UTC To Buy Rockwell Collins in $30B Deal

United Technologies' (UTC's) agreement to buy Rockwell Collins for $30 billion will create a business unit that combines Collins’s avionics, communications and interiors specialties with the extensive UTC Aerospace Systems (UTAS) portfolio. It also gives UTC more muscle to resist supply-chain cost reduction pressures that aircraft manufacturers have been exerting on suppliers.

The deal, announced September4 and approved by both boards, is expected to close next year. UTC will combine Collins with UTC Aerospace Systems (UTAS), creating Collins Aerospace Systems. Collins CEO Kelly Ortberg will be the unit’s CEO, with UTAS president Dave Gitlin adding the title of COO. 

A combined Collins/UTAS unit would generate $23 billion in 2017 revenue—75 percent from commercial business and the remainder from defense work. Sales would be split 60 percent and 40 percent between OEM and aftermarket, respectively.

UTC says the unit’s breadth and scale will lead to more internal efficiencies, generating $500 million in internal savings within four years, by streamlining administrative and some procurement functions. Customers stand to benefit as well, the company says.

"Our suite of capabilities will also provide greater options to meet customer demand for integrated systems and ultimately reduce weight and cost," said Greg Hayes, UTC CEO. "Our customers, both the airlines as well as the OEMs, are always looking for cost reductions, are looking for innovative solutions and services. The combination of Collins with our Aerospace Systems business gives us the scale to both innovate and reduce costs to meet the needs of those customers."

Connectivity Enhancements

Among the most fertile areas for collaboration is connectivity. Collins has a long history of developing onboard connectivity, such as sensors and servers needed to move data on and off aircraft. Its 2013 acquisition of Arinc gave it air-to-ground capabilities as well as some significant ancillary services, such as airport information systems. UTC's major systems, among them engines, have been incorporating more sensors and related features designed to drive efficiencies, particularly in predictive maintenance. Mix in the former B/E Aerospace, an interiors specialist, and the combined entity has deep expertise in all areas of the aircraft, and each has significant data-related upsides as operators seek more insight into the condition of their equipment. 

Collins's strategy in leveraging its B/E Aerospace purchase offers insight on possible UTC/Collins directions. Collins has an extensive dealer network selling avionics packages, while B/E Aerospace, which is heavily involved in both business and air transport cabins, does not. When discussing a Collins cockpit display system upgrade package on a business aircraft earlier this year, Collins began talking about products its new interiors business had.

"The dealer had no idea that there is another set of certified seats, and other interior products we can add to that package, like lighting and galley inserts,” Collins's Ortberg told reporters in May. “The package went from a flight-deck upgrade to an aircraft upgrade. The dealer is ecstatic about the business opportunities.”

Capitalizing on long-established customer connections that UTC and Collins has could lead to similar, incremental opportunities, ranging from onboard data management to developing software that link Collins avionics and UTC systems to generate fuel savings, for instance.

Hayes said that the UTAS and Collins product lines have “a couple of hundred million dollars” of overlap—much less than the $8 billion to $10 billion that last year’s proposed UTC-Honeywell merger faced. “There is not a big divestiture risk…You're not seeing consolidation in individual systems,” he noted.

While this may please regulators, others have concerns. Shortly after the deal was announced, Boeing said it intends "to take a hard look at the proposed combination," expressing doubt that the tie-up "would be in the best interest of—or add value to—our customers and industry."

Concern from Boeing, Airbus and others is not surprising. Supply-chain consolidation is seen as part of the ramifications of OEMs seeking higher margins by squeezing costs out of their suppliers, with the UTC-Collins tie-up serving as the largest example.

“We believe at least part of the motivation for [UTC] is the incremental pressure on the supply chain from Boeing, both from a price and economics standpoint,” said Canaccord Genuity analyst Ken Herbert. “We expect the supply chain to continue to look to get bigger, both to increase leverage in the marketplace, and also to provide additional opportunities to take out cost and realize synergies.”

A UTC-Rockwell Collins combination “would also be more challenging to bully” into cost-reduction agreements, such as those behind Boeing’s Partnering For Success, “whereas smaller suppliers are easier to push around,” said Vertical Research Partners analyst Robert Stallard. UTC generates half of its $57 billion in annual sales from Pratt & Whitney and UTAS. Collins generates $5.3 billion in annual revenue.

The deal's timing comes amid pressure at UTC to deliver on major programs while reducing costs. UTC subsidiary Pratt & Whitney is working to accelerate PW1000G geared turbofan production and address performance issues that have delayed deliveries and required costly upgrade programs for engines in service. Meanwhile, UTC is looking for ways to streamline.

“As we think about 2018, one of the things that we are focused on is structural cost reduction,” Hayes told analysts on a late-July earnings call. “It's organization. At the same time, the need to continue to reduce factory footprint remains. We're going to continue to go by the playbook of taking out high-cost locations for low-cost locations where the markets are moving.”

While the Collins acquisition will not create a simpler corporate organization, it should bring other benefits. “We believe UTC has sought greater scale in its aerospace business for some time, and Rockwell Collins enjoys leadership positions in avionics, interiors and connectivity,” Canaccord's Herbert said.

It also gives UTC more size in the all-important aftermarket segment. On July 1 Boeing started operating Boeing Global Services as an integrated business unit. The $14 billion business is targeting rapid growth in the next decade, with Boeing officials tossing around targets of $45 to $50 billion in annual revenue. Much of that growth is expected to come from commercial business—a prospect that has suppliers concerned.

“One of the fundamental strategic issues…is who gets to participate in the aftermarket,” Hayes said in July, before the Collins deal was announced. “The model has always been that the [OEMs] take big risks and invest big dollars, along with the first-tier suppliers, to develop all of these innovations . I think we need to have these discussions—as we have started to do with the big OEMs—about partnership risk revenue-sharing arrangements. But clearly, you can't continue with the current business model if the OEMs are going to demand a bigger and a much more significant chunk of the aftermarket.”

The UTC-Collins tie-up also raises speculation that the company will spin off its two core competencies: building systems (Otis Elevator and its Climate Controls and Security unit) and aerospace. "We shall see, but the newly named Collins Aerospace Systems potentially paves the way for United Technologies to split into two separate [aerospace and defense] and building systems companies," said Stallard. This would potentially unlock the value in Otis and CCS, with Aerospace Systems able to sustain the risk inherent with Pratt & Whitney."

UTC's Hayes says that although the company's primary focus is closing the deal while executing on current programs, it won't rule anything out.

"Once the deal is closed, integration is under way and we're confident in getting the synergies, we will have a large aerospace business and a large commercial business," Hayes said. "And then we will have an opportunity to see what makes most sense in terms of share owner value creation."