Is a Breakup Imminent at United Technologies?

Wide-moat

First, we currently put the probability of a breakup at less than 50%. We think CEO Greg Hayes doesn’t believe in a breakup, and his comments after the event stating that investors with a “longer-term perspective understand the benefits and synergies of having a larger company together” underpin our assessment. Second, according to management, it will cost about $400 million to standup separate companies, but make-whole payments on debt and other one-time costs could total $2 billion-$3 billion. Even after acknowledging the possibility this value might be exaggerated by management that we think doesn’t want to spin off its businesses, these are big numbers. Lastly, activist investor, Bill Ackman, who took a small position in United Technologies, remains quiescent (but this could change).

Our sum of the parts valuation, which includes Rockwell Collins, arrives at $145 per share versus a current price of around $128, and we arrive at roughly $14 billion of value (using shares outstanding post-Rockwell) potentially unlocked by a breakup. This is greater than the costs outlined by management. We’d note that our discounted cash flow valuation doesn’t incorporate a breakup and results in a $137 fair value.

Portfolio questions aside, nothing we heard changed our view that United Technologies will begin to grow as secular tailwinds in aerospace support revenue growth. The challenge will be translating this into margin expansion, particularly at Pratt & Whitney, which faces a ramp-up on its new geared turbofan engine and in its aerospace systems business that will need to integrate Rockwell.

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