By Ryan Barnes. Edited By Douglas A. McIntyre
United Technologies Corp. (UTX) – Current Price $68.10; Breakup Value $67
United Technologies is your prototypical conglomerate, with six designated operating segments that are not only distinct; they each have their own brand and are essentially independent companies operating under the same corporate roof. About the only thing they have in common is they are all industrial companies, serving generally business & government as opposed to retail customers. As such they are very exposed to the cyclical trends of both the general business cycle and the industries they operate in.
UTX has been benefiting from the peak of the cycle for a while now, with the stock more than doubling in the past four years. As such, the stock is more fully-valued than it has been for a long time. The best chance to extract further shareholder value would be for UTX to spin off some of the businesses that are operating at a more efficient level than their competitors. For example, the Pratt & Whitney and Hamilton Sundstrand companies, manufacturers of aircraft engines, generation systems, and aviation controls are running on 16% operating margins, while competitor Honeywell has less than 10% operating margins. By capitalizing on both the uptrend in the industry and the superior fundamentals by forming a publicly-traded company, the two firms could command a market cap of nearly $30 billion on a 1.8x sales valuation.
The helicopter-producing Sikorsky Company has been struggling of late, but with revenues are less than 8% of UTX totals, the best bet here is to hold on to the division and wait for fundamentals to improve before considering a sale, spin-off, or split-off. The same goes for the UTC Fire & Safety division, which is still digesting a large acquisition just a year ago.
This leaves two well-known industrial companies in Carrier (a maker of HVAC and refrigeration units) and Otis, a producer of elevator & escalator systems. While the U.S. residential housing market is undoubtedly in a slump, the two companies do more than half of their business overseas, where growth rates have been fantastic (can anyone say China?). The aggregate operating margin at the four companies left within UTX would remain about the same as it currently stands, with the added benefit of attracting potential investors who may have been scared off by the cyclical aircraft businesses.
The UTC and Sikorsky companies would be the relative weak links in the chain, but both units have been heavily invested in and fortunes could turn quickly, setting up possible sales in the future when demand would be greater. Also, the combined revenue of the two would be only 25% of company totals, so the valuation would still be driven by the Carrier and Otis companies. To reflect the absence of the “currently sexy” aircraft groups we should adjust the valuation of United Tech down slightly to the conglomerate average of 1.2x sales, which brings us to a total breakup value for UTX of $67. As we can see, the stock has definitely caught up to near full value; upside in the stock based on our analysis will only come with improved performance at the lagging Sikorsky and UTC divisions or a healthy rebound in the U.S. residential housing market. It could also be assumed that the aerospace spinoff would pull much of the current $7b in debt off the balance sheet, thereby reducing the debt/cap ratio for United Tech and allowing for a higher future multiple.
Ryan Barnes
Ryan Barnes has over 10 years’ experience in portfolio management and investment research, covering equities, fixed income, and derivative products. Ryan spent the past 5 years working as an institutional trader & manager for high-net worth investors, working with Merrill Lynch, Charles Schwab, Morgan Stanley, and many others. Ryan is currently working as a writer and financial modeling consultant on hedging and capital appreciation strategies, and does not own securities in the companies being covered.
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