Clash Of The Titans: Honeywell & United Technologies

| About: United Technologies (UTX)

Summary

I examine the potential but unlikely deal between Honeywell & United Technologies.

I used multiple methods in my process to determine whether a deal with United Technologies was attractive.

I determined that even if a deal would somehow pass regulatory scrutiny, the deal would not be attractive for Honeywell.

In this article, I will be looking at what a combined Honeywell (NYSE:HON) and United Technologies (NYSE:UTX) would look like along with an estimation of what Honeywell would be worth. As I was about done writing this article, there was an update that came out and it stated the UTX did not explore the deal because of "significant regulatory obstacles, customer concerns and valuation issues." As I will detail below, even if a deal somehow made it through regulatory issues, etc, Honeywell purchasing United Technologies would not be a very attractive deal in my opinion.

Combined Honeywell/United Technologies

To start, I looked at each company apart to assess how each of their business segments would fit together. The data in the following table was taken from a recent Honeywell earnings release and a recent United Technologies investor presentation.

Sales by Segment

Honeywell

United Tech.

Aerospace

$15237

Pratt & Whitney

$14082

Automation & Control

$14109

Climate, Controls & Security

$16707

Performance Materials

$9235

Aerospace Systems

$14094

Otis

$11980

Total

$38581

Total

$56863

Click to enlarge

[Table data in millions]

Combined Honeywell & United Technologies

When looking at combined company sales, I grouped Aerospace, Pratt & Whitney and Aerospace systems in one segment, Automation, control & security in another segment and performance materials and Otis [elevators] in their own segments. The combined data is in the table below as well as visually shown in the chart following the table. The combined company would be a massive player in aerospace as well as in automation, control and security markets. That massive scale in those two segments is the reason why a deal would face extremely tough scrutiny with regulators.

Combined

Aerospace

$43413

Automation, Control, Security

$30816

Otis

$11980

Performance Materials

$9235

Total

$95444

Click to enlarge

[Table data in millions]

Click to enlarge

[Chart data sourced from Honeywell's earnings release and United Tech.' investor presentation referenced above]

The Deal

The deal as noted by CNBC had the following terms "The discussions occurred within the past two weeks and were focused on a deal in which Honeywell offered a premium, largely in stock with some cash, for the smaller United Technologies." In determining whether a deal would be attractive, I first looked at the operating incomes for each company, which was sourced from Honeywell's earnings release, the United Technologies' investor presentation and that data. As you can see HON trades at a slight premium to UTX, however, that premium is well deserved given that HON before the news was up about 2% over the last year compared to a decline of nearly 30% for UTX.

Operating Income

Shares

Op Inc/Share

Current Price

Price/Op Inc

HON

$7466

789.3

9.46

$105.17

11.12

UTX

$8023

883.2

9.08

$92.37

10.17

Click to enlarge

[Table data from HON earnings release and UTX investor presentation]

UTX Purchase Price

The table below shows the process I went through to determine if the deal would be worth it for Honeywell. The key variables in the table are the UTX purchase price and the cash component of the deal. For a comparable premium for a potential deal, I looked at the premium for the Dow Chemical (NYSE:DOW) and DuPont (NYSE:DD) merger of equals, which had a 15.90% premium from the time when rumors of a deal were first mentioned on November 5th, 2015.

Cash Component

For the cash component, I looked at the most recent earnings transcript from Honeywell and found a question by Charles Stephen Tusa - JPMorgan Securities LLC that led to the amount of cash capacity that Honeywell has for a deal. "Can you just clear the air on if something big came up, kind of how far, what do you think your capacity is from a ratings agency perspective? How far would you be willing to go as far as capital deployment, call it, over the next couple of years?"

The answer provided by CEO Dave Cote shows that they expect to have $20-$30 billion of capacity as far as cash for potential deals. Being conservative, I used the $20 billion figure, which was the low end of the range given. "We had something like $20 billion to $30 billion in capacity over the next five years when you looked at cash generation and debt capacity as EBITDAR grew. I'd say that's still the case. We've only deployed about $6 billion, $8 billion out of the $30 billion or so we're going to generate and the capacity that we'll generate over that five-year period."

Deal Results

The table below shows that using a 15.90% premium to the current UTX share price and a cash component of $20 billion, the deal would be moderately attractive to Honeywell, with an upside of 9.31%. With "only" 9% upside to the current share price, this does not make the deal attractive in my opinion.

UTX Shares Outstanding

883,200,000

UTX Purchase Price: Current price x [15.90% premium]

$107.06

Deal Price

$94,555,392,000

Cash Component

$20,000,000,000

Total Needed to be HON stock

$74,555,392,000

HON price

$105.17

New HON Shares for deal

708,903,604

Current HON Shares

789,300,000

Total HON shares after deal

1,498,203,604

Combined Operating Profit

$15,489,000,000

Combined Op Profit/Share

10.34

Current HON Price/Op Profit

11.12

Estimated HON Share Price

$114.96

Click to enlarge

[Shares Outstanding data from Gurufocus]

Long-Term Impact of Deal

Looking at the long-term impact of the deal in terms of discounted cash flows, I found that HON would not see a large benefit from a deal with UTX. I conducted a discounted cash flow analysis and found that by doing the deal, HON would only see a 5.82% [$105.59-$99.78/$99.78=5.82%] increase in its fair value compared to a current standalone Honeywell.

I used data from the table below as well as the following Discount rate calculator and to calculate the terminal growth rate I used this calculator. I also assumed growth would last for five years and level off to the terminal growth rate.

FCF/Share & growth rate for combined company

FCF

Weight

FCF Growth

HON

4381

49.13%

9.26%

4.55%

UTX

4536

50.87%

9.47%

4.82%

Total FCF

8917

Weight FCF Growth

9.37%

Shares

1498

FCF/Share

5.95

Click to enlarge

[FCF data from Gurufocus, in millions]

  • FCF/Share: $5.95
  • Growth Rate: 9.26%
  • Terminal Growth Rate: 0.93%
  • Discount Rate: 5.72%

Combined company DCF vs. Current HON

HON/UTX Combined

DCF Calculations

CF/Share

PV

Year 1

1

6.51

$6.16

Year 2

2

7.12

$6.37

Year 3

3

7.79

$6.59

Year 4

4

8.52

$6.82

Year 5

5

9.32

$7.05

Year 6

6

9.37

$6.71

Year 7

7

9.42

$6.38

Year 8

8

9.47

$6.07

Year 9

9

9.53

$5.78

Year 10

10

9.58

$5.49

Year 11

11

9.64

$5.23

Year 12

12

9.69

$4.97

Year 13

13

9.75

$4.73

Year 14

14

9.80

$4.50

Year 15

15

9.86

$4.28

Year 16

16

9.91

$4.07

Year 17

17

9.97

$3.87

Year 18

18

10.03

$3.68

Year 19

19

10.08

$3.50

Year 20

20

10.14

$3.33

Fair Value

$105.59

Current Price

$105.17

Upside/Downside

0.40%

Click to enlarge

Standalone Honeywell DCF

  • FCF/Share: $5.95
  • Growth Rate: 9.26%
  • Terminal Growth Rate: 0.57%
  • Discount Rate: 5.72%

Current Standalone HON

DCF Calculations

CF/Share

PV

Year 1

1

6.06

$5.74

Year 2

2

6.63

$5.93

Year 3

3

7.24

$6.13

Year 4

4

7.91

$6.33

Year 5

5

8.64

$6.54

Year 6

6

8.72

$6.25

Year 7

7

8.80

$5.96

Year 8

8

8.89

$5.69

Year 9

9

8.97

$5.44

Year 10

10

9.05

$5.19

Year 11

11

9.14

$4.96

Year 12

12

9.22

$4.73

Year 13

13

9.31

$4.52

Year 14

14

9.40

$4.31

Year 15

15

9.48

$4.12

Year 16

16

9.57

$3.93

Year 17

17

9.66

$3.75

Year 18

18

9.75

$3.58

Year 19

19

9.84

$3.42

Year 20

20

9.93

$3.27

Fair Value

$99.78

Current Price

$105.17

Upside/Downside

-5.12%

Click to enlarge

Closing Thoughts

In closing, I believe that even if a deal with United Technologies were possible that it would not be in the best interest of Honeywell because the potential upside is limited because of the massive dilution that would occur because of the large stock component of a potential deal. The data shows that Honeywell would be better off by staying a standalone company and continuing to dominate United Technologies. With the news that was reported after hours, it looks like this deal will not be happening anytime soon, though.

Disclaimer: See here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.