CEO-to-CEO call paved way for United Technologies/Raytheon blockbuster

RAYTHEON and United Technologies announced plans to merge over the weekend. / BLOOMBERG NEWS FILE PHOTO/ALASTAIR MILLER
RAYTHEON and United Technologies announced plans to merge over the weekend. / BLOOMBERG NEWS FILE PHOTO/ALASTAIR MILLER

NEW YORK – When Greg Hayes took the reins at United Technologies Corp. in late 2014, the newly minted CEO said he would pursue huge deals to reshape the industrial conglomerate.

He’s been true to his word, though it took some pressure from activist investors to hasten the company’s transformation. Since late last year, he has completed the acquisition of Rockwell Collins and announced plans to spin off the Otis elevator division and Carrier air-conditioner business as he narrows the focus largely to commercial aviation.

But it was an inbound call in the middle of last year that set him on course for his biggest deal yet. That’s when Thomas Kennedy, Hayes’s counterpart at defense contractor Raytheon Co., phoned to suggest that the companies join forces. A combination would give rise to an aerospace and defense powerhouse, the executives envisioned, with complementary product lines and fairly little overlap.

“This had been on our radar screen forever,’’ Hayes said Monday on a joint conference call with Kennedy. “So the compelling logic was there.’’

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Engines to missiles

The discussions resulted in one of the industry’s biggest deals ever, forming a manufacturer with about $70 billion in sales and a product lineup ranging from jet engines to missiles, and cockpit electronics to cybersecurity services.

United Technologies shareholders will own 57% of the new Raytheon Technologies Corp. when the deal closes next year. The company is expected to be worth well over $100 billion, according to Bloomberg Intelligence.

Investors weren’t enthusiastic. United Technologies fell 2.1% to $129.33 at 2:08 p.m. in New York, the second-biggest decline on the Dow Jones Industrial Average. Raytheon climbed 1.2% to $188.08. Rival defense contractors Boeing Co., General Dynamics Corp. and Lockheed Martin Corp. were little changed while the broader market rallied.

The tie-up, which the companies billed as a merger of equals, will give United Technologies a hedge against the cycles of the aviation markets, Hayes said. That’s important as the company spins off its elevator and climate-controls businesses.

“A leading economic rationale behind the merger was that the resulting company would be far more resilient across business cycles due to its breadth and diversification,’’ said Nicholas Heymann, an analyst with William Blair & Co.

The deal will transform United Technologies from a smaller defense contractor into one of the biggest. About 54% of the new entity’s sales will be from defense, the companies said.

What Bloomberg Intelligence says

“With United Technologies’ plans to spin off its strong cash-generating Otis and Carrier businesses in 2020, and the ongoing cash drain of its new geared-turbofan engine, the company needed a company with robust cash flow to support efforts to return cash to shareholders, which it will have in Raytheon,” said Douglas Rothacker, an aerospace and defense analyst.

Approval is no sure thing. President Donald Trump said he would be concerned about the combination if there is overlap in the companies’ offerings.

“When I hear they’re merging, does that take away more competition?” Trump said in an interview on CNBC. “It’s hard to negotiate when you have two companies and sometimes only one bid.”

But the companies don’t compete directly with each other much, which “suggests limited regulatory resistance,’’ Cowen analyst Cai von Rumohr said in a note. Regulatory approval was a stumbling block in United Technologies’ ultimately successful acquisition last year of Rockwell Collins for $23 billion.

United Technologies makes both commercial and military engines, while Raytheon is focused most on defense. On the contracting side, the deal will combine F-35 fighter jet engines made by Pratt & Whitney, a United Technologies division, with Raytheon’s Patriot missile-defense products and expertise in areas such as radars and munitions.

The headquarters will be in the Boston area. Currently, United Technologies is based on Farmington, Conn., while Raytheon’s headquarters is in Waltham, Mass.

Raytheon Integrated Defense Systems, headquartered in Tewksbury, Mass., employed 1,020 full-time workers in Portsmouth as of May 2, 2019.

Raytheon IDS specializes in air and missile defense, large land- and sea-based radars and systems for managing command, control, communications, computers, cyber, intelligence, surveillance and reconnaissance, according to the company.

Deal flurry

The Raytheon transaction crowns a flurry of dealmaking by Hayes. In 2015, he agreed to sell the Sikorsky helicopter business to Lockheed Martin Corp. The next year, he foiled a takeover bid from Honeywell International Inc. Then United Technologies agreed in 2017 to buy Rockwell Collins, a maker of flight computers and other aircraft parts, closing the deal last year.

As other conglomerates faced pressure from activist investors to narrow their focus, Hayes argued in 2017 that United Technologies benefited from its mix of businesses.

He changed his tone last year as the Rockwell Collins deal advanced toward approval and two high-profile activists – Bill Ackman of Pershing Square Capital Management and Third Point’s Dan Loeb – revealed stakes in United Technologies and stepped up calls for a breakup. Hayes late last year announced plans to separate Otis and Carrier.

Financial outlook

After the Raytheon tie-up, the resulting company will have combined debt of about $26 billion, with about $24 billion of that coming from United Technologies, the companies said in a statement. There is no change to the 2019 financial outlook for either company.

The companies said they expect to return $18 billion to $20 billion to shareholders in the first 36 months after the merger and to see about $1 billion in annual cost savings by the fourth year.

Greater heft would enhance the ability of United Technologies to withstand cost pressures from customers such as Boeing and Airbus SE, said Douglas Rothacker, an analyst at Bloomberg Intelligence.

“Aerospace suppliers have been, and will continue to be, under immense pressure from Boeing and Airbus to cut costs,” he said. “We’ve seen consolidation in the sector as a way to counter these pricing and competitive pressures, and also to diversify to add revenue streams.”

Richard Clough is a reporter for Bloomberg News. PBN contributed to this article.