFJ Portfolio and undisclosed accounts.
In my October 23, 2018 United Technologies (UTX) article I concluded that UTX was fairly valued and disclosed that I had acquired a few hundred shares for a ‘Side Account’ within the FFJ Portfolio; UTX shares have been held in undisclosed accounts since April 18, 2008.
I followed up that article with this January 23, 2019 article in which I touched upon the significant transformation taking place (ie. impending spin-off of Otis and Carrier and the integration of Rockwell Automation). I will not revisit this subject matter in this article.
The merger of RTN, a leading defense company, and UTX, a leading aerospace company, comprised of Collins Aerospace and Pratt & Whitney will result in a newly created entity to be named Raytheon Technologies Corporation.
This new entity will have combined aerospace and defense segments revenue of ~$69B. An overview of the proposed transaction and the strategic rationale for the merger can be found by clicking on the link below.
Naturally a deal of this nature and magnitude does not close in short order and it is unlikely regulatory approval will be secured before Q1 2020. This timing works out well since the spin-offs of Otis and Carrier are expected to close in the first half of 2020 and UTX is in the midst of integrating Rockwell Collins which was acquired in late November 2018.
Although nothing is assured, I envision this merger being approved with minimal concessions because the companies are complementary in nature with less than 1% overlap in sales.
Source: UTX Aerospace Businesses and Raytheon to Combine in Merger of Equals Presentation – June 10 2019
Guidance is for the new entity to achieve an A category credit rating. This is encouraging for current UTX shareholders because Moody’s downgraded UTX’s long-term debt one notch from A3 to Baa1 in August 2018; this rating is the upper tier of the lower medium grade category and is investor grade. In addition, S&P Global downgraded UTX’s long-term debt by one notch (A- lowered to BBB+ on November 28th).
Raytheon shareholders will end up owning shares with a lower credit rating. Moody’s currently rates the senior unsecured long-term debt A3 which is the lowest tier of the upper medium grade category. S&P Global rates RTN A+ which is the top tier of the upper medium grade category.
An A category long-term unsecured debt credit rating is satisfactory for my purposes.
At the time of my October 23rd article I looked at UTX’s valuation on the basis of YTD EPS of $5.72, adjusted EPS of $5.67, and the revised adjusted EPS range of $7.20 - $7.30. I also anticipated that UTX’s full year EPS would be reasonably close to $7.25.
UTX was trading at ~$128 thus giving me a forward PE of ~17.66 which compared favorably to the 5 year average PE of ~18.5.
When I wrote my January 23rd article, UTX had recently reported GAAP EPS of $6.50 and Adjusted EPS of $7.61 and was projecting Adjusted EPS of $7.70 - $8.00 for FY2019. (cont’d.)
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