Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

United Technologies Corp. has a number of issues. Goodrich isn’t one of them.

It's been about five years since the industrial company announced it was buying airplane-landing gear maker Goodrich for $18.4 billion including debt. The deal, which closed in 2012, remains one of the largest transactions in the aerospace industry and was top of mind last week as Rockwell Collins Inc. agreed to acquire airplane seatmaker B/E Aerospace Inc. for $8.3 billion. While most megamergers destroy value, analysts and investors I spoke with had few complaints about the logic of the Goodrich deal -- or its execution, for that matter. And after reviewing the transaction, Gadfly gives it a polite clap.

And yet this is what United Technologies' stock has done since:

Falling Behind
United Technologies' gains over the last five years have paled in comparison to those of the S&P 500 Industrials Index.
Source: Bloomberg

Why the disparity? Like other industrial companies, the $84 billion conglomerate has been pressured by slow global growth and weak commodity prices. But those challenges were compounded by a downturn in United Technologies' more military-facing operations and by the plight of its Sikorsky helicopter unit, an earnings eyesore for years before it was sold in 2015. It didn't help that new CEO Greg Hayes kicked off his tenure with a series of guidance cuts. More recently, a much-anticipated, costly jet engine ran into production delays.

Goodrich Scorecard
United Technologies says the takeover added to earnings by year 2. While the company's stock performance has lagged behind peers, its valuation has risen.
Source: Bloomberg
The "after" EPS reflects 2016 projections. Ebitda multiple and market value are taken as of the close of trading on Monday.

Actually, the Goodrich deal has probably kept United Technologies' stock from dropping even lower, says Chip Pettengill, a fund manager at long-time shareholder Bahl & Gaynor.   The company's aerospace business is the main reason it was able to actually increase its 2016 organic growth forecast, while many of its peers reduced their outlooks. 

Buying Goodrich allowed United Technologies to take bigger advantage of planemakers' record order backlog, with the company doubling its share of the work on all next-generation aircraft. One example:  In 2013, United Technologies locked up agreements with Embraer SA to supply not only its auxiliary-power units and electrical systems, but wheels, brakes and nacelles (jet-engine casings) gained through the Goodrich transaction.  The order for engine casings alone represented a $12 billion business opportunity that wasn't accounted for in synergy calculations. 

We Fly High
A look at the some of the biggest deals in aerospace and defense.
Source: Bloomberg

Those wins helped quell initial criticism that United Technologies had overpaid by offering almost a 30 percent premium to Goodrich's all-time high. The deal was accretive by year two as promised, although the company never gave a final update on whether the 60-cent boost to 2013 earnings per share that it later targeted was achieved. United Technologies also made good on cost synergies: The company initially estimated it would reap as much as $400 million of savings, before later raising that target to $500 million. It achieved that goal by the end of 2015  -- ahead of the original schedule -- and is now seeking another $500 million of cost cuts in its aerospace systems division.  

It's worth noting that United Technologies set a low hurdle for itself, with Hayes (then the CFO) saying the initial synergy estimate was meant to be a "slam dunk." But it still gets points for following through on a strategy of under-promising and over-delivering, especially considering that executives reportedly had just one day with full access to Goodrich's books. They'd been in talks about a deal for much longer and United Technologies was familiar with the business, but you never know what might turn up. 

There were other benefits that aren't as easy to measure. To help pay for the purchase, United Technologies sold its Rocketdyne division to GenCorp and divested its Hamilton Sundstrand industrial unit to private equity firms. As oil prices tumbled, so did the value of the debt backing the latter deal:

Sign of the Times
This $1.68 billion loan helped back Carlyle and BC Partners' $3.46 billion purchase of Hamilton Sundstrand's pumps and compressors businesses.
Source: Bloomberg

Meanwhile, shares of GenCorp (now named Aerojet Rocketdyne Holdings Inc.) haven't gained much since the company closed on its purchase of the United Technologies unit.

Stuck in Orbit
Shares of rocket-maker Aerojet Rocketdyne are trading around where they were when the company closed on its purchase of United Technologies business.
Source: Bloomberg

Arguably, casting off those units to make room for Goodrich left United Technologies shareholders better off.  In fact, in the year after the Goodrich takeover closed, the company's stock did actually outperform industrial benchmarks.

Unfortunately, it didn't last -- and that brings us back to today. In addition to flagging global growth, margins are under pressure as United Technologies rolls out newer (and more expensive) jet engines and aerospace-systems equipment for planes that don't have as much need right now for the more-profitable maintenance work it can offer. The Otis elevator unit is also sacrificing profitability to try to win back market share in China.

Coming Up Short
United Technologies is valued at a discount to some of its biggest rivals.
Source: Bloomberg
Data is as of 10/31/16

So what should United Technologies do next? It has embarked on a buyback-heavy strategy, but still hasn't been able to give shareholders the kind of valuation it rebuffed earlier this year from would-be buyer Honeywell. The pressure has been building on management to break up the company -- or strike another large, revenue-boosting transaction. Rockwell Collins has often been a popular call, but with the $11 billion company now set to get even bigger, regulatory pushback may become more of an issue.

In other words, the Goodrich deal made the grade, but what have you done for me lately?

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

  1. Deals are ranked according to five grades (listed here from positive to negative): Slam Dunk, Polite Clap, Meh, Troubled and Cringeworthy. In assessing the performance of the Goodrich takeover, we took into account the execution of synergies; the earnings accretion following the deal's close; the company's share-price performance; and the additional revenue obtained as a result of the transaction. Other factors include the subsequent results of businesses that United Technologies divested to make room for Goodrich.

  2. Pettengill is a principal and fund manager at Bahl & Gaynor, which has more than $15 billion under management and advisement.  

  3. Total synergies from Goodrich eventually amounted to $600 million.

  4. Rolls-Royce Holdings Plc is another favorite, but Brexit makes a deal highly unlikely. HVAC company Nortek Inc. was speculated as a United Technologies target, but sold itself this year to Melrose Industries Plc. 

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

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