Raytheon deal with UTC gets cold shoulder from investors

Raytheon’s Tom Kennedy and his new merger partner, Greg Hayes of United Technologies, have a problem: Many investors aren’t convinced that the combination of the two companies is the win-win the chief executives say it is.

Since the surprise deal was unveiled Sunday, shares of Waltham-based Raytheon have fallen 4.8 percent. UTC, headquartered in Farmington, Conn., has lost 6.1 percent. The Standard & Poor’s 500 index, meanwhile, is little changed.

The companies are billing the combo as a “merger of equals” that would create the second-largest US defense and aerospace company, after Boeing. United Technologies would benefit from access to Raytheon’s defense expertise, a real plus as commercial customers are seeking to incorporate more advanced military tech. Raytheon would become less dependent on Pentagon contracts as it gains access to commercial buyers.

“It’s strategically sound,” said Nick Heymann, an analyst at William Blair & Co. “But it’s not economically compelling.”

UTC would be effectively buying control of Raytheon, whose shareholders will own only 43 percent of the new company, to be called Raytheon Technologies. Raytheon’s investors would not get a premium to the pre-deal stock price that usually accompanies an acquisition.

For UTC investors, it’s simply not clear that the company would be financially stronger by linking up with Raytheon. This may not be a case of one plus one equals three.

Here are five questions being asked by investors that Kennedy and Hayes need to better address if they want to pull the deal off.

1. Why should Raytheon shareholders sell without getting a premium? Sure, Raytheon’s stock underperformed several of its big competitors over the past five years. But with a total return of nearly 200 percent over that period, it topped the performance of UTC fourfold.

Of course, United Technologies has been penalized by investors for being a conglomerate, which is why it sold its Sikorsky helicopter division and is in the process of spinning off its Otis elevator and Carrier air conditioning businesses as separate companies.

As a streamlined aerospace supplier, investors such as hedge fund manager Bill Ackman say UTC will trade at a higher multiple to earnings.

But Raytheon investors are basically being asked to take it on faith that the combination of the two companies will boost earnings and provide better stocks returns than they have seen in the past.

2. Can the deal pass muster with the Pentagon and other big customers? Raytheon and UTC don’t expect a significant antitrust objection from the US government because there is little overlap between their product lines. But the Defense Department and customers such as Boeing and Airbus can renege on their contracts if there is a major change at their suppliers — like a merger. Enough resistance from customers could deep-six the deal.

There is also a wild card: President Trump.

“I want to see that we don’t hurt our competition,” Trump said in an interview with CNBC on Monday. “I hope the Raytheon deal, I hope it can happen. But I don’t want to see where we have one less person that can compete for an order.”

Some analysts think Trump will come around once he has more information, but you just never know with him. Plus, UTC’s Hayes drew Trump’s ire over Carrier’s plans to move jobs to Mexico.

3. Will Raytheon Technologies be penalized for being a hybrid company — split roughly evenly between the defense and commercial markets? Investors tend to like “pure plays” focused on a discrete market or customer base. Defense investors like Raytheon because it’s a pure-play military contractor. UTC has been undergoing a dramatic restructuring to become a pure-play aerospace company geared mainly to commercial customers.

Ackman, who pushed Hayes to streamline the company’s conglomerate holdings, summed up his opposition in an e-mail to the chief executive after The Wall Street Journal broke the news that a deal was brewing.

Raytheon, he said, is dependent on Pentagon budgets, “which have limited visibility and high volatility, and which can change drastically based on the dominant political party’s priorities.”

“It therefore makes no sense to us why you would consider a stock acquisition using today’s massively undervalued UTC common stock to buy a large business of inferior quality to the company’s existing businesses, and for which we cannot comprehend the strategic logic,” Ackman wrote in the e-mail.

Ackman is just one investor, and he has been wrong in the past. He backed drugmaker Valeant Pharmaceuticals, which was laid low by an accounting scandal, and bet against vitamin vendor Herbalife, whose shares failed to fall to zero as he predicted.

But as the market’s reaction shows, he isn’t alone in not liking this deal.

4. Just how much is UTC worth once Otis and Carrier are spun off? Heymann said terms of the deal put the value of the remaining UTC aerospace business at $59 billion. United Technologies spent $48 billion on the acquisitions of Rockwell Collins and Goodrich, two manufacturers of airplane parts. That suggests the remaining value of the company’s other parts is “pretty nominal,” he said, perhaps reflecting the projected $24 billion of net debt for UTC’s aerospace business.

5. Is United Technologies about to drop some bad news? Some investors are wondering why the deal, which had been in the works since last summer, was announced Sunday, eight days before the start of the big Paris Air Show. On Monday, UTC is scheduled to make a presentation at the show at 2:30 a.m. East Coast time. There are rumors that the company will disclose the loss of a customer for its new GTF jet engine.

That’s pure speculation. And it’s still too early to say that Raytheon Technologies will never take off. The strategic rationale is sound. The financial benefits may become clearer in time.

“I don’t see the negatives” for shareholders, said Jim Corridore, an analyst at CFRA Research. “There is very little to complain about in this deal.”

I argued yesterday that the combined company, with headquarters in the Boston area and no plans for significant layoffs, is good news for Raytheon and Massachusetts.

But is it also good news for Raytheon and UTC shareholders? The companies have some serious selling to do.

As of March 31, almost a quarter of UTC’s shares and 21 percent of Raytheon’s were in the hands of three shareholders: funds managed by State Street Corp., Vanguard Group, and BlackRock.

At least Kennedy and Hayes know who to call first.

Larry Edelman can be reached at larry.edelman@globe.com. Follow him on Twitter @GlobeNewsEd.