Industrials

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

Rockwell Collins Inc. shareholders just got another reason to like the company's takeover of B/E Aerospace. 

Shares of the $18 billion avionics company flirted with their worst decline since the financial crisis on Monday, after Bloomberg News reported Boeing Co. was seeking to develop competing navigation systems and flight controls for its jets. Boeing isn't Rockwell Collins's only customer, but it's a big one.

An agreement to supply displays and controls on Boeing's 777X was expected to generate $2 billion in revenue for Rockwell Collins over the life of the program, while a 2015 Bloomberg Intelligence analysis estimated the company could earn as much as $800,000 for each of the planemaker's 737MAX aircraft. So I can see why shareholders freaked out.

Simmer Down
Rockwell Collins's plunge on news of Boeing's avionics interest looks overblown
Source: Bloomberg

But those revenue opportunities won't vanish. For one thing, Boeing aims to bring its avionics offerings to the market next decade, suggesting it will be more inclined to put its products on new versions of planes, rather than reconfigure ones currently in production. And even then, it's not clear Boeing can come up with something on par with what Rockwell Collins can deliver.

This does point to a further tightening of the screws on aircraft suppliers. Whatever avionics market share Rockwell Collins maintains at Boeing is at risk of being less profitable. Good thing it recently announced a merger to combat that very issue.

Adding food carts and airplane seats to its product portfolio with the $8.3 billion takeover of B/E Aerospace set Rockwell Collins up to triple its typical work-share on a wide-body jet and double what it can supply for narrow-body planes. That means more overall revenue, but also the ability to better absorb customers' push for lower average costs.

Beyond that, Rockwell Collins's more diversified business model means any hit to its avionics business won't be as fatal as it might have been previously. Let's pause to appreciate the irony that the lack of product overlap between Rockwell Collins and B/E Aerospace, which so irked investors including Starboard Value, will arguably wind up being an even bigger benefit than the cost synergies those shareholders would have preferred to see.

Turbo Boost
The B/E Aerospace deal should be a boon to Rockwell Collins's revenue, which had been been stagnating as a record sales surge in commercial jets showed signs of winding down
Source: Bloomberg

Boeing's avionics foray is about wringing more money out of its jets through servicing agreements, which tend to be more profitable than the initial plane sale. Consider that Rockwell Collins's annual operating margin can be nearly triple Boeing's.

Avionics is a perfect way for Boeing to try to narrow that gap, because the systems must be frequently upgraded as technology improves. They also feature prominently in data collection to help make planes run more efficiently. Seats and kitchen galleys? Not quite as appealing, says Bloomberg Intelligence analyst George Ferguson.

Boeing earlier this year announced a collaboration on aircraft seating with automotive-interiors company Adient Plc, along with a similar arrangement with EnCore. But that's more about giving Boeing options in the event of production delays than a sign of internal cabin-fitting production aspirations.

Besides, much of B/E Aerospace's business comes from airlines, who not only buy seats when they order new planes from the likes of Boeing but also when they retrofit older models. They seem unlikely to categorically abandon that relationship for a bet on newer entrants. The extra competition here also won't be great for margins, but Rockwell Collins will still be in a position to command meaningful market share across the spectrum of plane parts.

And it has a head start, both in commercial and defense markets. Notable from last week's earnings update were CEO Kelly Ortberg's comments about greater cross-selling opportunities on B/E Aerospace products than Rockwell Collins had anticipated, particularly in government sales.

This may be a rare case of a deal becoming smarter with time

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

  1. For what it's worth, Rockwell confirmed last week it remains on track to reap $200 million of cost savings from the deal -- not earth shattering, to be sure, but more than the $160 million it had initially targeted.

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

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net