Great Expectations in Defense and More

President Trump ran on a platform that included increased defense spending by both the US and its NATO allies and stocks in this sector already reflect this positive backdrop. However, the market also appreciates that there is many a slip ‘twixt the cup and the lip and that expectations are not reality.

A case in point is the stock of Rockwell Collins, which rose from $111 at the start of August to a recent $131 when United Technologies (UT) confirmed that they would acquire the entire company. The UT acquisition of Rockwell Collins, a deal valued at more than $20 billion, would create one of the world’s biggest aircraft equipment makers.

UT and Rockwell Collins are industrial conglomerates that include companies with a significant presence in civilian and defense aerospace. UT already owns Pratt & Whitney, the world’s biggest jet engine maker whose customers include both Boeing and Airbus. Other divisions of UT also make aircraft wheels and landing gear.

Rockwell Collins also provides products to both civilian and defense aerospace companies and is best known for sophisticated cockpit displays and communication systems. Earlier this year, Rockwell Collins itself acquired B/E Aerospace, a maker of airplane seats and other interior components, for roughly $6 billion.

Should the UT acquisition of Rockwell Collins close, it would rank as the largest aerospace deal on record, eclipsing United Technologies’ 2012 acquisition of Goodrich Corp. for about $16.5 billion The acquisition would boost United Technologies’ business supplying Boeing Co. and Airbus SE. Analysts don’t expect significant antitrust issues, given that United Technologies and Rockwell make different airplane parts.

This transaction seems well-timed. In addition to the cold war styled arms competition with Russia (discussed above in this issue) the aerospace industry, dominated by Boeing and Airbus, is ramping up for a new generation of jets. On August 31, 2017, the Wall St. Journal reported that Airbus had a confirmed backlog of 6,771 planes, which would take about ten years to work through at the current rate of production.

One would ordinarily expect increased mergers and acquisitions activity in an economy marked by strong confidence numbers. However, the current high valuations in the stock market mean that investors in public companies will probably not be the most likely beneficiaries of takeover premiums.

The more likely scenario is that public companies will use their appreciated stock as scrip to buy private companies they want to acquire. UT’s acquisition of Rockwell Collins reflects this dynamic of using appreciated stock as scrip. UT will pay $140 per share for Rockwell Collins, $93.33 in cash and $46.67 in UT stock.

About Chris Donnelly

Christopher J. Donnelly, is an experienced attorney, bond analyst and fixed income strategist, with years of experience in structured finance, distressed bonds and bond related litigation in a variety of industries and the emerging markets. He is a graduate of Rutgers University (BA), The University of Pennsylvania (JD) and New York University, (LLM in Taxation). Chris is a Managing Director of Straacom, LLC and can be contacted at cdonnelly@straacom.com. Straacom provides strategic research, analysis and communications for publication and on assignment for private clients.

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