WASHINGTON — United Technologies will spend the next several months weighing whether to divest its Sikorsky unit, in what analysts say is a reflection of shrinking profit margins across the defense sector.
Sikorsky is "just not quite as attractive as the rest of the businesses," Hayes said, noting the subsidiary's role "as a platform provider, as opposed to a system provider, differentiates Sikorsky from the rest of the portfolio."
Hayes called the decision "not an easy one," but said it was "the right one for Sikorsky's customers, for Sikorsky's employees, and for our shareholders."
"If the military business outlook was as strong as some people make it out to be, you wouldn't be seeing these sorts of decisions," Callan said. "You wouldn't see Exelis being sold to Harris, ATK merging with Orbital.
"It's also a strong signal that to stay in this business may require more investment, and certainly further cost reduction, and some companies will make that decision and some will make the decision to just get out," he added.
Anita Antenucci, senior managing director at Houlihan Lokey, said the spinoff of defense firms is a subtle trend that is part of the larger wave of mergers and acquisitions that experts have been waiting for. She said it's an option more viable now than the 1990s, when the public was less likely to support small, independent defense firms on the market.
Steve Grundman, principal of Grundman Advisory and Lund Fellow at the Atlantic Council, sees another potential trend, one that could have negative consequences for the defense industry.
"While it's not yet the rule, UTC's announcement appears to repeat a template of multi-industrials exiting or curtailing their exposure to defense," Grundman said. "It's a playbook for the industry as a whole that I would regard as a regressive, unwelcome trend — the retreat from the defense market of multi-industrials — because I regard the participation of strong multi-industrial companies in the defense sector as improving its stability and propensity to innovate."
Mike Blades, an analyst with Frost & Sullivan, said it is smart for big conglomerates to begin limiting their role in the defense sector.
"Those large companies will never get out of that business, but spreading that risk will be a big concern for how they run their business from now on," Blades said.
US tax law says that the sale of a company results in a gain tax; a spinoff does not need to pay that tax. But there is a wrinkle: If the spinoff is bought by another company within a two-year period, the burden of proof is on the original company to prove this wasn't a tax avoidance scheme. After two years, the burden shifts to the IRS to prove anything is amiss.
Because of how long Sikorsky has been owned by UTC, the tax bill for a sale would be huge, likely negating the possibility of another firm buying Sikorsky from UTC in the short term.
That's not a major issue for the rotorcraft unit. The analysts all agreed a stand-alone Sikorsky would be able to survive, and Hayes pledged not to cripple Sikorsky with debt if it was spun off, saying, "we want to make sure they will be a successful, stand-alone company."
The picture remains blurry about potential buyers after the two-year period has passed. While Sikorsky has a huge portfolio, it is not one that matches up well with another rotorcraft company.
According to a Teal Group analysis, military rotorcraft saw a 7.9 percent compound annual growth rate between 2004 and 2013, with an unheard of 66 percent jump from 2008-2012. That unsustainable growth has slowed and is projected to continue to decline, while the commercial market is on an upswing.
"All the other stuff UTC does is going to be demanded and needed, not just on the military but also on the commercial side," he added. "Their CEO is charged with growth, and while Sikorsky may have steady sales, it won't show huge growth."
Teal's Richard Aboulafia doubts Sikorsky would be absorbed by one of its rivals in the rotorcraft market, for both financial and political reasons.
"I don't think anyone has the stomach for a European firm buying Sikorsky," Aboulafia said. "Textron just doesn't have the cash to do this, so it won't be Bell Helicopter. As for Boeing, someone would kill that merger — it could be DoJ or DoD, but there would be so many knives out that there's no way."
Callan agreed that another helicopter company may not be a fit, but noted that future buyers could come from a non-rotorcraft company that sees synergies with what Sikorsky does. Antenucci, however, disagrees.
"Synergies with another helicopter company would always be much greater than with a non-helicopter company," she noted. "The helicopter industry is still a segment of defense that is less consolidated than other platform businesses, in part because the conglomerates that own some of them were not looking to add to their individual helicopter units — UTC would never go buy another helicopter company when Sikorsky has a lower return on sales than their other businesses."
"You may not want to announce something now and then find out the budget coughs up a different set of answers than expected and you have to change plans," Callan said, noting that "helicopters got whacked" in previous budget discussions.
For now, the Pentagon is staying out of it. Frank Kendall, the top acquisition official at DoD, told reporters last week he was keeping an eye on the situation.
"At this point, based on what I know about that deal, I'm neutral about it," Kendall said. "It should not impact us as far as cost or rates are concerned, I think. I'd be interested in knowing the answer to that question…. I've just got to make sure it doesn't affect our prices very much."
Joe Gould in Washington contributed to this story.
Aaron Mehta was deputy editor and senior Pentagon correspondent for Defense News, covering policy, strategy and acquisition at the highest levels of the Defense Department and its international partners.