No one was surprised when United Technologies (UTX: $110/share) announced its takeover of Rockwell Collins (COL) last week. After all, a deal between the two companies had been rumored for months. By the time the official news came out, there had been plenty of time for the market to evaluate a potential merger.

The advanced warning of this merger made the market’s reaction all the more striking. UTX dropped 6% the day the deal was announced as investors balked at the $140/share price tag. The market clearly does not believe COL can generate the synergies UTX needs to create value with this acquisition, and looking at the numbers we have to agree.

Simply put, the price UTX will pay for this acquisition – which comes to ~$33 billion when accounting for all forms of debt and unfunded pension liabilities – makes it almost impossible for the deal to create long-term value for shareholders.

COL’s Declining Profitability

Beyond the deal’s valuation, it’s worth looking at the business UTX plans to acquire. A hefty premium may be warranted if COL were a rapidly growing, highly profitable business. However, Figure 1 makes it clear that the opposite is true. COL has seen its return on invested capital (ROIC) declined every year since 2007.

Figure 1: COL ROIC Since 2001

Sources: New Constructs, LLC and company filings.

COL’s declining profitability has gone hand in hand with a rising valuation. Even before the acquisition rumors gained steam, the stock was up nearly 30% over the prior year. UTX did not just pay a significant premium to acquire COL, it paid a premium on top of an already inflated valuation for a company with declining profitability.

Acquisition Price Implies Unrealistic Growth

When we evaluate any acquisition, we want to answer one key question: Can the acquired company generate enough after-tax profit (NOPAT) for the deal to earn a ROIC greater than the acquiring company’s weighted average cost of capital (WACC). Many mergers are “earnings accretive” but don’t meet this basic test of economic value.

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