United Technologies (UTX) shares are cruising higher in pre-market trading after agreeing to merge with Raytheon Co. (RTN) on Sunday.
Shares of the Farmington, Connecticut-based conglomerate moved up with the surprise blockbuster all-stock deal that will become Raytheon Technologies Corp., a serious challenger for defense and aerospace dominance alongside Lockheed Martin (LMT) , Northrop Grumman (NOC) , and the recently troubled Boeing (BA) .
"The combination of United Technologies and Raytheon will define the future of aerospace and defense," said Greg Hayes, United Technologies Chairman and CEO. "By joining forces, we will have unsurpassed technology and expanded R&D capabilities that will allow us to invest through business cycles and address our customers' highest priorities. Merging our portfolios will also deliver cost and revenue synergies that will create long-term value for our customers and shareowners."
The newly formed company expects to return $18 billion to $20 billion of capital to shareholders in the first 36 months following the merger, as well as about $500 million in annual savings, over the same period. The deal is expected to close in the first half of 2020, pending regulatory approval.
The blockbuster comes at a key point in time as cyclical worries about each company have surfaced and further allows the new company to curry favor with the Pentagon that wants increased R&D spend on a broader array of capabilities, not least of which is outer space.
"Parallels with the other recent defense mega-deal Harris Corporation (HRS) /L3 Technologies (LLL) , and the growing importance of quasi-commercial capabilities offers upside to the $500 million synergy target, in our opinion," Seaport Global analyst Josh Sullivan said. "The Pentagon is increasingly rewarding commercial development/cycle speed, which also allows commercial margin profiles. Therefore, the integration of RTN with UTX's commercial infrastructure is ahead of the curve."
He added that the deal is particularly positive for UTX shareholders as it allows the company to de-lever and shed some of its ancillary businesses, like Otis Elevator and Carrier, without sacrificing business diversity.
"For UTX, the deal is positive from a financial perspective, adding scale, and balance/stability by reduced leverage/greater diversity ," J.P. Morgan analyst Seth Seifman said. "Key for UTX here is the strong RTN balance sheet, which will act as a cushion to the high standing leverage."
He said that amidst the noise, UTX is "undeniably cheap" as it heads on to become not only one of the largest defense supplier as part of the new company, but also the most diversified player.
"Scale not only helps to push back against the framer duopoly and their push for more of the value out of the supply chain, this portfolio structure would also help to provide ample air cover for both earnings and cash in future engine development campaigns which are likely to continue to prove highly competitive," Seifman reasoned. "From a synergy perspective, the company capabilities should support increased developments in connected aircraft systems."
Still, given the sprawling nature of the new company, integration risk is a notable concern among many defense analysts that have seen many companies overextend themselves across too many industries.
"We see relatively few opportunities to drive revenue synergies as the product portfolios for both companies do not appear to be particularly complementary," Credit Suisse analyst Robert Springarn said. "We also note that neither company owns platforms that can serve as a sales conduit for the other's products, with only a few exceptions such as GPS receivers on missiles."
He added that the merger's rationale in terms of curtailing cyclicality of each business is not overly compelling, given the secular trend of increased defense spending.
"We do not believe there was much pre-existing downside that needed to be hedged, though we wonder if UTX's motivation was partially in response to the supply chain disintermediation underway from Boeing," Springarn mused. "We have believed UTX is among the most exposed to pressure from BA over the long term."
Additionally, the combination of debt and pension liabilities remains a looming risk.
In the immediate term, the market seems to be focusing on synergies rather than integration risk, as shares of both companies surge.
Upon approval, Raytheon shareholders will receive 2.3348 shares in the combined company for each Raytheon share. United Technologies shareholders will own approximately 57% of the combined company.
A conference call explaining the deal is underway now, listen in here.
