United Technologies battles credit raters: corporate finance
United Technologies Corp. is betting it will raise $12 billion in debt to finance the largest takeover in the 77-year history of the maker of Pratt & Whitney jet engines without endangering its “sacrosanct” credit grade.
Chief Financial Officer Greg Hayes told analysts on a conference call yesterday the Hartford, Connecticut-based company plans to borrow the money to pay for its $16.5 billion acquisition of Goodrich Corp., with most of the debt maturing within five years. United Technologies, rated the sixth highest level of investment grade, said Sept. 21 it may pay for about 25 percent of the purchase by selling stock.
United Technologies is wagering it will be able to balance the interests of shareholders and fixed-income investors as it suspends stock repurchases and cuts back on further acquisitions to focus on repaying debt. While Moody’s Investors Service affirmed its A2 grade on the company, Standard & Poor’s assigned a “negative” outlook to its equivalent A rank and Fitch Ratings warned of a possible downgrade.
“It’s a hallmark of United Technologies that they’ll never do anything which is damaging to either the shareholders or the bondholders,” Hitin Anand, an analyst at CreditSights Inc. in New York, said yesterday in a telephone interview. “Ratings agencies really give you a lot of credit if you use equity as a component of the financing and don’t put all the burden on the bondholders.”
Ebitda Climbs
The company’s ratio of debt to earnings before interest, taxes, depreciation and amortization may climb to about three times as a result of the acquisition, Moody’s analysts Russell Solomon and Michael Mulvaney wrote yesterday in a note to clients. That compares with 1.24 as of June 30, according to data compiled by Bloomberg. Halting share buybacks, limiting acquisitions and repaying debt should allow it cut leverage to two times within two years and avoid a downgrade, they wrote.
“Keeping the credit rating, especially in times like these, I mean it is sacrosanct,” Hayes said during the conference call. “We knew that we had to do a little bit in terms of equity to hold the rating and we would have to suspend share buyback, but again, the deal makes sense even with the issuance of 25 percent equity.”
United Technologies “worked very closely with the rating agencies” to ensure the structure of its acquisition will preserve its rankings, Hayes said.
“The debt/equity split they outlined was an important starting point,” Russell Solomon, senior vice president of the corporate finance group at Moody’s in New York, said in a phone interview. “If the transaction was financed entirely with debt, it would almost certainly have resulted in a downgrade, potentially more than a notch.”
John Moran, a United Technologies spokesman, declined to comment beyond Hayes’s statements on the conference call.
Stock Price Drops
United Technologies climbed 92 cents, or 1.4 percent, to $69.23 at 11:50 a.m. in New York Stock Exchange Composite trading, outpacing the S&P 500, which has increased 0.1 percent. The company has lost 13 percent this year through yesterday.
Its $1.25 billion of 4.5 percent notes due in April 2020 fell 0.4 cents to 112.2 cents on the dollar at 10:31 a.m. in New York, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority. Relative yields on the company’s debt expanded 9 basis points, or 0.09 percentage point yesterday, to 138 compared with an average 13 basis-point expansion to 251 for investment-grade corporate bonds, Bank of America Merrill Lynch index data show.
“There was disappointment and a feeling that perhaps they didn’t need to issue equity,” said Ben-Ari Elias, an analyst at Sterne Agree & Leach Inc. in New York, who has a “buy” rating on the stock. “They’ve said recently that their stock is very cheap and that they’d like to buy back as much as possible, and here they are trying to issue more at a supposedly very cheap price.”
Combining Businesses
United Technologies plans to combine its Hamilton Sundstrand aviation equipment business and Goodrich, the world’s largest maker of aircraft landing gear, into a new unit called UTC Aerospace Systems based in Charlotte, North Carolina, it said Sept. 21 in a statement.
Based on 2011 estimates, the purchase adds sales of about $8 billion a year, boosting revenue to $66 billion for United Technologies, which also makes Sikorsky helicopters and Otis elevators. The company affirmed guidance of $58 billion of revenue and earnings per share as much as $5.45 in 2011 yesterday.
The Goodrich purchase, valued at $18.4 billion including $1.9 billion in net debt, will be funded in part with a $15 billion bridge loan United Technologies said it obtained. It’s the largest acquisition ever in the aerospace and defense industry, Bloomberg data show, and the company’s first aerospace acquisition of more than $1 billion since 1999, when it paid $4 billion to takeover Sundstrand Corp.
Potential Pitfalls
A weakening global economy or defense spending cuts may yet lead S&P to cut its rating on United Technologies, analysts Gregoire Buet and Dan Picciotto wrote yesterday in a statement.
Additional leverage from the acquisition leads to “deteriorating” credit quality, according to Carol Levenson, director of research at GimmeCredit LLC, who downgraded the company from “stable” yesterday.
“The announced acquisition of Goodrich, while tempered by some equity funding, will damage its credit profile although not catastrophically,” Levenson wrote. “A bondholder can’t help but like a company that brags as much about low leverage and high free cash flow as it does about EPS growth.”
--With assistance from Rachel Layne in Boston. Editors: Sharon L. Lynch, Faris Khan.
To contact the reporters on this story: Tim Catts in New York at tcatts1bloomberg.net; Joseph Ciolli in New York at jciollibloomberg.net;
To contact the editor responsible for this story: Alan Goldstein at agoldstein5bloomberg.net.