United Technologies Corp. struck a deal to acquire military contractor Raytheon Co., continuing the sprawling industrial conglomerate’s transformation into a company focused on aerospace and defense.
The proposed deal intensifies the consolidation in the aerospace and defense industry as plane makers seek better terms from suppliers and the Pentagon puts more pressure on contractors to cut costs and invest more of their own money in new technologies such as space systems and cybersecurity.
The companies, with a total market value of roughly $166 billion, would become the world’s second-largest aerospace-and-defense company by sales behind Boeing Co., with annual revenue of more than $70 billion last year.
"There is some truth to the idea that bigger is better," Jefferies analyst Sheila Kahyaoglu wrote in a note to clients Sunday. "With common customers there is some leverage to size and the supply chain."
The Journal first reported Saturday that the two sides were nearing a deal.
The combined entity would be split roughly 50/50 between commercial and defense sales, though military is likely to shrink as a proportion as UTC’s Pratt & Whitney division ramps up deliveries of its latest jetliner engines. A third of the two companies’ aerospace and defense revenues last year — some $25 billion — came from the Pentagon.
Byron Callan, a defense analyst at Capital Alpha LLC., said the proposed deal reflected the likely slowing of military spending increases and the need for companies to boost their investment in new technologies.
The tie-up would complete a radical transformation at UTC, a once sprawling conglomerate that already plans to spin off its Otis elevator and Carrier building-systems businesses into separate companies.
Raytheon would be combining with UTC’s’ remaining aerospace business, and all the transactions would take place at the same time. UTC has said the spinoffs will take place in the first half of next year.
The deal would be one of the largest of the year and isn’t expected to attract significant antitrust scrutiny, analysts say, because UTC and Raytheon don’t compete against each other in most of their markets.
The deal unites Pratt & Whitney engines used on commercial planes and the F-35 combat jet, with Raytheon, which produces missiles such as the Tomahawk together with radars and other electronic-warfare systems.
"There is minimal overlap for the two companies," said Ms. Kahyaoglu, predicting few antitrust issues for the deal. The companies could mutually benefit from their separate expertise, she said, such as leveraging UTC’s expertise in global positioning systems across Raytheon’s missile programs.
The deal would be one of the largest in a year that has included some big mergers but otherwise has been lackluster. Right now the biggest proposed acquisition is Bristol-Myers Squibb Co.’s $74 billion purchase of rival drugmaker Celgene Corp.
Farmington, Conn.-based UTC, which acquired Rockwell Collins for $23 billion late last year, is one of America’s last remaining big industrial conglomerates — though it is set to radically transform with the spinoffs and now the merger.
The Otis elevator division and Carrier building-systems businesses will become separate publicly traded companies, leaving UTC as a pure-play aerospace company. The rationale for the split was clear in the company’s first-quarter results as the aerospace portions of its business posted strong growth.
Investors are pressuring traditional conglomerates to become more focused. Rivals Honeywell International Inc. and General Electric Co. are both shaving off units to streamline their businesses. Several activist investors had pushed UTC to split, and Mr. Hayes has openly expressed his preference for smaller, more focused companies.
Waltham, Mass.-based Raytheon sales rose 6.7% last year to $27.1 billion but it has largely avoided big deals. It has invested heavily in recent years ahead of the recent uptick in Pentagon spending, and has the biggest export business among the five largest U.S. defense contractors.
In addition to other benefits from increased scale, analysts say the proposed deal could help the enlarged company weather any slowdown in the commercial aerospace and defense markets.
While commercial aircraft sales have been booming during an unprecedented 13-year surge in orders that has left Airbus and Boeing with backlogs of more than 13,000 jetliners, analysts have cautioned that slowing air traffic could force aircraft makers to reverse production increases.
The two-year uptick in Pentagon spending on new aircraft, missiles and other defense equipment is also running out of steam, with analysts projecting muted growth over the next several years.
Pentagon spending fell sharply between 2013 and 2017 because of broader federal budget pressures and then expanded at a clip of around 10% in the final Obama administration budget and the first two of the Trump administration. Spending increases are now slowing to low single-digit increases, and much of the additional money is being directed at refreshing U.S. nuclear forces.
Before World War II, the government relied on a mix of federally-funded arsenals and civilian companies to provide war materiel, though after the war that trend shifted to private industry providing the bulk of the Pentagon’s needs, according to a report on industry consolidation released earlier this year from the Center for Strategic and International Studies, a Washington-based think tank.
After the Cold War, lawmakers and other policy makers helped spur a push toward industry consolidation amid a perception of dwindling enemy threats to the U.S. combined with budget drawdowns, which left substantial excess capacity. From 1993 to 2000, the number of what are considered prime contractors for the Defense Department fell from 50 to six, researchers found.
Just as major mergers were being wrapped up, the U.S. was attacked on Sept. 11, 2001, launching the country into the longest war in its history. Under the Trump administration, defense budgets have soared as U.S., European and other manufacturers have boosted production.
UTC and Raytheon are both well positioned in the F-35 program, where production is increasing. Raytheon also has big franchises in missile defense with the Patriot system — a big seller overseas — and munitions such as the Tomahawk cruise missile.
"The potential for defense budgets to flatten in the next couple of years could add a sense of urgency" for companies to reposition themselves, Ms. Kahyaoglu at Jefferies said.
–Thomas Gryta and Ben Kesling contributed to this article.
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