A Merger And Two Spin-Offs

A Merger And Two Spin-Offs

On Friday April 3rd 2020, the newly formed Raytheon Technologies (RTX) completed its merger of Raytheon Company (RTN) and United technologies Corporation (UTC). This merger induced the spin-offs of Carrier (CARR) and Otis (OTIS). Headquartered in Waltham, MA, Raytheon Technologies is one of the largest aerospace defense companies in the world.

Raytheon Technologies highlighted the constituent pieces of the newly formed conglomerate in their latest press release:1

  • Collins Aerospace Systems specializes in aerostructures, avionics, interiors, mechanical systems, mission systems and power controls that serve customers across the commercial, regional, business aviation and military sectors.
  • Pratt & Whitney designs, manufactures and services the world’s most advanced aircraft engines and auxiliary power systems for commercial, military and business aircraft.
  • Raytheon Intelligence & Space specializes in developing advanced sensors, training, and cyber and software solutions — delivering the disruptive technologies its customers need to succeed in any domain, against any challenge.
  • Raytheon Missiles & Defense provides the industry’s most advanced end-to-end solutions to detect, track and engage threats.

However, I for one am most interested in the spun off Otis business. I specifically got into United Technologies for the Otis exposure and now that the business has spun off into its own firm, I will be looking at the valuation OTIS shares have garnered thus far.

To start, United Technologies described its previously owned Otis business as followed:

“Otis is the world’s largest elevator and escalator manufacturing, installation and service company. Otis designs, manufactures, sells and installs a wide range of passenger and freight elevators as well as escalators and moving walkways. In addition to new equipment, Otis provides modernization products to upgrade elevators and escalators as well as maintenance and repair services for both its products and those of other manufacturers. Otis serves customers in the commercial, residential and infrastructure property sectors around the world. Otis sells direct and through sales representatives and distributors.”2

Otis, founded in 1853 by Elisha Otis who invented the elevator safety brake, is trusted to operate in some of the world’s most renowned buildings, including the Empire State Building and the Eiffel Tower.3 According to a recent publication by Fortune Business Insights, the global escalator and elevator market was estimated to be worth $70.95B in 2018, implying an 18.2% market share for Otis. The same study forecasted a 6.4% CAGR for the market from 2019-2026.4 The two largest competitors to Otis are Schindler Holdings (15.6% of the estimated 2018 market) and KONE Oyi (14.6% of the estimated 2018 market), which I will use as comparisons later in this piece. Parsing through United Technologies 10-K filings I found several key line items describing Otis’s operations.

This data graphic was created on Microsoft Excel using data from the SEC’s Edgar platform for Otis financials.2

On the positive side, 2019 revenues were $13.1B (up 1.6% from 2018) and operating income was just shy of $2B, yielding an operating margin of 14.9% (up 2 basis points from 2018). Revenues are geographically diversified with U.S. sales representing 27% of total sales for the past three years, while the European segment was 30% of sales in 2019 and the Asia Pacific segment was 35% for the same year. Furthermore, Otis has a fairly even split between product sales and service sales. In 2019 product sales were 43% and service sales were 57%; importantly, the service sales are highly recurring in nature and thus more stable. Capital expenditure has been little changed, rising from 0.7% in 2015 to 1.1% in 2019. Depreciation and amortization appear to be stable throughout the past five years, rising from 1.5% in 2015 to 2.6% in 2019. The goodwill has fallen from $1.74B in 2017 to $1.65B in 2019 (which I interpret as a lack of expensive acquisitions in recent years). And the last reported backlog in 2018 was over $16B and growing. On the cautionary side, the operating margin for Otis has declined from 19.5% in 2015 to 14.9% in 2019. The stabilization in the margin the past fiscal year helps ease my mind that the trend will not continue.

Holders of United Technologies stock received .5 shares of OTIS for every share of UTX owned. According to a press release from the Otis Investor Relations section, “UTC distributed 433,079,455 shares of common stock of the Company in the Distribution.”5 That share count with the closing share price of $47.32 on 4/3/2020 yields a current market cap of $20.5B. Using that forecasted market cap and the respective firm’s 2019 financials highlights, I created the following comparison to top competitors KONE and Schindler:

The data graphic above was created on Microsoft Excel using data from the SEC’s Edgar platform for Otis financials and Seeking Alpha for KONE and Schindler Holding financials.2,6

The real striking aspect of these financial highlights is just how similar they are; it seems clear to me that these firms are competitive and each hold large portions of the total market they operate in. From a relative valuation perspective, Otis is the most profitable firm in terms of operating income and yet is valued the least in terms of market cap. This fact gives Otis the lowest price to EBIT multiple among its peers. Another favorable and telling multiple, a measure of return on assets, operating income to total assets, shows Otis is the most efficient amongst these two peers at generating income per unit of total assets.

Taking the 2019 price multiples of KONE and Schindler, and applying them to the respective financials of Otis’s 2019 results yields the following implied prices of Otis shares:

This data graphic was created on Microsoft Excel using data from the SEC’s Edgar platform for Otis financials and Seeking Alpha for KONE and Schindler Holding financials.2,6

Aside from the financials, I see Otis as a firm well positioned for the future. The substantial order backlog cushions Otis’s business for the exact type of economic slowdown we are currently in. The CEO Judy Marks stated something similar herself in the firm’s press release today, “Otis continues to be well-positioned for sustained, long-term growth as our business model brings recurring revenue even in times of economic headwinds.“3 Looking towards the future, the products and services offered by the firm should fit in nicely into a world with an expanding middle class and continued urbanization and modernization trends. I suspect the newly spun off Otis business will establish a dividend in the near future and expect the underlying business to grow slowly and steadily in the years to come.

Disclosure: I am a holder of CARR, OTIS and RTX shares as a result of the previously described corporate merger and spin-offs. I intend to increase my position in OTIS in the week ahead following this post.

4/8/2020 Update:

While the balance sheet highlights looked fine from past United Technology company filings, the pro forma balance sheet released by Otis does not tell the same story.7 I’d be remiss if I didn’t mention the long-term debt Otis has added to its balance sheet as a result of the company spin-off. The firm issued $5.3B in long term notes and is expected to have drawn on a $1B credit facility. The added liabilities are not ideal for hopes of a strong dividend program in the near term, instead much of the firm’s cash flow will be aimed at decreasing this debt load in the years to come. Fortunately, Otis has sizable positive cashflows and should be able handle the debt payments as they come due. None the less this is a risk that I did not outline originally that I wanted to spell out. Below is the debt schedule and a few ratios to showcase the size of this current debt total in comparison to some of Otis’s historical financial operations.

This data graphic was created on Microsoft Excel using data from Otis’s website under the SEC filings section.7

4/9/2020 Update:

Given the added debt I took another look at the relative valuation of Otis based on closing prices for 4/9/2020 and came to the following implied price ranges. An enterprise valuation multiple look showcases a more holistic approach to valuing a firm’s entire capital structure rather than just its equity.   

This data graphic was created on Microsoft Excel using data from the SEC’s Edgar platform for Otis financials and Seeking Alpha for KONE and Schindler Holding financials.2,6

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