The Weekly Wire: For Your Situational Awareness 6.14.19

 In Weekly Wire
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Raytheon and UTC to Merge and Become Raytheon Technologies

Hamilton Cook, Research Associate

United Technologies and Raytheon have agreed to an all-stock merger that would create a $74 billion aerospace and defense giant. The combined company, Raytheon Technologies, would join two of the largest systems manufacturers to create the scale necessary to counter increased supplier pressure from customers such as Boeing and increase internal R&D to remain competitive against industry peers and deter in-sourcing. The company would also be better prepared for a possible cyclical decline in defense budgets as well as a potential slowdown in the commercial aerospace market.

Raytheon Technologies would consist of four units. Raytheon’s four existing units would be consolidated down to two: Intelligence, Space, & Airborne Systems, and Integrated Defense & Missile Systems. Collins Aerospace, the newly formed combination of Rockwell Collins and UTC Aerospace Systems, would form the third business of the company, focusing on avionics, communications, navigation, aerostructures, and other aircraft components. UTC’s Pratt & Whitney engine division would remain a separate division. There is minimal product overlap between the two companies, which will likely help streamline the deal.

However, there are still several potential obstacles for the deal to go through by the first half of 2020. First, the deal will need to pass an anti-trust review in the US with the Department of Justice running the process supported by the Department of Defense’s Industrial Policy Office. The most significant overlap between the two companies’ portfolios is in airborne radio systems, the ARC-210 and ARC-231, but also would include potential overlap within the two companies’ significant EO/IR portfolios. Concerns might also be raised that the consolidation of a missile component supplier (UTC) with the world’s largest missile manufacturer (Raytheon) may negatively impact the wider industrial base. But such concerns may be dealt with via divestments and/or bespoke industrial base agreements with the Pentagon. Such agreements would likely be similar to those required of Northrop Grumman after its acquisition of Orbital ATK, where the Federal Trade Commission mandated that, as the sole-source provider of solid rocket engines, Orbital had to completely firewall its teams supporting that portion of the Northrop and Boeing bids.

Second, the merger requires regulatory approval from nine countries outside of the US. Due to burgeoning trade wars, it is possible that the deal will face increased scrutiny from international regulators. Although European regulatory authorities may closely assess the competitive impacts from the deal, management has highlighted that China approval, which held up the United Technologies-Rockwell Collins deal, isn’t required for this merger.

Third, activist shareholders are challenging the deal because of concerns over the potential dilution of their UTC shares and the merger seemingly lacks a sound strategic rationale. These investors believe that UTC’s stock is undervalued due to a conglomerate discount and that value will be unlocked through UTC’s planned spinoffs of Carrier and Otis. Additionally, shareholders don’t seem to appreciate Raytheon’s greater exposure to defense markets and there is a view that Raytheon’s agreement to merge with UTC portends falling defense budgets over the mid-term.

New Zealand

On June 11, New Zealand selected the C-130J Super Hercules to replace its aging fleet of C-130H aircraft as part of its Defence Capability Plan worth more than $1 billion. According to the plan, “Preserving the tactical airlift capability of the New Zealand Defence Force is the highest priority.” New Zealand’s C-130H aircraft have been in service since the 1960s and need to be replaced due to rising maintenance costs associated with their growing obsolescence. New Zealand plans to pursue the acquisition of the C-130J from the US using the Foreign Military Sale process. However, a price, quantity and delivery schedule have not yet been determined.

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Turkey

The US is now threatening to remove Turkish suppliers that participate in the F-35 program if Turkey proceeds with the acquisition of the Russian-made S-400 air-and-missile defense (AMD) system. Acting Defense Secretary Patrick Shanahan wrote a letter on June 6 detailing the US’s decision to remove Turkey from the F-35 program should the country receive the Russian system. If Turkey continues to move forward with the S-400, F-35 contracts with Turkish suppliers would be terminated in 2020 alongside the training of Turkish pilots who operate the F-35. Turkey originally signed a contract to purchase 100 F-35As, which leaves the question of what will happen to Turkey’s fighter aircraft if the US cancels the acquisition. According to Defense News, Turkish companies supply 937 parts for the F-35. If those suppliers are removed, F-35 Program Executive Vice Adm. Matt Winter states that between 50-75 F-35s could be delayed over the next couple years. Tension over Turkey’s S-400 acquisition has steadily increased over the last few months, with the US and other NATO allies raising concern about the acquisition of the Russian AMD system being integrated into a NATO military architecture. Should the F-35 purchase fall through for Turkey, it could potentially look towards Russia to fulfill its fighter requirement with the Su-57.

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Brazil

On June 7, Brazil agreed to transfer two Type 209/1400 submarines to the Argentine Navy by the end of the year. The deal was finalized during President Jair Bolsonaro’s first visit to Argentina and includes the potential transfer of two more vessels. The submarines will need to be repaired by Argentina before becoming operational. In addition to the Type 209/1400s, the Brazilian Navy fields one modified Type 209/1450. São Paulo will replace the submarines transferred to Argentina with four Scorpene-type diesel-electric submarines being built by the joint Franco-Brazilian firm ICN. The first delivery is scheduled for 2020, although Avascent Analytics believes it will be delayed several years. The submarines address a capability gap for Argentina after the tragic loss of the ARA San Juan in 2017, which left the service with two aging submarines that were too costly to maintain.

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Japan

On May 28, the Japanese Ministry of Defense’s Acquisition, Logistics, and Technology Agency (ATLA) released a request for information (RFI) that has gone largely unnoticed in the Western defense press. The RFI seeks information for short-range surface-to-air missile systems that can fill air defense roles for the Ground Self Defense Forces (GSDF) and base air defense roles for the Air Self Defense Forces (ASDF). The wording in the RFI suggests that Japan plans to replace its Type 93 Surface-to-Air missile (SAM) operated by the GSDF and the Type 11 Base Defense SAM operated by the ASDF. The Type 93 fulfills very short-range air defense roles, using missiles adapted from a man-portable air defense system. The Type 11 fires a larger missile with slightly longer range. The RFI states that ATLA is interested in product families that can standardize equipment specifications. Avascent Analytics believes that this suggests ATLA could be interested in solutions that can fill both roles, which would cut down on logistics and maintenance costs. The ability to reduce costs is crucial as Japan must meet growing security interests amidst an uncertain economic future. The GSDF also operates its own variant of the Type 11, presenting yet another mission set that could come under standardized equipment. Despite the different missions the Type 93 and Type 11 currently perform, there does appear to be some overlap between the mission sets, enough that a more modern system may now be able to perform both missions.

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