Raytheon-United Technologies Merger

Raytheon-United Technologies Merger

On June 9th, Raytheon (RTN) and United Technologies (UTX) announced they had entered into an

agreement to combine their operations in an all-stock merger of equals. The new entity would have

around $74B in annual sales within the defense and aerospace industries. Excluded from the combined

company would be Carrier and Otis segments that United Technologies is in the process of separating

into stand-alone companies.

Under the terms of agreement, Raytheon shareowners will receive 2.3348 shares for each share held

and retain 43% of the new company while United Technologies shareowners would retain the remaining

57%. Expected to close in 2Q2020, the timing would coincide with Otis and Carrier separation.

The press release states expectations from both boards of a ¡°highly complementary technology and

R&D platform¡± that is forecast to return $1B-$20B of capital to investors in the first three years while

capturing ¡°more than¡± $1B in annual run-rate cost synergies.

With business overlap estimated to be around 2%, investors have not reflected the same bullish

sentiment in the merger, as reflected by the stock price of each company. Following the announcement,

shares traded lower and have remained below their pre-June 9th prices, underperforming industry peers

and S&P.

The opposition and apathy to this merger is not limited to individual shareholders, activist funds have

expressed their objection as well. While Trump expressed concerns about unfair competitive advantage,

the Department of Defense recently said that they see ¡°no major concerns¡± with the deal.

Third Point Opposition

Headed by Daniel Loeb, the asset management firm and stakeholder in United Technologies sent a letter

to the board of directors outlining ¨C and questioning ¨C reasons why they are opposed to the merger

with Raytheon.

The letter states that while the rationale behind the proposed merger was seen as being understandable

from Raytheon¡¯s side, United Technologies would have very little to gain in return. Raytheon would gain

competitive advantage in multiple industries including hypersonics and directed energy weapons but

the cyber and data analysis capabilities they would bring could be achieved through supply agreements

or collaborative work with other companies.

Third Point also expressed concern that Raytheon CEO¡¯s comments during the Paris Air Show ¨C that his

company would be ¡°out of business¡± within a decade if it were to mirror peers in capital spending ¨C was

intended to scare or pressure shareholders into voting for the deal.

As United Technologies is currently breaking up into three companies through Otis and Carrier

separations, Third Point questions the motivation of a merger ¨C the point of separating these two units

was to focus on their core business. The sudden decision to look into a merger of this magnitude at a

point where their shares are depressed (from earlier-2019 levels), especially with a near-term outlook

that the 3-way split would be beneficial to the stock¡¯s price is seen as being ¡°questionable¡±.

Furthermore, as United Technologies is still integrating Rockwell Collins acquisition, they should keep

focusing on the task at hand, considering management has a poor performance track record as

evidenced by underachieving business segments, including Otis and Carrier. This, Third Point contends,

has led to shares underperforming S&P by 41% over the past five years.

Third Point isn¡¯t the only fund that has voiced opposition to this merger; Bill Ackman¡¯s Pershing Square is

equally against the deal.

The activist shareholder believes this transaction will not only be highly dilutive from share issuance, but

also be negative to their aerospace business. Ackman had supported United Technologies spinoff or

divestiture of non-core segments which were expected to bring about value appreciation to the stock,

an outcome that is likely to be hindered by the Raytheon merger. As such, Pershing Square has said they

would urge shareholders to vote against the deal.

RBC Capital

After hosting analyst meetings with United Technologies CFO, the analyst factually presented the

company¡¯s rationale for the deal. Not surprisingly, the bulk of investors¡¯ questions were focused on the

same subject.

United Technologies unwavering reasoning includes the view that the integration process would not be

¡°intense¡± due to minimal direct business overlap. With a large and broad range of technologies the two

companies have, cross-industry transfer in key business segments would benefit as a result.

Hypersonics, for example, would draw on United Technologies expertise on heat management, while

Raytheon¡¯s leadership position in military aircraft cybersecurity would be one of their major

contributions. Within sensors and analytics field where both companies have considerable development

knowledge, there would be an opportunity for ¡°sizeable synergies¡±.

As part of a combined entity, United Technologies believes they would be in a better position to

compete against Boeing (BA) and Airbus (EADSY) who continue to expand their verticals further into

avionics. A more diversified company would also be able to weather cyclical downturns better.

Cowen

Based on projected synergies in multiple segments, Cowen¡¯s analyst is bullish on the merger proposal.

Seen from United Technologies¡¯ point of view, the benefit would also extend to their heavier debt

burden of $24B, compared to Raytheon¡¯s $2B-$3B.

Regarding the pullback in share price when news of the merger was made public, the analyst thinks that

investors either don¡¯t like the proposal, or have a misunderstanding of the details, failing to see that this

would be a ¡°win-win situation¡± that would provide United Technologies the opportunity to benefit from

synergies, as well as financial flexibility.

Credit Suisse

Following Raytheon¡¯s earnings release, Credit Suisse discussed management input regarding the deal.

Aside from expectations of a ¡°complementary merger¡±, they also stated that investor feedback has been

¡°positive¡±, which is contrary to sentiment expressed by shareholders. This also is a stark contrast to Bill

Ackman and Dan Loeb¡¯s opinions.

Although Raytheon reported 2Q revenue growth of 7% and raised FY2019 guidance, the analyst brought

up concerns of their long-term prospects attributed to ¡°slowing DoD budget growth¡±, and more

pertinently, market share loss of High-Speed Anti-Radiation Missile (HARM) franchise as Northrop

Grumman (NOC) extends its reach into missiles as they expand their verticals. As well, recently merged

L3Harris Technologies (LHX) could pose a competitive threat in defense electronics segment. Despite

what United Technologies could bring into the deal, Credit Suisse does not believe it would improve any

of these issues.

Seaport Global

Briefly mentioned in their bullish United Technologies note after 2Q results, the analyst is nevertheless

¡°a supporter¡± of the merger. Cited were opportunities in hypersonics, drones and associated businesses

within defense sector which has seen increased budget allocations under the current administration.

United Technologies¡¯ contribution would be from the aerospace industry though Pratt & Whitney and

737MAX program: current management assumption is 42 aircraft per month for the balance of 2019,

and a ramp thereafter.

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