United Technologies Corp and Raytheon on Sunday agreed to an all-share merger of equals that will create a new aerospace and defence giant and challenge the industry's long-standing pecking order.
Under the terms of the deal, UTC will merge its aerospace business with Raytheon to form a $120 billion powerhouse. It will be a critical supplier of military equipment and rank as the second-largest defence contractor by revenue, after Lockheed Martin but ahead of Boeing.
On completion of the deal, UTC shareholders will control 57 per cent of the new group while the remainder will be owned by Raytheon shareholders, who will receive 2.3348 shares in the new combined company for each existing share. UTC will control eight of the 15 board seats, with the rest to come from Raytheon.
The deal is expected to close in the first half of 2020, soon after UTC completes the previously announced spin-off of its Otis elevator and Carrier building-systems businesses.
UTC chairman and chief executive Greg Hayes will lead the combined company and Raytheon's Tom Kennedy will serve as chairman. After two years, however, Mr Hayes will take on both roles of CEO and chairman.
The deal will provide Raytheon and UTC with scale and diversification across defence and commercial aerospace and could help the combined group weather any slowdowns. Analysts have warned that, after an unprecedented boom in commercial aviation over the past decade, weaker growth could slow production.
Patriot-missile maker Raytheon, which has suffered a 10 per cent fall in its share price over the past year, had a market value of $52b based on its last closing stock price, and net debt of about $4b. Shares in UTC have risen 3.4 per cent in the past year, giving it a market value of $114b including the units of its business that will not be part of the tie-up with Raytheon. By contrast, it has net debt of $44b.
This creates the broadest aerospace and defence supplier possible. There's no overlap and it gives them enormous critical mass but . . . was additional critical mass really needed?
A deal will combine Raytheon's operations in missile defence and precision weapons with those of UTC's Collins Aerospace, a maker of cockpit avionics and the Pratt & Whitney (P&W) aero-engines division. P&W has long been the lead engine supplier to the Pentagon — it powers the F-35 fighter jet among other military aircraft — and also makes the first-of-a-kind geared turbofan jet engine that powers the Airbus A320neo. Together, the companies employ about 180,000 people globally.
The combined company will have about $74b in sales in 2019. It expects to return $18b-$20b of capital to shareholders in the first three years after the transaction closes.
Mr Hayes told the Financial Times that the two companies served the same markets and had complementary technologies that would strengthen each other's businesses. "What we are creating is a technology conglomerate with great focus in the markets we play in," he said.
The UTC aerospace division currently makes about 75 per cent of its sales from the commercial aviation market and 25 per cent from military equipment, After the merger, that split will become almost exactly 50-50.
Technologies that could be taken "from one side to benefit the other's companies" included P&W's expertise in high-temperature materials, and the Rockwell Collins' Global Positioning System, Mr Hayes said.
Another critical area, he said, was Raytheon's expertise in cyber security. "Adopting that into the commercial aerospace ecosystem is highly important as it becomes more and more connected," he said.
The Pentagon has previously indicated it would not look kindly on mergers between its five "prime" defence contractors, but given the lack of overlap the deal may not face much regulatory opposition. The two companies say they do not expect significant antitrust issues, with less than 1 per cent of their combined sales showing any potential overlap.
Hayes said that although the deal would need to be approved by competition authorities including the US and EU, he did not believe there was any requirement to secure approval from China. UTC's acquisition of avionics specialist Rockwell Collins, announced in September 2017, did not close until November 2018 after Chinese authorities delayed a decision as trade tensions with the US grew.
Analysts greeted the potential merger with caution, however. They noted that it was barely six months since the $30b acquisition of Rockwell Collins, a deal that was already driven with the aim of gaining greater leverage against aircraft manufacturers that have tried to push down costs among suppliers.
"This creates the broadest aerospace and defence supplier possible. There's no overlap and it gives them enormous critical mass but . . . was additional critical mass really needed after the Rockwell Collins deal?" said Richard Aboulafia, analyst at the Teal Group.
"It gives them counter cyclicality, it gets them broader defence exposure, but I'm a little concerned about how you execute on this merger. United Technologies already had a lot of work to do before this. They haven't even divested the elevators and air conditioners yet and even absorbing all their different aerospace assets was a work in progress, and now this," he added.
For Boeing, which has been focused on resolving the crisis surrounding the 737 Max after two deadly crashes of the aircraft model, the deal comes at a tricky time.
"One of Boeing's key objectives is to press suppliers on cost so creating a monster supplier in both civil and military presents challenges for Boeing," said Aboulafia.
Boeing said in a statement that it would review the proposed merger: "Our interests are in adding value to our customers and in ensuring the long-term health and competitiveness of the aerospace industry and of our supply chain."
Nick Cunningham, analyst at Agency Partners, described it as "an odd combination in some ways" but said the rationale would likely be "risk diversification as well as overall scale".
"UTC may also be thinking about carrying the ruinous cost of funding the next technology developments in aero-engines from a larger base," he added.
UTC may also argue that reducing its exposure to the commercial aerospace market at a time of heightened trade tensions, in particular between the US and China, is not a bad thing.
The International Air Transport Association, the industry's trade body, cited fears over protectionism among wider concerns this month. The Chinese government took its time before approving UTC's acquisition of Rockwell and demanded that both companies dispose of certain assets.
Coming just days before the start of the industry's biennial get-together at the Paris Air Show the deal is likely to be the main topic of conversation among executives. It could also have wider repercussions in Europe and prompt rivals to re-evaluate their strategies.
Analysts at Agency Partners said it might encourage the French government to look again at a possible combination between aero-engine group Safran and Thales, the defence specialist, as "the nearest comparable pairing".