United Technologies cuts to the core

The company continues to sell off assets to help pay for its Goodrich deal.

By InvestorPlace Jun 19, 2012 10:04AM

By Will Ashworth

United Technologies (UTX) is considering selling its Pratt & Whitney Power Systems division for $1 billion, Reuters reported, citing unnamed sources. The segment produces power systems that generate electricity for businesses and cities. Its technology is based on its aircraft engines, and while it's a perfectly good business, United Technologies is focusing all of its attention on its core segments of aerospace and propulsion.

Let's just say it's cutting to the core.

Most of this focus on the core came about as a result of its yet-to-close $16.5 billion acquisition of aircraft components maker Goodrich Corporation (GR). Last September, I highlighted the reasons I thought the conglomerate's purchase of Goodrich made 3M (MMM) a much better stock to own. Nine months later, and not much has changed to alter my opinion.

To originally seal the deal, United Technologies intended to issue 57.1 million shares to Goodrich shareholders, which is a dilution of 6%. In addition, it planned to add $12.4 billion in new debt while also assuming another $1.9 billion in Goodrich debt, increasing its debt-to-capital ratio from 32% before the deal to 92% after. Historically, this figure never has been above 42%, suggesting UTX is entering completely uncharted territory.

To quell shareholder discontent, United Technologies has been persuaded to eliminate the need to dilute shareholders by selling non-core assets instead. CFO Greg Hayes announced June 14 that it was looking to sell as much as $3 billion in assets to help pay for the Goodrich deal.

The Pratt & Whitney divestiture is the first piece of the puzzle. It's also believed that private equity firms TPG Capital and Carlyle Group (CG) are interested in some of United Technologies' industrial businesses within its Hamilton Sundstrand unit, which are valued between $3.5 billion and $4 billion. If UTX is able to unload these businesses, it won't have to issue new stock -- a definite plus for long-term shareholders.

Goodrich finished fiscal 2011 with $8.1 billion in sales, most of which was from commercial aviation firms. The rationale for the deal was that United Technologies gained a very complimentary business to its own Hamilton Sundstrand aerospace systems' unit. The end result is a combined entity that can participate in a much broader development of commercial aircraft, which ultimately should lead to significant organic revenue growth. At least that's the theory, and I have no reason to doubt its rationale.

Unfortunately, the amount of debt United Technologies has undertaken to make this happen seems too steep a price to pay. Ironically, in the same press release that CFO Hayes talks about possible asset sales, he also criticizes the Obama government for failing to tackle the long-term federal debt. That's rich considering United Technologies is doubling its own long-term debt to do this deal. Hayes' motto must be "Do as I say, not as I do."

3M's total return from Sept. 30, 2011 (when I recommended its stock) to June 18 is about 24%, which compares favorably with both United Technologies at 8.5% and the S&P 500's 19%. The Goodrich deal hasn't been well received by investors, and the lagging return confirms this. Asset sales or no asset sales, the Goodrich deal likely will cause United Technologies one big case of indigestion.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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