May 19, 2015

Textron Is Best Option for Sikorsky Sale Over Spinoff

Source: Bloomberg
By: 

For United Technologies Corp., merging its Sikorsky helicopter unit with Textron Inc. could be a good alternative to a traditional spinoff.

The $106 billion maker of aircraft engines and elevators announced in March that it would divest Sikorsky, either by selling it or spinning it off. A final decision by United Technologies will come in about a month.

Analysts initially said a spinoff of Sikorsky was more likely because of the massive tax bill tied to selling a business that United Technologies has owned since 1929. But there’s an alternative.

United Technologies could spin off Sikorsky and then merge it with Textron through a stock swap, in a transaction known as a Reverse Morris Trust. As long as United Technologies’ shareholders ended up with more than 50 percent of the combined entity, the deal would be tax-free. Textron’s $13 billion market value makes the manufacturer of Bell helicopters much closer to the right size for this type of a transaction than giants such as Boeing Co. or Lockheed Martin Corp. that could also be interested.

“Textron is the only one that really qualifies,” Jason Gursky, an analyst at Citigroup Inc., said in a phone interview. “You have to have two roughly equal partners come together.”

Deal Mechanics

Sikorsky should be valued at about $8 billion as a standalone entity, analysts have estimated. That means Textron would need to shed about $3 billion in assets and take on some debt to make a deal work, according to Jeffrey Sprague of Vertical Research Partners.

Textron can do that by spinning off its industrial unit, which makes golf carts and fuel systems, he said. That has a side benefit of better focusing the company, which also makes Cessna aircraft, on the aerospace and defense industries.

“It’s in our space, so of course we’ll pay attention to it,” said Textron Chief Executive Officer Scott Donnelly in a May 7 interview. “Obviously at this stage of the game, it is very much directed and managed by what UTC wants to do.”

United Technologies CEO Greg Hayes said in an interview last month that he’d sell Sikorsky if buyers can overcome the tax hurdles. Boeing, Lockheed and Airbus Group NV are considering bids for Sikorsky, or taking a minority stake, the Wall Street Journal reported on Tuesday.

An acquisition of Sikorsky would be the aerospace and defense industry’s biggest deal since 2012 when United Technologies bought Goodrich Corp. for more than $16 billion, according to data compiled by Bloomberg.

Bigger Share

For Textron, one benefit would be getting major new military contracts as deliveries drop off for the V-22 Osprey combat aircraft that the company co-develops with Boeing, said Doug Rothacker, an analyst with Bloomberg Intelligence. An acquisition of Sikorsky would give Textron a bigger and broader slice of the commercial helicopter market.

“Textron makes little helicopters, Sikorsky makes bigger helicopters,” said Cai Von Rumohr, an analyst with Cowen Group Inc. “They’re both in military, and in different areas. The fit is probably best with Textron.”

Textron may have to stretch financially to get a deal done. Sprague of Vertical Research estimated it would need to take on about $1 billion of debt. Also, combining with Sikorsky to create a helicopter powerhouse may draw regulatory scrutiny, said Chip Pettengill, principal and fund manager at United Technologies investor Bahl & Gaynor Investment Counsel Inc.

Eventual Target

Should United Technologies instead pursue a spinoff of Sikorsky, the division may end up getting acquired eventually anyway. Buyers just may wait awhile before making a move.

Lockheed Martin, General Dynamics Corp. or Boeing may be among the defense companies intrigued by the chance to buy the helicopter maker, said Pettengill. London-based BAE Systems Plc is another possibility, said Loren Thompson, chief operating officer at Lexington Institute.

Boeing is the likeliest buyer among the big defense companies because Sikorsky would complement its existing U.S. helicopter manufacturing business. Production of Sikorsky’s new combat-rescue helicopter and other U.S. programs should start to ramp up early in the next decade, which would soften the blow from dwindling deliveries of Chicago-based Boeing’s F-15 and F/A-18 fighter planes.

While Boeing is a good fit strategically and financially, antitrust objections would make a transaction difficult, according to Citigroup’s Gursky. Combined, Boeing and Sikorsky would control more than 80 percent of the U.S. military helicopter market and more than 60 percent of the global military market, he said.

Chaz Bickers, a Boeing spokesman, declined to comment.

If Textron can overcome its own challenges to a deal, it’s got a prime opportunity to approach Sikorsky now.

“If they could do it, I think it would make a lot of sense for the companies,” Bahl & Gaynor’s Pettengill, whose firm oversees about $14 billion, said in a phone interview. “There would be wonderful synergies there just in terms of the engineering, product know-how, the manufacturing.”