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John Engle
John Engle
Articles (604) 

Is Raytheon Technologies Proving the Doubters Wrong?

Wall Street analysts, once skeptical of Raytheon's merger with United Technologies, now see it as a boon

January 12, 2021 | About:

Raytheon Co. and United Technologies Corp. faced many doubters ahead of their merger. From its announcement in June 2019, the deal faced pushback from investors. The companies forged ahead regardless, officially forming Raytheon Technologies Corp. (NYSE:RTX) in April 2020.

In the months since the merger, however, analysts and investors have largely changed their tune. Indeed, Raytheon Technologies seems to have captured Wall Street's interest. Analysts have showered the company with upgrades and buy ratings in recent months.

Expectations are clearly running high for Raytheon Technologies in 2021, but can the freshly restructured aerospace giant deliver the goods?

Born from a merger of giants

Raytheon Technologies came into being in April 2020 following the merger of Raytheon, a major U.S. defense contractor and industrial corporation, and United Technologies, a global manufacturer of aircraft engine and aerospace systems.

The new entity was reorganized to take advantage of each of its predecessor companies' strengths. The result was four business segments: Raytheon Intelligence & Space (RIS), Raytheon Missiles & Defense (RMD), Pratt & Whitney and Collins Aerospace.

RIS was organized as part of the formation of Raytheon Technologies, combining two business units of the former Raytheon. RMD is also a combination of two Raytheon legacy businesses, Raytheon Integrated Defense Systems and Raytheon Missile Systems. Pratt & Whitney, previously a division of United Technologies, designs and builds aircraft engines and gas turbines. Collins Aerospace, another former United Technologies unit, designs, manufactures and services systems and components for commercial and business aviation, military and defense, helicopters and space industries.

With a combined $75 billion in annual sales at the time of the merger, Raytheon Technologies' four business segments represent a powerful force in aerospace and defense.

Skeptics argue size is not everything

While Raytheon Technologies emerged from the combination of Raytheon and United Technologies with a bigger industry presence, many doubted whether greater size would translate into greater value for either company.

United Technologies investors were especially distraught, with many lamenting that a merger would undo recent progress toward streamlining its sprawling operations, which had included the spinoff of two business segments, elevator and escalator manufacturer Otis Worldwide Corp. (NYSE:OTIS) and heating and cooling equipment manufacturer Carrier Global Corp. (NYSE:CARR). Several heavy-hitting shareholders pushed back, including activist Dan Loeb, who lambasted the proposed merger as having "no strategic or financial rationale" other than "empire building" on the part of management. Bill Ackman (Trades, Portfolio), another storied activist investor, threatened a fight:

"We are extremely concerned about what we have read. If the company intends to go forward with such a transaction, we will oppose it, publicly if necessary, as we expect will the substantial majority of the company's shareholders."

While efforts to block the merger ultimately failed, many investors remained dubious about Raytheon Technologies' prospects.

Pandemic puts synergies to the test

From the outset, Raytheon and United Technologies contended that a key benefit of a merger would be greater resilience in the face of economic downturns and disruptions. Anthony O'Brien, then Raytheon's chief financial officer, made this point emphatically during an interview at the 2019 Paris Air Show:

"[It] provides resiliency and it allows the company to be a stronger competitor in any cycle. Because of the financial strength of the company out of the gate, [it] allows us to continue to invest mutually in technologies — whether it be on the commercial, the defense side or a technology that benefits both — and at the same time, in parallel continue to shareholders."

This claim has already been put to the test thanks to the outbreak of the coronavirus. In the early months of the pandemic, Raytheon Technologies seemed to be proving its value, as its lucrative defense business offset the collapse in demand for its commercial aerospace products. However, as the commercial aerospace downturn dragged on, Raytheon Technologies faced even more pressure, eventually forcing it to make cutbacks. By the end of October, the company had shed about 20% of its commercial aircraft workforce.

While Raytheon Technologies' commercial segment looks set to struggle along with the rest of the aerospace industry, its defense business remains robust. As Ron Epstein, managing director for aerospace and defense at Bank of America Merrill Lynch Global Research, observed in November, defense is a good business to be in these days:

"Companies that are largely in the defense business are doing just fine...the impact of covid-19 on their operations has been minimal."

Outlook uncertain

Despite the challenges facing Raytheon Technologies' commercial aerospace business, Wall Street analysts have grown increasingly bullish on Raytheon Technologies. With strong cash flow from its defense business expected to continue softening the blow from commercial losses, the analyst consensus is highly positive, with an average price target of $80.78. That translates to 13% upside from the Jan. 12 close of $71.52.

Having fallen from a 52-week high of $158.44, there may be even more upside for Raytheon Technologies than analysts anticipate, provided the company sees a turnaround in its commercial aerospace business. That may take some time, however, as management does not anticipate a return to normalcy until 2023.

Taken as a whole, I find Raytheon Technologies quite compelling at its current price level. While a full recovery is unlikely to be achieved anytime soon, I see ample reason to believe in a long-term value appreciation.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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