United Technologies is a better buy than Raytheon, this investor says

Regulators are still poring over the details but the merger between Raytheon (Raytheon Stock Quote, Chart, News NYSE:RTN) and United Technologies (United Technologies Stock Quote, Chart, News NYSE:UTX)) is likely to go ahead, according to Christopher Blumas of GlobeInvest Capital, who argues that in the meantime, of the two companies, UTX is the better stock to own.

Defence contractor Raytheon and aerospace company United Technologies announced their merger plans in early June, with the boards from each company agreeing to a $121-billion tie-up that would add another big conglomerate to the already consolidated aviation and defence sectors.

As of 2019, the combined entity would have sales of about $74 billion, making it second only to Boeing in terms of US defence contractors.

That piling up of power has been the talk of the town this summer as investors wait for news from the US Department of Defence and the Department of Justice, both currently scrutinizing the deal for potential antitrust issues. News broke in late August from the Pentagon’s undersecretary for acquisition and sustainment, Ellen Lord, who said that while the potential merger is still under review she nonetheless felt that there are “no major concerns that I know of right now.”

But with a deal still likely months away, investors have been left wondering where the chips will fall, eventually. Blumas says that both companies are solid investments but favours United Technologies over the near term.

“I do like Raytheon, I do like the merger and I really like United Technologies,” said Blumas, vice-president and portfolio manager for GlobeInvest Capital Management, who spoke to BNN Bloomberg on Tuesday.

“Our preference has been to be on the United Technologies side because I think that more value will be created through the merger, the continued acquisition plan and then the spinning off of those non-core assets,” he says. “For Raytheon, if the deal falls apart, there’s a lot more downside than upside, so my preference would be just to not play there and to get on the side where more value can get created over the longer term.”

The market’s reaction to the planned merger has been mixed. Both RTN and UTX took an initial hit on the announcement in early June but have traded up and down over ensuing weeks. United Technologies is now up 29 per cent year-to-date, while Raytheon is up 31 per cent. Both stocks have gained a little over ten per cent since the late-August report from the Pentagon.

Blumas says with the latest uptick in share prices, there’s likely little upside left until a decision on the merger is reached.

“There’s only so far that this one can run,” Blumas says. “With their merger arrangement, there’s going to be a kind of cap in terms of how high the share price can go. This thing would trade in a fairly narrow band because it’s merger arbitrage players who are betting on whether or not the deal will go through.”

“I think that this is a deal that has a really high probability of getting completed,” he says. “Why you might want to pick the Raytheon side as opposed to United Technologies is that it might be a little more of a value bump. If you bought it and held it, what you’re left with is a company with a much better competitive position long-term with a really good balance sheet that’s capable of doing further deals.”