Opinion: Reasons To Cheer Honeywell-UTC Merger Failure

Credit: UTC Aerospace Systems

Credit: UTC Aerospace Systems

3/8/16

By Kevin Michaels
Aviation Week & Space Technology

Why a Honeywell-UTC merger would have been bad for aerospace

No Deal

The drama is over, at least for now. On March 1, Honeywell withdrew its bid to acquire United Technologies Corp. (UTC) in what would have been a $90 billion megamerger of two U.S. industrial giants that also happen to be the industry’s largest aircraft systems suppliers. Combined, the new firm would have boasted revenue of $97 billion and world-beating positions in numerous aerospace and industrial markets.

Honeywell CEO David Cote labeled the bid “an incredible deal” for UTC shareholders. UTC CEO Gregory Hayes countered that the deal raised major aerospace customer concerns and would never survive antitrust scrutiny. Who was right, and what does this acquisition attempt mean for the aerospace industry?

From an aerospace perspective, the significant business overlap would have concerned regulatory authorities not only in the U.S. and Europe, but also Brazil, Canada and China. The segments with the most significant concentration include auxiliary power units, small engines, air management systems, electrical power generation/distribution, wheels and brakes, aircraft lighting and sensors. Combined, revenue from these is in excess of $10 billion. In many instances, the merger would have united the two leading global suppliers and would have likely been blocked or at a minimum resulted in major divestitures, possibly to key competitors. Divestitures alone might have offset much of Honeywell’s anticipated $3.5 billion in value creation from the deal.

If the transaction had overcome regulatory opposition, it would have then faced the wrath of customers. Airbus, Boeing, Bombardier and Embraer all registered their opposition to the deal, which runs counter to their own supply-chain strategies—such as Boeing’s Partnership for Success (PFS) initiative and Airbus’s Scope+—to increase supplier leverage. There is a strong likelihood that some of these OEMs would have responded to the Honeywell-UTC behemoth by actively promoting alternative suppliers to preserve competition, or even have pursued limited vertical integration. Boeing’s recent move to award the landing gear for the 777X and transition the 777 Classic from UTC Aerospace Systems (UTAS) to Canadian supplier Heroux-Devtek is a case in point. Heroux has never built a system of this size, and this action was widely viewed as a signal to suppliers that Boeing will “walk the talk” on PFS.

Customer satisfaction would have been another concern of folding UTAS and Pratt & Whitney into Honeywell Aerospace. Honeywell’s complex and unwieldy 3-D organizational structure appears to be better suited to leaning out operations and enhancing margins than agility and ease of doing business. “They’ve taken matrix management to a place where it is unworkable,” says one former executive. The result is subpar responsiveness—particularly in the aftermarket. Not surprisingly, it ranks at the bottom of many aerospace customer satisfaction report cards, and adding the non-divested parts of UTAS and Pratt & Whitney could exacerbate the situation.

Perhaps the strongest rationale for the transaction, at least from a Honeywell Aerospace perspective, is to rekindle growth. Honeywell’s corporate strategy in recent years favored its non-aerospace businesses, resulting in lost market share in many important product segments. The associated reduction in development expenses contributed to an expanding operating margin, but not growth. In fact, Honeywell Aerospace’s revenue has been flat since 2007, while the aggregate value of aircraft deliveries increased 60%. In contrast, UTC has pursued a strategy that better balances shareholder returns with innovation—including investing in breakthrough products such as the Geared Turbofan, the F135 and Boeing 787 variable frequency electrical system. And it is poised for breakout revenue growth as the Airbus A320neo and Joint Strike Fighter ramp up in the next several years.

Overall, I side with the UTC argument that this megamerger is unlikely to pass muster with regulators and would be bad for the aerospace industry. But is it an indication of further Tier 1 consolidation? Quite possibly, and here’s why. After years of uninterrupted growth, the value of aircraft deliveries is set to plateau within this decade. At the same time, Tier 1 suppliers are facing increased customer bargaining leverage as a result of customer consolidation and aggressive supply chain and procurement practices. There are also headwinds in the aftermarket—all at a time of unyielding financial market expectations.

In this environment, shareholder value can be created when companies with superior scale, productivity and supply chain practices acquire lesser performers. Precision Castparts demonstrated the value-creation potential of this approach, but as Honeywell-UTC reminds us, it must be balanced against customers and regulators. Thus, additional Tier 1 consolidation may be more “small bore” and targeted than that of megamergers.

The original article can be found here.

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