United Technologies: Breakup Mixed Messages Are Getting Old

(Bloomberg) -- United Technologies Corp. CEO Greg Hayes can’t keep waffling. 

Activist investor Third Point LLC, led by Dan Loeb, for the first time detailed its motivation for investing in United Technologies and called on the company to split itself into three companies focused on climate controls, elevators and aerospace. The idea of a breakup isn’t new. but United Technologies has spent an inordinate amount of time laying out reasons not to do one, even as it claims to be studying a split. This is starting to get aggravating for some followers of the company, and perhaps Third Point is one of them.

United Technologies’ business units have different capital requirements, growth profiles and debt capacities. There are few obvious benefits to packaging them together, but there’s a very obvious reason for breaking them apart: an improved valuation.

Third Point estimates United Technologies’ parts should be valued at more than $190 a share by year-end 2019, with upside to $210, compared with about $120 on Friday. That’s more aggressive than the $150 average of three sum-of-the-parts estimates compiled by Bloomberg Opinion, which is still a healthy 25 percent boost. But Third Point makes some interesting points about how aerospace investors tend to look past the big losses that characterize the early stages of a product launch, whereas multi-industrial investors tend to want stability. Third Point gets to its target valuation in part by stripping out losses on United Technologies’ costly geared turbofan (GTF) jet engine because it chooses to focus instead on the profit improvements set to come.  

The answer on the valuation is arguably somewhere in the middle between analysts and Third Point. But what was most interesting to me from Third Point’s letter was the taking to task of Hayes for being wishy-washy on the merits of a split and for giving incongruent estimates on the math working against one.

Third Point highlights how Hayes said in March that each unit has “all of the infrastructure and all of the SG&A they need to run the businesses on a day-to-day basis,” but also said there would be $200 million in added costs to run each division as a stand-alone company and as much as $3 billion in one-time separation costs largely because of debt refinancing. At one point, it was $100 million in dis-synergies, then it was as much as $250 million, now it’s $200 million. Hayes has characterized those as ballpark estimates, so I’ll give him some benefit of the doubt here. But again, a breakup isn’t exactly a new idea, and it’s time to do better than ballpark numbers. 

As I’ve noted before, the company has seemed to acknowledge the flaws in its conglomerate structure by holding separate investor days for its two major divisions and saying business-unit executives don’t pay attention to what’s happening elsewhere in the company. Many of Hayes’s seemingly endless supply of excuses for remaining as-is have been nullified by the pending $30 billion purchase of avionics maker Rockwell Collins Inc. and the tax overhaul in the U.S. And yet Hayes continues to kick the can down the road.

Hayes said in February that he would study a breakup after the Rockwell Collins deal closed, but analysts and investors have told me that, privately, he’s not enthusiastic about the idea. Third Point expressed that sentiment in its letter, and and United Technologies seemingly reinforced that on Friday with its own statement. The company said it “disagrees” with some of the hedge fund’s assertions, with the boilerplate caveat that it’s “always open to the input of shareholders.” At the very least, it’s a sign that the discussions with the activist investor over a breakup won’t be as smooth as many had thought they might.

Hayes’s lip service was nice for a while, but in the absence of action at a time when a large number of multi-industrial companies are rethinking their structures and identities, it’s getting a little old.

  1. The value per share includes dividends and assumes billion of GTF losses in The upside estimate is based on assigning credit to the positive net present value of the GTF.

©2018 Bloomberg L.P.

Bloomberg
Stay Updated With OnWeb News On BloombergQuint