In the business world, there's a constant tension between the imperative to grow and the desire to be nimble. The one creates conglomerates and leads to huge M&A deals, the other breeds spinoffs and causes CEOs to talk about "unlocking value." It's the second that was on display this week as $100 billion industrial giant United Technologies (NYSE:UTX) revealed the unsurprising news that it was preparing to divide itself into three parts once it finished assimilating its recent $23 billion purchase of aerospace major Rockwell Collins. Headed for their own independent existences are Otis, the elevator and escalator maker, and Carrier, the heating and cooling business.
In this segment from MarketFoolery, host Mac Greer and senior analysts Andy Cross and Ron Gross consider what it all means for the company, the issues its competitors are facing, and how investors should respond to the news.
A full transcript follows the video.
This video was recorded on Nov. 27, 2018.
Mac Greer: But guys, let's kick off with a story about United Technologies. This is an industrial manufacturing giant. Andy, a lot people don't know this name, but they may know the brands, like Carrier and Otis, as in the elevators. United Technologies is splitting itself up into three companies. One company will be called, yes, United Technologies. That'll focus on aerospace. A second company, Otis, maker of elevators and escalators. The third company, Carrier -- yes, heating and AC. Andy, what's behind the breakup here?
Andy Cross: This is the worst-kept secret on Wall Street. This has been in the news and rumored for at least a year. Actually, the company's been talking about trying to unlock shareholder value, that euphemism, for a couple of years. Now, they finally announced it. They just acquired Rockwell Collins for $23 billion. They talked about, after that acquisition, it might be time to split up the company. And now they are.
They're splitting into three different companies. This is a $100 billion company. It's not a small company. It's actually very well-run. The operating margins and returns on capital are very good for industrial companies. Not the fastest-growing thing in the world. But this is an example of, we see what's happening with Honeywell, another competitor of theirs. We see the disaster at General Electric and what's going on there. That's now a $66 billion company, so it's smaller than United Technologies is. These are companies that are trying to get nimbler, faster, able to operate in growing markets, and deliver for shareholders what they may want. If you want aerospace, now you have an opportunity to invest just in aerospace. Same with elevators, same with HVAC businesses, which are both very good businesses. Not the fastest-growing businesses, but good businesses.
I think this is actually a good move for shareholders. I don't know if I'll be buying the stock now ahead of this spin-offs and split-ups. I may just wait to be able to pick which one I want to buy. Also, we have to see how they spin off. They do have a lot of debt on the balance sheet. We have to figure out how that's going to get distributed among the companies and figure out what they're going to do with the dividends, depending on if you're a dividend hunter or not. United Technologies pays a 2.2% difference. For dividend-seekers, it does matter which companies you own on that regard.
Ron Gross: I agree. I think this makes good sense. Long been pushed by Dan Loeb over at Third Point, a pretty well-known activist investor who is famous for things like Yahoo, Nestlé, Baxter, lots of different large companies that he's gone after in the past.
Sometimes the conglomerate model makes sense, and sometimes it doesn't. It works in the case of a company like Berkshire Hathaway because it's very decentralized, and he makes sure he keeps CEOs in place of each autonomous business unit. They can run the way they always have. In a very centralized conglomerate, it's very difficult. It's a totally different cost structure and operating structure to run an aerospace business vs. a heating and air conditioning business. So, those often don't work. Splitting it up is often the best way, as Andy said, to create shareholder value.
Greer: Ron, we were talking before the show, and you mentioned that your dad worked for an elevator company, but it was wasn't Otis.
Gross: It wasn't Otis.
Greer: I thought Otis was the only game in town here.
Gross: I'm racking my brain to recall if they were a competitor to or a supplier to Otis. I really can't remember. It was in my younger days. But there was always a lot of elevator talk going on in my home, rails and wiring and cables.
Greer: I have to ask, your dad worked for an elevator company. Did the job have a lot of ups and downs? Ba-dum-tss.
Gross: I don't even know where to go with that.
Cross: Looking at these looking at these two businesses, Otis is the largest elevator and escalator operator by a large factor. They're 30% larger than the next nearest competitor. It's a lot of high recurring revenues. Both these businesses, Otis and Carrier, require very little ongoing capital investments. And they're very profitable. Profit margins are somewhere in the high teens. They're already profitable. They don't grow particularly fast, but they're very stable businesses. And they're large businesses. We're talking $12-18 billion businesses in sales per year. They are large businesses. Smaller than the faster-growing, more exciting aerospace business.
To Ron's point, shed those. There's very little overlap. Get rid of those businesses, let those teams go off and manage that. Let investors choose which ones they want to own. I do think it's interesting. There are studies done about the value of spin-offs 18 months, two years after the spin-offs happen, and how lucrative they can be for shareholders. This is something I'm interested in watching, which one actually does well over the next five years.
Gross: Andy is right that Otis is not a fast-growing company, but it would have been a wonderful one if you got in on the ground floor.
Gross: Thank you!
Greer: And I enjoyed Andy's elevator pitch there. Oh, man!
Gross: This is going downhill quick.
Cross: Does the show get better from here?
Greer: It can only go up. We're on the lobby, people. We're moving up.
Andy Cross owns shares of BRK-B. Mac Greer has no position in any of the stocks mentioned. Ron Gross owns shares of BRK-B. The Motley Fool owns shares of and recommends BRK-B. The Motley Fool recommends Nestle. The Motley Fool has a disclosure policy.