United Technologies Corp. [UTX] is exploring the divestiture of its $7.5 billion helicopter business because the long-term growth and earnings outlook at Sikorsky Aircraft doesn’t fit with the rest UTC’s operating portfolio, which has greater scale and is poised to take advantage of global megatrends favoring urban growth and increased demand for commercial air travel, the company’s chief said on March 12.
The helicopter business has “its ups and downs” and is a “very, very good business,” Greg Hayes, UTC’s president and CEO, said at an investor and analyst meeting. “It’s just not quite the business we want in terms of long-term margin potential, long-term growth.”
UTC had $65.1 billion in sales in 2014.
As part of a just completed portfolio review the company announced in December, UTC on the evening of March 11 announced that it is reviewing strategic alternatives for Sikorsky, including a potential tax-free spinoff.
“Today, Sikorsky is a world leader in the design, manufacture and service of military and commercial helicopter platforms,” Hayes said in a statement on March 11. “It has unmatched technological capabilities, outstanding people and a strong backlog. Looking to the future, we are evaluating whether Sikorsky’s unique business as a rotorcraft OEM with a predominantly military customer base is best positioned as a stand-alone company, and whether a separation would allow United Technologies to better focus on providing high-technology systems and services to the aerospace and building industries.”
Unlike the rest of UTC’s businesses, which sell systems for buildings, and commercial and military aircraft, Sikorsky is a platform business that develops and manufactures helicopters, and with its largest customer being the Defense Department, margins are “inherently lower,” Hayes said. About 70 percent of Sikorsky’s sales are defense-related.
Some of Sikorsky’s marquis wins in recent years, including the CH-53K heavy lift helicopter for the Marines, the Marine One presidential helicopter, and the HH-60W Combat Rescue Helicopter, won’t be in production until later this decade or early in the 2020s.
“And so the question between now and then is how do you survive?” Hayes asked. “And it’s going to be relatively flat sales for the next few years because we’re in the development mode until we get into actual production,” he said of the CH-53K, which won’t see “real volume until into the 2020s.”
According to briefing charts UTC presented as part of its investor presentation, Sikorsky ranks at the bottom of its operations in terms of growth outlook. The business is expected to average top line growth between 3 to 5 percent annually, with its aircraft engine business Pratt & Whitney projected to grow at rates between 6 and 8 percent, its Aerospace Systems business between 5 and 7 percent, and its building and industrial systems businesses between 4 and 6 percent.
That helicopter business also lagged the others in terms of operating margins, just over 10 percent last year versus nearly 15 percent at P&W, around 17 to 18 percent for its Aerospace Systems and building and related security systems, and more than 20 percent for its Otis elevator unit.
Hayes began the investor presentation saying that UTC is focused on attaining organic sales growth that exceeds Gross Domestic Product over the long-term. To do this, the company is keying on the megatrends across the globe that show an continued shift in populations from farm to city, which necessitates more building-related technologies like elevators, air conditioners and security systems, and a continued increase in commercial passenger air traffic as the middle class expands.
UTC’s briefing charts showed the middle class growing from 27 percent of the world’s population in 2010, to an estimated 58 percent in 2030. The population over that time is expected to grow from 6.9 billion people to 8.4 billion.
“We have positioned both our commercial building systems and our commercial aerospace systems businesses to take advantage of these megatrends,” Hayes said. “As the middle class grows and people move from “the farms to the factories, they need places to live, they need apartments, they need elevators and air conditioners, they need fire and security systems and once in a while they want to go home to see mom and dad so they get on an airplane. I think importantly, less than 80 percent of the world’s population has ever flown on an airplane today and that’s going to change as we see this growing middle class.”
UTC said it expects to conclude its strategic review of Sikorsky before the end of this year. It also said that no timetable has been set and there is no guarantee that a spinoff or other transaction related to the business unit will occur.
Sterne Agee aerospace and defense analyst put Sikorsky’s value at between $7 billion and $8.5 billion as part of a spinoff while Jefferies analyst Howard Rubel believes UTC could fetch $8 billion in terms of enterprise value for a sale.
Rubel said “anyone” is a potential buyer for Sikorsky.
“We figure the major defense contractors will consider the transactions, regardless of their current participation in the helicopter business, including international buyers,” Rubel said in a note to clients. “Private equity may consider it too.”