What accounts for two multi-industrial companies’ differing views of the attractiveness of similar subsidiaries?
I do not own shares in Sikorsky. None of my friends own shares in Sikorsky. That’s because, since 1929, United Technologies Corporation has in effect owned all the shares in Sikorsky. Indeed, the other four of the world’s five largest helicopter manufacturers are also owned by larger and somewhat diversified companies: Bell by Textron, Eurocopter by Airbus, AgustaWestland by Finmeccanica, and Vertol by Boeing. If I wanted to participate in owning a rotocraft-making enterprise, I could buy into UTC, TXT, EAD, FNC, or BA. I won’t (see below), and as we all know, UTC is now rethinking its participation in that line of business too. A sale or spin-off would then break that uniform pattern of ownership. So what determines the efficient owner of a helicopter maker—or any other company that’s half commercial manufacturer and half defense contractor?
In an editorial this week, Aviation Week & Space Technology asserts that it’s a terrible idea for UTC to sell or spin off Sikorsky. “Bowing to Wall Street,” they call it. It’s also clear in the subtext that my personal lack of enthusiasm for owning UTC is not subject to the same opprobrium. Much of the case is a complaint about the tension between the long-term interests of the company and the plans of a newly-stalled shareholder-focused CEO (Gregory Hayes). That begs several questions. Why wouldn’t shareholders have long-term interests? Are they so infantile that they can’t be expected to look after themselves? If I owned the shares, I’d be insulted. After all, in a tax-free spinoff, the same shareholders will own the same assets—just in two different companies.
More fundamentally, as Lawrence Garfield might remind us to ask, just what are the company’s interests, if not making money for the shareholders? Any company is the instrument of its shareholders, and for very good reason—the shareholders’ interests are residual. After everyone else gets theirs—the customers their helicopters, the employees their remuneration, the suppliers their receivables, the various governments their taxes—and afterwards, the owners get whatever remains. To have that chance at getting theirs, they must have the right to do as they please with the investment. When their agents the managers do well, those owners can do very well for themselves. When their customers in government, who are also effectively their regulators, cap their profits, they can only do so well.
Thus the ostensible issue for UTC: selling jet engines and aircraft parts to other commercial manufacturers brings higher margins. But this recitation of the various stakeholders reminds us that not everyone who’s interested in Sikorsky is interested in the net-net returns to UTC. To start, there is that customer-regulator. While AvWeek extols UTC’s $10 billion investment in Pratt & Whitney’s geared turbofan project, it otherwise laments the industry’s disinterest in independently “funding research in new technologies and products to ensure long-term competitiveness.” Some owner at some point may rationally choose to cut-and-run, but the government may have an even longer-term interest in a continuing supply of up-to-date military helicopters.
Which, admittedly, the government could also get from Bell, Eurocopter, AgustaWestland, or Vertol. So while Sikorsky is a fine company, it is thus not a “national asset”. The French government recently had a similar choice to make. Airbus is planning to divest its stake in Dassault, which it only owns because the French government assigned its shares to partly state-owned Airbus when the company was formed. This time, the generally cash-strapped ministers are not exercising their option to buy, and instead figuring that institutional investors will do a fine job of prodding the board to look after the company.
Indeed, there are limits to government or management’s scope of attention. This past December, I addressed the issue of much more diversified defense contractors, such as Lockheed Martin, Raytheon, and L-3. Whatever the merits of their cases, I noted how Ellen Lord, CEO of Textron Systems, often makes a strong case for how her company—a cousin to Bell—benefits from its association with a “multi-industrial” (don’t say conglomerate) parent. But the example I cited from consultants Jim McTaggart and Ron Langford of CRA Marakon bears repeating:
The management teams of pure plays can typically make much larger decisions much faster since they don’t have to navigate the control systems set up by the much larger diversified companies. Years ago when Duracell was spun out of Kraft, Bob Kidder, Duracell’s CEO at the time, said that the biggest advantage was not having to get capital approvals in excess of $500k from the “cheese people” so that the quality and pace of decision-making improved significantly.
The French may be cheese people, but they decline to be those cheese people. Textron Corporate could be the cheese people, but I’ve never heard anyone at Bell much complain about guidance from Providence. It could be that Textron has better figured out how to leverage the assets and talents of the rest of the family of companies in a way that United Technologies hasn’t—or even can’t, depending on just what those assets and talents are. I might hazard a guess that Gregory Hayes and his staff have made that determination, and after some careful and extended consideration.
In contrast to today’s uniform pattern of ownership, there may not be a single efficient model for who should own and run a defense contractor. That’s not a price theorist’s answer, but an institutionalist’s answer. Defense contractors don’t make cheese; they make much more complicated products. So it’s possible that the gritty institutional details matter in who they are and what they can do. Before we question too vehemently whether Sikorsky should or should not reside in UTC’s portfolio, we might just give present management the benefit of the doubt.
James Hasík is a senior fellow at the Brent Scowcroft Center on International Security. As a rule, he does not directly invest in the defense contractors he analyzes.