Deals

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

Warning: A Rockwell Collins Inc. takeover is apt to cause altitude sickness. 

Shares of the maker of avionics and cabin interiors spiked in late trading on Friday after Bloomberg News reported United Technologies Corp. was considering buying the $19 billion company. The idea of a Rockwell Collins purchase isn't new. Last year, Starboard Value reportedly pushed management to pursue a sale rather than proceed with a takeover of airplane seat-maker B/E Aerospace (that deal closed in April). But it's jarring to see United Technologies thinking seriously about it.

CEO Greg Hayes has shown a greater willingness to consider M&A as the company wraps up a commitment to return $22 billion to shareholders through dividends and buybacks. But he's talked about targets in the $250 million to $1 billion range and signaled a bigger bet would be partly dependent on tax reform that gave the company access to its roughly $6 billion in overseas cash. Hayes has also been adamant about not overpaying. Going after Rockwell Collins would seem to go against this deal-making philosophy. 

Why Though?
Rockwell Collins has never been particularly cheap, but it's gotten more expensive of late
Source: Bloomberg

Rockwell Collins had climbed 28 percent this year before news of United Technologies' interest, reaching a record high and a valuation that's more than 16 times its projected 2017 Ebitda. That makes it the second-most expensive U.S. aircraft supplier -- before even accounting for a premium. Recall that one big motivator for United Technologies' decision to return so much money to shareholders as opposed to striking deals was that management felt its stock was undervalued and a poor currency for M&A. Granted shares of United Technologies have rebounded this year, but the company's valuation is still well below that of its would-be target.

Justifying a Rockwell Collins bid at these levels would be a stretch. At a 30 percent premium to its unaffected stock price, or about $155 a share, with at least three-quarters of the bill paid in cash, a deal would add less than 20 percent to United Technologies' 2018 earnings per share, according to data compiled by Bloomberg. That's if United Technologies can reap cost-savings benefits comparable to what it ultimately obtained through the $18 billion purchase of Goodrich Corp. in 2012 -- hardly a sure thing given how well run Rockwell Collins is. Buying companies that are themselves still in the process of integrating deals can also be tricky.

Little Fat to Cut
Rockwell Collins's profitability exceeds that of United Technologies' aerospace systems business and the company as a whole. That may limit the cost synergies.
Source: Bloomberg

The strategic argument here would be similar to Rockwell Collins's logic for the B/E Aerospace deal: a bigger share of the work on an airplane means more revenue, a better position from which to benefit as jets become more digitally connected and the ability to manage costs as Boeing Co. and Airbus SE push for reductions. I can't fault the appeal of that, but I also can't see Boeing or Airbus being thrilled about the largest airplane-parts supplier getting even bigger. Both companies expressed concerns over a possible combination of United Technologies and avionics-maker Honeywell International Inc. last year, which was one reason why Hayes said that combination "ain't gonna happen." By the same logic, those concerns should preclude a deal between United Technologies and Rockwell Collins.

Breaking With Tradition
United Technologies hasn't historically been a big spender on M&A. It's worth noting that Hayes was CFO when the company undertook the $18 billion purchase of Goodrich.
Source: Bloomberg

Perhaps the most intriguing side effect of a hypothetical Rockwell Collins takeover is that it would further tilt United Technologies' business toward aerospace, perhaps paving the way for a speculated spin-off of its HVAC and elevator units. United Technologies' main arguments against such a split have been the cost of establishing another stand-alone company and the loss of cash flow needed to fund its capital-intensive jet engine operations. The synergies and cash flow a Rockwell Collins deal would bring could help mitigate those objections.  

That raises the prospect of whether United Technologies is thinking about more creative deal structures than a straight takeover of Rockwell Collins. But Hayes will have to be particularly crafty to get around the price and antitrust hurdles.

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

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