United Technologies' Breakup Should Unlock Value

In the wake of completing the Rockwell Collins deal,

Using PitchBook's median 10-year enterprise value/EBIT multiples for United Technologies’ business unit peers and our projections for each unit's 2019 operating profit, we calculate an enterprise value of about $194 billion, which is nearly 50% above the current $131 billion enterprise value. Backing out debt, pensions, corporate costs, dissynergies, and other items, we arrive at a value of $168 per share. We believe United Technologies’ aerospace business has an enterprise value of $107 billion, which represents about 55% of our total enterprise value for the company. The Carrier business accounts for 27% of our sum-of-the-parts valuation ($52 billion enterprise value), and we put Otis’ enterprise value at roughly $36 billion based on peer multiples.

Both the Carrier and Otis spin-offs are expected to be tax-free, and one-time separation costs are likely to be $2.5 billion-$3 billion with another several hundred million in startup costs. Management didn't discuss how liabilities will be split among the businesses, but it did affirm that all three should have investment-grade credit ratings.

Including Rockwell Collins on a pro forma basis, the United Technologies aerospace business generated about $39 billion of revenue ($23 billion from aircraft systems and the remainder from engines) in 2017. While Pratt & Whitney continues to face challenges fielding its new geared turbofan engine, we believe the aerospace business possesses a wide moat and durable competitive advantages. Consistent with our existing moat analysis of the climate, controls, and security unit, we'd expect the new Carrier business to be a narrow-moat company, but we think Otis possesses a wide moat thanks to its large installed base of elevators.

Otis will be a pure-play elevator and escalator company and will be the smallest of the three businesses. Otis had $12.3 billion in revenue in 2017 and should come in around $12.7 billion for 2018; we project $13.1 billion of revenue coupled with 15.9% operating margins in 2019. Otis continues to struggle in China, where it has lost share to Kone, but it does enjoy the largest installed base of elevators in the world, and its investment in optimizing its services business should help drive margin expansion.

The Carrier business is more of a mixed bag with HVAC, refrigeration, fire, and security included in the $17.8 billion of revenue it generated in 2017. The Carrier-branded HVAC business is the largest, generating around $9 billion in revenue. Consistent with our view of the legacy CCS businesses, we view the new Carrier company as having a narrow moat, benefiting from strong brands and a decent aftermarket business. We forecast $19.6 billion of revenue coupled with 17.9% operating margins in 2019 for CCS currently. Free cash conversion has been running below 100% for CCS. Lastly, to support deleveraging following the Rockwell deal, United Technologies is likely to sell part of the fire and security business in CCS before the spin-off. This business represents about $2.5 billion of revenue and $250 million of operating profit.