With the stock market crashing, and crashing again, buying stocks is probably the last thing on most investors' minds today. Then again, $80 billion-market-capped United Technologies (NYSE:UTX) is not "most investors."
Late last week, The Wall Street Journal broke the news that here in the middle of a market meltdown, the smart stock shoppers at United Tech are busily crunching numbers and preparing to bid for rival HVAC manufacturer Nortek (NASDAQ:NTK).
What is Nortek?
Valued today at $1.39 billion in market capitalization (it cost only $1.2 billion before the Journal reported it was for sale), Nortek is an industrial conglomerate operating in five segments. In descending order of size (according to data from S&P Capital IQ), these include:
- Air Quality and Home Solutions (exhaust fans, air exchangers, central vacuums)
- Residential and Commercial HVAC (air conditioners, furnaces, heat pumps)
- Custom and Commercial Air Solutions (similar products, primarily for commercial use)
- Security and Control Solutions (alarm systems, garage openers)
- Ergonomic and Productivity Solutions (computer screens to control all of the above)
These businesses range in size from $300 million to $600 million in annual revenue, with the company as a whole pulling down about $2.5 billion annually, at about a 4.8% operating profit margin.
And why does United Technologies want to buy Nortek?
A much larger conglomerate doing business in everything from elevators to aircraft engines, under new CEO Gregory Hayes, United Technologies is refocusing its energies on commercial building technologies. The company recently confirmed it is selling its Sikorsky helicopters division to Lockheed Martin for $9 billion and now needs to figure out how to redeploy that cash.
At $16.8 billion annually, Climate, Controls, and Security is already the biggest business in UTC's $65.1 billion annual empire. Bringing Nortek into the fold will make it even bigger.
But should it buy Nortek?
Whether you think buying Nortek is a good idea depends on whether you believe United Technologies can do a better job with (i.e., extract more profit from) Nortek's $2.5 billion revenue stream than its current owners have managed. From at least one perspective, you see, Nortek is a bit of a train wreck. Unprofitable today, it's recorded net losses in each of the last two years -- and four of the past five. At first glance, Nortek hardly looks like something worth buying in the middle of a market meltdown.
Viewed another way, though, Nortek could be a pretty nice bargain. Bought for today's $1.4 billion valuation, Nortek would cost UTC less than 0.6 times Nortek's annual sales. UTC stock, in contrast, costs more than twice as much, at 1.3 times sales.
Meanwhile, although it earns no net profits, Nortek does earn operating profits (i.e., it would have been profitable but for the cost of interest, taxes, and various one-time items). In fact, at its current operating profit margin, Nortek earned about $123 million in operating profit on its revenues last year. If, after buying Nortek, UTC is able to improve the latter's operations so as to extract something like the 16.5% margin that UTC's own Climate, Controls, and Security business achieves, then this would work out to $413 million in annual profits from UTC's new subsidiary -- $290 million better than Nortek made on its own.
That certainly sounds like something worth paying $1 billion and change for. That sounds like a good argument in favor of having UTC buy Nortek.