This holiday season, you might want to check for one more Christmas present under the tree.
And it comes in the form of a spin-off. Let me explain.
United Technologies Corp. (NYSE:UTX) completed a $23 billion merger with Rockwell Collins Inc. on Nov. 26.
Normally, the story of a sprawling conglomerate acquiring an aerospace contractor would pretty much end there.
That’s because the idea behind these kinds of bolt-on buyouts is to create new synergies that make the bigger, newer firm more competitive and more profitable.
Of course, United Technologies wants to take advantage of the Trump administration’s defense buildup, one of the biggest we’ve seen since the Reagan era.
But in this case, the merger served as a catalyst for a much bigger change.
The same day United Technologies closed the books on the deal, it announced a broad realignment that surprised Wall Street.
Following the Rockwell acquisition, United Technologies said it would break itself up into three standalone companies.
That’s great news for investors because studies have shown that these kinds of spin-offs usually lead to market-beating gains.
Just the sort of late Christmas gift investors can enjoy.
That’s why today, while you enjoy the company of family and friends, I’m going to show you how to get in on the action.
Why (Corporate) Breakups Are Good News
Now then, almost by definition, a corporate breakup is a rallying point for a company’s stock.
The reason is simple. As companies bulk up over the years, they often find that the sheer size and complexity of the parent firm’s operations serve as a brake on fast-growing units.
Take a look at United Technologies to see why. Founded in 1974, the firm mostly grew organically through the 1990s. But at the dawn of the new century, it went on an acquisition spree in which it bought or invested in roughly 10 companies.
That led to corporate bloat.
And I’m not the only one who thinks some companies get too big to operate efficiently for their shareholders. The empirical data prove exactly what I’m talking about.
Lehman Bros. studied 85 spin-offs between 2000 and 2005 and found that they beat the S&P 500 by as much as 45% in their first two years as independent companies.
And the further you look back, the brighter the picture gets.
Consider that two professors at Pennsylvania State University examined 30 years of market data covering 174 spin-offs. Their study revealed that in the first three years of operations, these new companies showed price appreciations of 76%, beating the S&P 500 by 31%.
No wonder activist investors called for United Technologies to break itself up. This past spring, Daniel S. Loeb’s Third Point hedge fund sent the firm a letter urging a breakup “to reverse its years of underperformance and realize the full potential of its franchise assets.”
A Lumbering Giant
Loeb’s team saw a firm that had simply tried to eat more than it could swallow. Management clearly have a lot on their plate in trying to manage this sprawling set of operations.
United Technologies is best known as a major player in defense with its Collins Aerospace and Pratt & Whitney divisions. But it’s also a major supplier in building construction, with its Otis Elevator Co. and Carrier Corp. divisions.
These various divisions were bulked up by a seemingly endless set of acquisitions. In recent memory, United Technologies has picked up…
- Chubb Security
- Schweitzer Aircraft
- Boeing’s Rocketdyne division
- Goodrich Corp.
Beyond those, United Tech bought a dozen other firms and invested in several joint ventures. That’s not to suggest that all these deals were a mistake.
Instead, they created powerful platforms for growth. But it’s hard to see how these platforms were able to create cross-selling synergies.
In the end, management wisely agreed that a breakup would unlock hidden value. As United Technologies noted in late November, a split into three separate firms will enable each one to “have the strategic focus and financial flexibility to deliver innovative customer solutions and drive long-term value.”
Let’s take a closer look at what the biggest of the three “new” firms, United Technologies, will bring to bear.
A New Defense Pure Play
We’re now looking at a much leaner defense and aerospace firm. By joining forces, United Technologies and Rockwell Collins will have combined sales of almost $40 billion.
Collins Aerospace, the successor to Rockwell Collins, is a leader in aircraft electronics systems (avionics), plane interiors, landing systems, power controls, and more.
The firm employs 16,000 engineers who operate under a $3 billion yearly R&D budget. Some of that staff is focused on defense contracts, where Rockwell Collins builds systems for military communications, navigation, and guidance; missile actuation; and simulation, training, and range instrumentation.
Meanwhile, United Technologies’ Pratt & Whitney division is a global leader in aircraft propulsion with a growing number of engine programs. Those engines are so well regarded in the industry that the firm has backlog of orders that will take seven years to fulfill.
By bringing these two firms together, the new United Technologies will have the ability to design and build almost every part of an aircraft (apart from the airframe).
As you know, the Boeing Co. (NYSE:BA) and Airbus SE (OTC ADR:EADSY) control almost all of the $6.1 trillion commercial aerospace market. But don’t be surprised to see United Technologies develop a plan to target that massive market, now that Rockwell Collins is in-house.
United Technologies’ spin-offs also have a lot of value to unlock.
Otis Elevator has more than $12 billion in yearly sales, much of that in the form of recurring revenue. Otis produces more than $2 billion in adjusted earnings each year, and the firm is a great way to play the global trend of urbanization.
Meanwhile, Carrier is a global leader in heating, ventilation, and air conditioning (HVAC). It has around $18 billion in yearly sales and is quite profitable. Last year, it brought roughly $3.5 billion in adjusted earnings.
Here’s the thing. As these firms will soon be run by their own dedicated management teams, they’re bound to unleash new waves of innovation.
That’s why spin-offs tend to perform so well, as I noted earlier.
Three Stocks for the Price of One – Tax Free
The move to break into three separate firms has been well designed. Investors owning shares of United Technologies today will get shares in all three firms once the process is completed in the next 12 to 18 months.
The deal is structured to avoid payment of any taxes. Just as important, each firm will have ample cash on the balance sheet to help fund the next waves of R&D.
Plus, all three of these firms will pay a combined dividend least as much as United Technologies’ current $2.94-a-share payout.
To be clear, you want to own a firm before such spin-offs unfold. If you wait until this process is complete, history says you will already have left a lot of profits on the table.
I am looking for 30% upside over the next two years as investors come to see the embedded value that’s about to get unlocked in this investor-focused spin-off.
That’s the kind of Christmas gift you’ll be bragging to your friends about for years to come – even if it did come a day late.
Now, before I go, I want to tell you about another aerospace innovation – one that’s driving weapons and vehicles to travel at previously unheard-of speeds – 5 miles per second, or 15,300 mph.
And here’s the best part. A tiny Alabama defense tech company holds one of the keys to this technology – and it stands to profit from tens of billions in Pentagon contracts that are starting to roll out.
But those multibillion-dollar contracts aren’t going to roll out forever. So I hope you’ll check my presentation on this firm before this opportunity passes you by. To check it out, click here.
See you back here soon.