Raytheon Is United Technologies’ $50 Billion Finishing Touch

(Bloomberg Opinion) -- The news that aerospace and defense giants United Technologies Corp. and Raytheon Co. were looking to merge sent ripples through both industries and beyond. For good reason, too: Combining the two companies creates a powerhouse that will rank second only to Boeing Co. But for United Technologies’ CEO Greg Hayes, it also marks one final masterstroke of dealmaking to cap off the near total transformation of a company whose roots go back more than 150 years.

Hayes has been in his job since 2014, and for every day of that tenure there's been some sort of M&A question percolating around the company. First, he sold United Technologies’ Sikorsky helicopter unit to Lockheed Martin Corp. for $9 billion in 2015 and then last year acquired avionics-maker Rockwell Collins Inc. for $30 billion in what was then the largest aerospace deal. On Sunday, Hayes was again at the helm as United Technologies announced an all-stock deal for Raytheon, whose $52 billion market value makes it the company’s – and industry’s – largest target yet. 

The Rockwell Collins acquisition paved the way for United Technologies to go forward with a three-way split that will see the Carrier building-controls and Otis elevator units stand alone in a dramatic rethinking of the company’s identity. The Raytheon deal – which is set to be completed next year, after the spinoffs – will let United Technologies get the benefits of that breakup without sacrificing any of its size. United Technologies’ aerospace divisions and Raytheon are expected to generate more than $75 billion in revenue this year between them, according to analysts’ estimates. That’s in the range of what United Technologies’ had predicted its current mix of businesses will generate this year before the breakup. The difference, of course, is that a United Technologies-Raytheon combination will be an aerospace and defense behemoth rather than a sprawling amalgamation of businesses with varying capital requirements, margin profiles and growth potential.

I’ve wondered whether the industrial breakup trend has perhaps gone too far and if some of these slimmed-down companies may miss their diversity when the next recession hits. A merger with Raytheon will help intermediate that risk for United Technologies by increasing its exposure to the defense industry at a time when analysts are worrying commercial air traffic growth may be wobbling after a long boom that’s supported hefty plane order backlogs. Budgets proposed by President Donald Trump’s administration and House Democrats would put U.S. military spending in 2020 at the highest level since World War II, except for a handful of years at the height of the Iraq War, according to the Washington Post. Raytheon’s missile-defense systems are in demand amid heightened geopolitical tension and 40% of its backlog is linked to overseas sales, the most among its peers, according to Bloomberg Intelligence analyst Douglas Rothacker. That should keep the company relatively insulated should support for a robust Pentagon budget wane after the next election.

The proposed merger will also put United Technologies aerospace assets on nearly equal footing with Boeing in terms of breadth and negotiating leverage. Boeing has spent the last few years pushing its suppliers to make ever more aggressive cost cuts, while at the same time threatening to erode their market share by bringing more parts and services work in house. But the aerospace giant’s reputation has taken a serious hit after two fatal crashes prompted a global grounding of its 737 Max jet. American Airlines Group Inc. said Sunday that it’s pulling the plane from its schedule through Sept. 3 in a sign that the timeline for the Max’s return remains very uncertain.

I wrote last month about how the Max crisis has raised uncomfortable questions about how much control Boeing has already over the aerospace market and whether those questions could shift the balance of power back in favor of suppliers. I wasn’t expecting the pendulum to swing quite this quickly, but the United Technologies-Raytheon merger will certainly have that effect. Boeing had initially pushed back against United Technologies’ takeover of Rockwell Collins but dropped its opposition after getting the two companies to agree to a cost-cutting initiative and vowing to wrangle some of their targeted cost savings for itself. I don’t think it will have the same leverage this time around.

That doesn’t mean United Technologies won’t encounter any antitrust pushback to this deal. There isn’t much overlap between United Technologies and Raytheon’s defense businesses, but the Pentagon has been wary in the past of deals involving top contractors. The combination also comes amid bipartisan outrage over the seemingly outrageous markups that TransDigm Group Inc. charged for parts sold to the Defense Department, which has prompted lawmakers to push for reforms of the contracting process to allow acquisition officers to seek backup data on underlying production costs.

Then there is the question of China. As a multi-national company, United Technologies may be required to get regulatory approval for the deal there. There was some concern that China might drag its heels on approving the company’s purchase of Rockwell Collins like it did with Qualcomm Inc.’s failed takeover of NXP Semiconductors NV. The Rockwell Collins deal did eventually get China’s signoff, but it took longer than some expected, and it’s unclear how the country would treat a megamerger amid escalating trade tensions with the U.S. and a debate around whether aircraft orders could get caught in the fray. 

United Technologies investors had been fixated these past few months on a possible merger alternative for the planned Carrier spinoff. A deal like that would have made sense. But United Technologies’ Hayes appears to have had much grander ideas in mind that could generate an even bigger payoff.  

American is also in talks with Airbus SE about an order for a longer-range version of its largest single-aisle jet. Airbus has an opportunity to steal sales away from a potential new mid-market Boeing plane that hasn't been officially announced yet and may get put on the back burner because of the Max crisis.

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

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