NEW YORK (The Deal) -- United Technologies (UTX) surprised no one with its Monday announcement that it plans to sell or spin off its Sikorsky Aircraft helicopter business, but the accompanying guidance for the unit illustrates what a difficult challenge the company has in shopping the business.
Hartford, Conn.-based United Technologies said in March that it was considering options for Sikorsky, a maker of military and commercial helicopters, and added Monday that a final decision whether to sell or spin off the unit would come by the end of the third quarter.
The conglomerate has been looking for ways to spark growth and could invest proceeds from a separation in other areas of its business.
"Our strategic review has confirmed that exiting the helicopter business is the best path forward for United Technologies," Chief Executive Gregory Hayes said in a statement. "Separation of Sikorsky from the portfolio will allow both United Technologies and Sikorsky to better focus on their core businesses."
UNITED TECHNOLOGIES CEO GREGORY HAYES
A potential auction of Sikorsky has attracted the attention of a number of potential bidders, including Airbus, Boeing (BA), Lockheed Martin (LMT), and Textron (TXT).
A sale would likely be better for United Technologies shareholders because a spinoff would likely bring only $1.5 billion to $2 billion in cash upstream to the parent, Cowen analyst Cai von Rumohr wrote in a research note.
But he and other analysts have warned that a sale is complicated by United Technologies' low tax base.
Sikorsky has been a part of United Technologies since the 1920s and carries a near-zero cost basis. Potential suitors must either pay a substantial premium over the business' value to compensate for the added taxes vs. a spinoff or find the way to orchestrate a Reverse Morris Trust, where Sikorsky could be shed tax-free if United Technologies ends up with a majority stake in the new entity.
United Technologies would love to find a cash deal, but it is unclear whether any suitor is willing to pay up to offset the tax implication, aerospace sources say.
That challenge was made harder on Monday when United Technologies trimmed its outlook for Sikorsky for the year due to weakness in the energy markets.
Although commercial sales make up only about one-third of Sikorsky's overall total, those sales are heavily concentrated in the oil and gas markets. Although the weak guidance could lower the overall valuation for Sikorsky and make a cash deal more palatable for potential buyers, the weakness makes it less likely that a buyer would be willing to offer the substantial premium to book that United Technologies seems likely to demand to offset taxes.
Another challenge for potential buyers is that defense contracts are usually structured in such a way that the majority of cost savings go back to the customer instead of staying with the vendor. So a buyer would have to find a way to justify paying a substantial premium without falling back on the synergies that a deal would provide.
Coupled with significant potential antitrust hurdles that most of the interested buyers could face defense sources still believe a spinout is more likely despite the interest that Sikorsky has received from other strategics.