United Tech’s Transformation Is Near

United Technologies (UTX) is on the verge of breaking apart and then merging with Raytheon (RTN). The transformation should take place in April, and additional details have been announced. It seems the soon-to-be-merged defense and aeronautics powerhouse Raytheon Technologies (RTX) as it will be known, is fairly valued at an anticipated price of $82. However, the two spins should offer interesting opportunities.

Each share of UTX will convert into 1 share of RTX, plus ½ share of Otis Elevator (OTIS) and 1 share of Carrier (CARR). Each share of RTN will convert in 2.33 shares of RTX.

Based on the numbers, with UTX trading at $130 and RTN at $190, RTX is worth $81 (RTN $/2.33) and translates to a value of $49 for the spins of OTIS and CARR combined.

RTX is calculated to have earned $5.50 in 2019 and, at a valuation of $8, would equate to a PE of 14.8x, which is competitive in the large-cap defense and aerospace sector.

Carrier is calculated to have earned $2.00 a share in 2019.  EPS are expected to grow by 3% in 2020, and then to ramp up to the 8% to 9% range going forward.  CARR is expected to carry a high level of debt at $10 billion, with the anticipation of paying down debt over time. 

Of interest to CARR investors is the 18-year residential HVAC product cycle, from installation to replacement. Houses built from 2000 to 2005 should be ready for their heating and air conditioning replacement. Reviewing these dates, 2000 to 2005 were robust new construction years, ranging from 1.5 million unit to 2.0 million units per year. Compare this to the 0.5 million housing starts annually from 2009 to 2011 and the sub-1 million starts until 2014. Housing starts have only recently exceeded 1.5 million annually. The HVAC product life cycle should drive CARR replacement business over the next 5 years.     

Otis Elevator is calculated to have earned $2.20 a share in 2019 with a 5% anticipated growth rate. Earnings are expected to grow in the 5% to 8% range. OTIS is projected to be split off with $6 billion in debt, also on the higher side. About half of revenues is generated from service work which is substantially more profitable than new elevator installations. 

Of interest to OTIS investors should be the battle over the European elevator firm, ThyssenKrupp Elevator. The parent firm, Thyssenkrupp AG (TYEKF) is seeking to sell its elevator business and has received interest from the two main Euro competitors, Finnish-firm Kone Oyj (KNYJF) and Swiss-based Schindler Holding AG (SCHN.SW), in addition to private equity firms. It seems the bidding is currently valuing ThyssenKrupp Elevator at around $19 billion, or about 1.3x revenues.

After the separation and based on the trading valuation for UTX, OTIS and CARR combined should be valued at around $49, with a combined EPS of $4.20. This translates to a projected PE of around 12x. European elevator companies are currently trading at an average PE of 28x and HVAC firms are trading at PEs in the 15x range. There can be a case made for OTIS and CARR to trade at a combined valuation of 20x PE, or $84.

Investors should expect both OTIS and CARR to be targets of acquisitions within their first few years, either from competitors or from private equity firms.   

As a shareholder of both UTX and RTN, I expect to be adding to my holdings of OTIS and CARR when they begin trading. I also expect to hold the new RTX as a long-term position in my bucket of equities bought primarily for capital gains.         

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