Breaking Away

Trump Makes a United Technologies Split Less Taxing

U.S. tax changes lend even more logic to the idea of a split.
Photographer: Daniel Acker/Bloomberg
UNITED TECHNOLOGIES CORP
+0.47
As of 9:30 AM EST
134.44 USD
ROCKWELL COLLINS INC
+0.05
As of 9:30 AM EST
136.70 USD

United Technologies Corp. is running out of excuses for putting off a breakup.

The industrial conglomerate agreed last year to acquire avionics maker Rockwell Collins Inc. for $30 billion, a pricey deal that analysts estimate will struggle to generate returns that outpace the cost of capital. Investors had been hoping CEO Greg Hayes would offset the sticker shock by concurrently separating the aerospace-focused units from the parts of the company that make air conditioners and elevators. Instead, he pushed any breakup conversation several years down the road, in part because he says United Technologies needs the cash flow from all its businesses to pay down the hefty debt burden it's taking on in conjunction with the Rockwell deal.

Slow Motion

United Technologies shares have underperformed over the past year, in part because of disappointment about its hesitation at a breakup. Percent change relative to Jan. 4, 2017:

Source: Bloomberg

That argument was always a bit suspect. United Technologies could take a $20 billion dividend from a spinoff of its high-cash-flow industrial businesses by levering them up to 3.5 times, a level Standard & Poor's has allowed at the BBB tier for fellow industrial conglomerate Roper Technologies Inc., says Bloomberg Intelligence analyst Joel Levington. That would give the remaining aerospace company plenty of resources with which to pay off the Rockwell Collins debt, setting it up as the lower-levered growth story of the two halves. 

This kind of financial engineering becomes even more doable now, with the tax legislation President Donald Trump recently signed into law.  

United Technologies, like many multinational companies, has kept a good deal of its cash stored abroad where it's exempt from onerous U.S. tax penalties, but also unable to be used for $30 billion domestic acquisitions, dividends or buybacks, among other things. The tax overhaul will force United Technologies to bring that bounty home. It will pay a 15.5 percent tax on what it's already accrued, but the company will then enjoy much easier access to its foreign earnings going forward. 1 This means that in the above breakup scenario, the leftover aerospace company would have even greater financial flexibility. 

Cash Influx

United Technologies will have much more financial flexibility after the passage of U.S. tax legislation

Source: Bloomberg, company filings

NOTE: This is a very rough analysis that assumes 93 percent of United Technologies cash is still held overseas and that the company brings all of that back at a tax rate of 15.5 percent, without making any other adjustments. The actual amounts will vary and this is meant to be illustrative of the potential. United Technologies's planned new debt is per its proxy statement filed in December.

According to the company's 2016 annual filing, 93 percent of United Technologies' cash was held by foreign subsidiaries. It had $8.5 billion in cash at the end of the third quarter. Hayes complained about the old U.S. tax system last February, saying, "If I had access to that cash, there's a lot of things that I could do in terms of investments here in the U.S., in terms of capital deployment." Well, here is your shot. 

Even if United Technologies doesn't adopt this line of thinking, there's still reason to think tax reform might speed up consideration of a breakup because the company likely won't have as much of a debt burden to deal with. After the one-time tax penalty on its overseas cash, we are still talking about billions in resources that for all intents and purposes weren't available when United Technologies ran the numbers on the Rockwell deal over the summer.

RBC analyst Matt McConnell estimates United Technologies' overall cash stockpile could grow to $11.5 billion by the third quarter of next year when the Rockwell takeover is scheduled to close, given its plan to suspend share buybacks. That likely means its proposed $14.4 billion in new debt to help fund the cash portion of its Rockwell Collins offer is conservative; it shouldn't need nearly that much. Starting out with less debt should shorten the company's timeline for getting comfortable enough with its leverage to contemplate a separation of its businesses. 

Industrial Odds and Ends

In a breakup, Rockwell Collins would help replenish the scale and cash generation United Technologies would lose by separating out its more industrial assets

Source: Bloomberg

NOTE: I used 2018 estimates for Rockwell Collins to capture the impact of the $8.3 billion B/E Aerospace acquisition, which was completed last April.

Of course, United Technologies may still come up with other reasons not to split itself apart. A previous argument that the company needed the cash thrown off by its climate-technologies and elevator operations to fund expensive investments in its jet engine business is undermined by Rockwell's strong earnings and cash generation. But Hayes has in the past also cited the $200 million to $250 million in costs required to duplicate centralized functions and supply-chain agreements for a separate public company. He's also suggested that once Rockwell has been integrated and the synergies of the deal have been realized, United Technologies may be able to command fuller value for all its pieces in the public market. I'm skeptical that will happen.

Breakup or not, one place United Technologies' freed-up overseas cash likely will not be going is to restoring jobs at its Carrier plants in Indianapolis. The company pledged to keep 800 positions that had been slated to move to Mexico at the behest of President Trump in 2016. Hundreds of jobs still headed south, and those that were saved may eventually be filled by robots. The "jobs" part of the Tax Cuts and Jobs Act, as the tax legislation is billed, was always less of a sure thing.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. Companies will pay an 8 percent levy on less liquid assets.

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

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