Reuters is reporting that United Technologies (NYSE:UTX) is arranging substantial financing for a large potential acquisition. As such, possible target companies mentioned in the article, including: Goodrich Corp (NYSE:GR), Rockwell Collins (NYSE:COL), Textron Inc (NYSE:TXT), Honeywell International (NYSE:HON) and Tyco International (NYSE:TYC) have rallied. For example, TYC is up around 7%, COL is up around 6% and TXT is up around 7%. While each company could fit strategically alongside United Technology's existing businesses, we think Tyco International is an unlikely acquisition target because of its large current market capitalization and the potential loss of its advantaged tax status under an acquisition scenario.
This factor would not completely prohibit a UTX and TYC union, but we think it diminishes the probability of success. UTX has a market capitalization of $68 billion and an enterprise value of $75 billion. In contrast, TYC has a market capitalization of $20 billion and an enterprise value of $22 billion. This makes them one of the bigger potential acquisitions and as such, UTX may gravitate towards smaller companies that Reuters mentioned in their article.
Tyco International is headquartered in Switzerland and as such, they have a low realized corporate tax rate. This is actually one of the company's competitive advantages because it adds an additional level of potential earnings accretion to acquisitions. During fiscal year 2010, their effective tax rate was around 11% and going forward, the company's realized tax rate should be well below the roughly 35% that it would be if they were incorporated in the United States. This is a major hurdle to any acquisition attempts from US based companies like UTX. As such, we think it will be hard for UTX and TYC to bridge the buyout price gap between what UTX management wants to pay and what TYC management expects. In light of this, TYC shareholders would be wise to temper their enthusiasm if the stock price continues to rise solely based on expectations of a buyout offer from United Technologies.
Disclosure: I am long TYC.