We warned that the deal could be too focused on financial engineering,rather than fundamental synergies and cost savings. Barron’s also highlighted an odd aspect of the transaction: Raytheon shareholders will be paid with United Technologies stock, after two previously announced spinoffs have gone through, an arrangement that makes the deal difficult to value.
But even with the decline this week, United Technologies shares are still up nearly 18% since the start of 2019.
What’s new. On Friday, Vertical Research analyst Jeffrey Sprague boosted his rating on United Technologies to Buy from Hold, although he trimmed his price target by $5, to $145. “The market has reacted to United Technologies’ proposed merger with Raytheon with a collective thumbs down,” pushing the shares, “which were already arguably cheap on a sum-of-the-parts basis” down further, he said.
He notes that there are plenty of concerns, from the already complex nature of the company to worries that management is too focused on “empire building,” while Raytheon shareholders have their own gripes, from the price to the dilution of Raytheon’s status a pure-play defense company.
“While we understand all these points, and they have some degree of merit, we think they are now fully in the stock and United Technologies shares are attractively valued,” Sprague wrote. (His colleague still has a Hold rating on Raytheon.)
Looking ahead. The boards of directors of both companies have already approved the deal, so Sprague believes it will likely go ahead, despite the stocks’ reactions. And that’s not necessarily a bad thing. Assuming modest growth in 2020 and some cost synergies, earnings at the combined company could rise enough to give it a price/earnings ratio of less than 10 times, a discount to its peers, he estimated.
Shareholders may reject the merger, although Sprague says it is more likely that those opposed are selling now, rather than waiting to vote. He argues that even if the combination doesn’t happen, United Technologies is too cheap to ignore at current levels.