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Aerospace Bulks Up · Bloomberg Intelligence

0:05
Speaker 1: Welcome to the Bloomberg P and L Podcast. I'm Pim Fox.
0:08
Speaker 1: Along with my co host Lisa Abramowitz. Each day we
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Speaker 1: bring you the most important, noteworthy, and useful interviews for
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Speaker 1: or the trading floor. Find the Bloomberg P M L
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Speaker 1: Podcast on Apple Podcasts, SoundCloud, and Bloomberg dot com. Well,
0:32
Speaker 1: there's a setup for us talking about United Technology and
0:35
Speaker 1: its acquisition of Rockwell Collins twenty three billion dollars the
0:39
Speaker 1: price tag. Joining us now Doug Rothacker. He is our
0:42
Speaker 1: Bloomberg intelligence expert when it comes to all things aerospace
0:46
Speaker 1: and defense. Uh, Doug, thanks very much for being with me.
0:50
Speaker 1: Maybe you could just explain what this is going to do,
0:53
Speaker 1: first of all, to the industry and the two largest customers,
0:56
Speaker 1: Boeing and Airbus. Yes, good morning, thanks for having me.
1:00
Speaker 1: So the first thing is that this creates the world's
1:02
Speaker 1: largest aerospace supplier, you know, forty billion dollar portfolio stretching
1:07
Speaker 1: basically the inside and outside of the aircraft kind of
1:10
Speaker 1: knows to tail engines, avionics, interiors, communications, etcetera. So that
1:16
Speaker 1: obviously helps in protective pricing and competitive pressures. You know,
1:19
Speaker 1: both among tiers and with Bowing and Airbus. And then
1:23
Speaker 1: the other point I would make is that you know,
1:25
Speaker 1: we've seen supplier consolidation pick up steam here over the
1:28
Speaker 1: past year, and I suspect this trend obviously not to
1:31
Speaker 1: this size you up and down the supply chain will
1:33
Speaker 1: will continue. The supplanting suppling is really getting squeezed by
1:37
Speaker 1: Bowing and Airbus from a pricing standpoint. So obviously this
1:40
Speaker 1: is a way that they can u combat those challenges
1:42
Speaker 1: with greater scale. Doug, maybe just give us a little
1:45
Speaker 1: insight into how the industry works. Is it possible for
1:48
Speaker 1: a company like United Technologies, let's say, post merger, uh
1:52
Speaker 1: post acquisition with Rockwell Collins, to be able to go
1:55
Speaker 1: to Boeing and say, look, you know you want to
1:57
Speaker 1: buy these this Avionyx pack edge and you want to
2:00
Speaker 1: buy this seat upgrade package. We've got the b E
2:04
Speaker 1: Aerospace or what was formally b Aerospace in the portfolio.
2:08
Speaker 1: Oh and by the way, we'd like to sell you
2:10
Speaker 1: our geared turbo fan engines. Will give you, you know,
2:14
Speaker 1: a discount if you take all three. Right. So I
2:17
Speaker 1: would say not only to Bowing Airbus, but also to
2:19
Speaker 1: the customers. Remember they the UH the one key factor
2:24
Speaker 1: with the b Airspace acquisition is the large exposure to
2:27
Speaker 1: direct consumer you know, the airline UH customers, So they
2:30
Speaker 1: can go right to airline customers with better pricing, you know,
2:34
Speaker 1: given this greater scale, UH And obviously you know there,
2:38
Speaker 1: you would expect them to be able to do the
2:40
Speaker 1: same directly to bowing an airbus. So I think you,
2:42
Speaker 1: I think you hit the nail on the head, all right.
2:44
Speaker 1: So having said that, maybe just lead us now into
2:47
Speaker 1: what this does have specifically to United Technologies, because does
2:51
Speaker 1: it really need to be a conglomerate that has an
2:57
Speaker 1: h v A C systems business us A an otis
3:02
Speaker 1: elevator and escalator business, Right, So I think that will
3:05
Speaker 1: be the biggest question on investor's mind over the next
3:07
Speaker 1: year as this plays out. They expect to close the
3:09
Speaker 1: deal by the third quarter of two as an eighteen.
3:12
Speaker 1: And it was a pretty pointed comment they had in
3:14
Speaker 1: the press release announcing the deal that after the close
3:16
Speaker 1: of the of the acquisition they're going to pursue any
3:19
Speaker 1: and all strategic uh, you know, opportunities for United Technologies.
3:24
Speaker 1: And I think that was a clear uh discussion or
3:27
Speaker 1: a point to the potential for a breakup. Uh you know,
3:30
Speaker 1: they've talked consistently about how they feel their shares are
3:34
Speaker 1: you know, under appreciated if you will, in the marketplace
3:37
Speaker 1: and undervalue, and so obviously being able to split the
3:40
Speaker 1: companies up where you have larger multiples for the industrial
3:44
Speaker 1: uh peers is obviously a way to be able to
3:46
Speaker 1: do that. So I think in the near term that's
3:48
Speaker 1: kind of on the back burner until they uh you know,
3:51
Speaker 1: a focus over the next year is going to be
3:52
Speaker 1: paying down a lot of the debt that they're taking
3:54
Speaker 1: on uh to finance this deal. Um. But I think
3:58
Speaker 1: when you get into mid end late next year that
4:00
Speaker 1: that will be really a focus among the investment community
4:03
Speaker 1: of what, you know, what this company looks like over
4:06
Speaker 1: the next few years. And I suspect the possibility or
4:10
Speaker 1: the probability, I should say, of them breaking up is
4:12
Speaker 1: greater than not at this point, Doug, I beg your
4:14
Speaker 1: pardon just to just to remind me again which is
4:17
Speaker 1: the higher margin business and which demands the higher multiple. Sure,
4:21
Speaker 1: so they have otis elevator business and h fact business,
4:24
Speaker 1: and both of those uh peers in those industries command
4:27
Speaker 1: greater multiples than than what you would see in the
4:30
Speaker 1: aerospace business. So would that embolden management to split off
4:35
Speaker 1: that business because they wanted what reward shareholders for having
4:40
Speaker 1: held those companies in the portfolio beg your pardon, no problem.
4:45
Speaker 1: They would just want to essentially unlocked the value that's
4:47
Speaker 1: basically tied tied down if you will, right now by
4:50
Speaker 1: being they're essentially gonna be overweight aerospace businesses by about
4:53
Speaker 1: six percent. Now, So if you think about the multiple
4:56
Speaker 1: that could be extracted or or seeing what you know,
5:00
Speaker 1: high cash flow business and high margin businesses that you
5:03
Speaker 1: have with the elevator and HVACT businesses um either with
5:07
Speaker 1: a strategic barger excuse me, strategic buyer or in the
5:10
Speaker 1: public space, uh, you know, would likely be more than
5:13
Speaker 1: what they would realize as a conglomerate. Right. Yeah. The
5:15
Speaker 1: shares of UT actually United Technologies are down about three
5:19
Speaker 1: and three quarters of a percent. Shares of Rockwall Collins
5:21
Speaker 1: up three quarters of a percent. Rockwell Collins earlier in
5:25
Speaker 1: the year, I believe it was April, they closed on
5:27
Speaker 1: that deal to buy b E Aerospace. So we're gonna
5:29
Speaker 1: see even more consolidation. Who's left, Yeah, I think big
5:33
Speaker 1: deals like this, there's really not many left. But I
5:36
Speaker 1: would say, you know, up and down the supply chain
5:38
Speaker 1: that there will be a considered effort to grain to
5:41
Speaker 1: gain greater scale. Spirit Aero Systems, although they've kind of
5:44
Speaker 1: walked a little bit back on the discussion. You know,
5:46
Speaker 1: Spirit air Systems as Boeing's largest supplier, and up until
5:50
Speaker 1: recently they even said that they were looking for possible
5:53
Speaker 1: acquisitions in this space. So uh, you know, again, deals
5:57
Speaker 1: of this size probably are likely, but I would suspect
6:01
Speaker 1: that you would see uh, situations occur um for the
6:05
Speaker 1: supply chain to be able to gain greater scale and
6:08
Speaker 1: you know, fight the Bowing and airbus price and pressure
6:11
Speaker 1: and after market pressure that they're seeing. Doug, just to
6:13
Speaker 1: give you about thirty seconds or so, I know that
6:16
Speaker 1: everybody's got a huge backlog for aircraft and we're predicting,
6:20
Speaker 1: you know, we're gonna add lots of new airplanes, quieter, faster,
6:23
Speaker 1: all that. This is a cyclical business, isn't it. It is.
6:28
Speaker 1: We're ten years into the airspace cycle right now, and
6:30
Speaker 1: you kind of wonder about the legs that are left.
6:32
Speaker 1: I think, based on Bowing and airbus production rates, you know,
6:34
Speaker 1: we see a few more years of increased production, particularly
6:38
Speaker 1: with the narrow bodies, but we've seen wide body production
6:40
Speaker 1: come down, particularly with the transition to the Bowing Triple
6:45
Speaker 1: seven as they work into their their Triple seven X program. Um.
6:49
Speaker 1: You know, Airbus A Brady production is being cut. Um,
6:52
Speaker 1: So there's concerns in the wide body production rates and
6:55
Speaker 1: you know about the legs if you will, of this
6:58
Speaker 1: aerospace cycle. We gotta leave it there at Thanks very much,
7:00
Speaker 1: Doug Rothor. He is our Bloomberg intelligence expert when it
7:03
Speaker 1: comes to all things aerospace and defense. Now we're scheduled
7:20
Speaker 1: to talk to Tom Hanlon. He is the global investment
7:22
Speaker 1: strategist that has sent private capital management at US Bank
7:25
Speaker 1: and he joins us from Minneapolis. Tom, thank you for
7:28
Speaker 1: being with us. Maybe you could just start off by
7:31
Speaker 1: I thought this was an interesting point that you made
7:33
Speaker 1: that the U. S consumer appears indifferent to whatever the
7:37
Speaker 1: volatility is, whether it is US politics or geopolitics. American
7:43
Speaker 1: consumers are just going on their merry way. Where do
7:45
Speaker 1: you what does that amply? Well, good morning, Tom, and
7:49
Speaker 1: uh yeah, and it's not just the US consumers, it's
7:52
Speaker 1: consumers worldwide. But you know, you look at the data,
7:55
Speaker 1: and consumers keep on consuming and manufacturers keep on manufacturing,
7:59
Speaker 1: no matter the headline is, whether it's domestic politics or geopolitics.
8:03
Speaker 1: And uh um yeah, yeah. I mean you look at
8:06
Speaker 1: the market action today. Um, you know, we're down a
8:08
Speaker 1: little on the SMP, but more on the financials um
8:11
Speaker 1: than the broad markets. That tells us that the action
8:14
Speaker 1: is less to do with with North koreanda was over
8:17
Speaker 1: the weekend and more to do about people's perceptions of
8:19
Speaker 1: the FED. So where do you come down? I mean,
8:21
Speaker 1: do you buy this notion that the consumer is going
8:24
Speaker 1: to continue to spend and that manufacturing companies that continue
8:29
Speaker 1: to make things regardless of what goes on in Washington
8:33
Speaker 1: or another political capitals. Yeah. I mean if you look
8:36
Speaker 1: at the just the underlying trends of just the broad
8:38
Speaker 1: economy or or labor market or uh you know globally
8:43
Speaker 1: not just in the United States but elsewhere. Um, it's
8:46
Speaker 1: it's fairly sanguine. I mean, it's not aggressive to the
8:48
Speaker 1: point where central banks are going to tighten aggressively. It's
8:51
Speaker 1: not so a weak that that you're getting concerned about
8:54
Speaker 1: the consumer. And you know, the synchronized recovery gets set
8:58
Speaker 1: a lot, but it's more like a lack of dispersion
9:02
Speaker 1: in growth rates around the world. So everybody is low,
9:04
Speaker 1: everybody's slow, but positive and and that's a pretty decent
9:08
Speaker 1: back drop for kind of all participants. Okay, So if
9:11
Speaker 1: that's the backdrop and that's the position, are you and
9:14
Speaker 1: all in bull we have written, we have been and
9:18
Speaker 1: remain um pro risk in terms of client portfolios. We
9:22
Speaker 1: we still tilt towards equities relative to fixed income on
9:26
Speaker 1: our primary uh places where we look to invest are
9:30
Speaker 1: still United States, Europe, in Japan where we still have
9:32
Speaker 1: the highest confidence about the economics fundamentals. Have you taken
9:36
Speaker 1: any profits lately? No, we haven't. We haven't many material
9:40
Speaker 1: changes to our to our outlook on I think our
9:44
Speaker 1: diligence and vigilance of risks is probably uh increased based
9:48
Speaker 1: on the political landscape and and also domestic politics. UM,
9:52
Speaker 1: but we still we still remain um kind of on
9:54
Speaker 1: our trajectory of the narrative that we have, which is
9:58
Speaker 1: pro growth and progres sense. So does that mean that
10:01
Speaker 1: you're focusing on technology stocks? What specific industry groups can
10:05
Speaker 1: you share with us? The NASDAK is up more than
10:08
Speaker 1: this year. Yeah, I mean, we're still mostly broad market
10:12
Speaker 1: participants on you know, anything that that benefits from a
10:16
Speaker 1: low inflation um uh a fed's accommodative policy. So that's
10:21
Speaker 1: that's still good for free domestic us consumption. And because
10:24
Speaker 1: the global growth backdrop um U s exporters are still
10:28
Speaker 1: a good place to be as well, because then I
10:29
Speaker 1: never seen that in the manufacturing data. Well, tell us
10:32
Speaker 1: about your view on the dollar, because that has been
10:35
Speaker 1: weakening after a run of strength earlier in the year.
10:40
Speaker 1: If the dollar continues to weaken or you're going to
10:42
Speaker 1: see increased commodity prices, but that will be offset by
10:45
Speaker 1: increased sales overseas. I think that's probably a fair assessment. Um.
10:50
Speaker 1: You know another uh sort of backdrop of of a
10:54
Speaker 1: week or dollar that also tends to be good for
10:57
Speaker 1: UM four markets on you know, it's a good construct
11:01
Speaker 1: for emerging market equities to have a dollar sound more
11:04
Speaker 1: of a weakening trend and a than a strengthening trend.
11:07
Speaker 1: And and uh, you know the dollar and you may
11:09
Speaker 1: see it the act today coming out to Labor Day
11:11
Speaker 1: weekend with the news, um it's actually weaker rather than
11:13
Speaker 1: stronger today and the end's not really acting um terrely
11:18
Speaker 1: volpal today, So again it tells us that's more about
11:20
Speaker 1: the Fed and people trying to price in whether there's
11:23
Speaker 1: a rate hike between now and your end than anything else. Well,
11:26
Speaker 1: do you believe that there will be a rate hike
11:27
Speaker 1: by the Federal Reserve this year? Our base case has
11:30
Speaker 1: been that we were likely to see one before the
11:32
Speaker 1: end of the year. UM, And we just continue to
11:35
Speaker 1: monitor that and obviously got a lot of speakers this
11:38
Speaker 1: week from the Fair Reserve as well to watch for it.
11:41
Speaker 1: But you haven't seen this wage growth in the United States?
11:44
Speaker 1: Does that temper your enthusiasm? Yeah, it's really been stubborn.
11:49
Speaker 1: And it's not just the US phenomena. It's it's global
11:51
Speaker 1: and it there's probably um, it's probably bifurcated in different industries.
11:56
Speaker 1: You probably get wage growth in some industries where we
11:58
Speaker 1: have u not a lot of supply a labor, and
12:02
Speaker 1: then you know it's offset again in the areas where
12:05
Speaker 1: you've got kind of surplus of labor, so it kind
12:07
Speaker 1: of comes out in little wage growth. We still think
12:10
Speaker 1: that we're going to see that. We still think that
12:12
Speaker 1: that in general, UM, with positive economic conditions and positive consumption,
12:17
Speaker 1: that that wage growth will come all right. I want
12:19
Speaker 1: to thank you for for joining us, Thanks for giving
12:22
Speaker 1: us your thoughts. You're you're a bull? Can we say
12:24
Speaker 1: that you're a bull? But with caution? Does that make sense?
12:30
Speaker 1: That makes all right? Good, We'll leave it there. Thanks
12:33
Speaker 1: very much. Tom Handling, he is the global investment strategist
12:36
Speaker 1: at Ascent Private Capital Management at a US bank. Joining
12:40
Speaker 1: us from Minneapolis. Well, in addition to immigration or another
12:56
Speaker 1: topic that has drawn the attention of lawmakers as well
13:00
Speaker 1: as the administration, of course, is North Korea. Joining me
13:04
Speaker 1: now is Dr Robert Pape. He is the author and
13:06
Speaker 1: a professor of political science at the University of Chicago,
13:10
Speaker 1: and he is the director of Chicago Project on Security
13:14
Speaker 1: and Terrorism. Dr Pape, thanks very much for being with us.
13:18
Speaker 1: You've written that the economic sanctions will not work with
13:23
Speaker 1: North Korea. Tell us a little bit about your reasoning. Um,
13:27
Speaker 1: China is not going to enforce the tight sanctions that
13:32
Speaker 1: would really bite. And the reason is because China does
13:37
Speaker 1: not want the North Korean regime to collapse. If the
13:41
Speaker 1: North regian North Korean regime collapses, there's a very good
13:46
Speaker 1: chance that US and South Korean troops would rush right
13:49
Speaker 1: into North Korea, possibly up to the border with China.
13:53
Speaker 1: That's exactly the scenario that led China to intervene in
13:58
Speaker 1: the Korean War in the nineteen fifties. This is a
14:01
Speaker 1: vital national security interest to China, and so bullying China
14:06
Speaker 1: threatening to cut off trade with China, this is not
14:09
Speaker 1: going to work, um and so we really need to
14:13
Speaker 1: look for an alternative track because at the moment, Trump's
14:17
Speaker 1: strategy of coercive diplomacy is backfiring. So what is the
14:21
Speaker 1: alternative track? In your opinion, the alternative track is to
14:26
Speaker 1: build on the cooperation among the six parties that worked
14:31
Speaker 1: in the second part of the Bush administration. The best
14:34
Speaker 1: we've gotten, the most we've frozen the North Korean regime's
14:39
Speaker 1: nuclear program was from two thousand and six to two
14:43
Speaker 1: thousand and nine when the Bush administration. This is no
14:46
Speaker 1: wimpy administration, UH engaged in six party talks which actually
14:52
Speaker 1: had quite a bit of effect all the way through
14:54
Speaker 1: the end of Bush's presidency. This is something we need
14:58
Speaker 1: to restart, and in fact we can involve. We could
15:02
Speaker 1: evolve our current policy of pushing forward tough stenctions into
15:06
Speaker 1: a common economic policy on North Korea, common among China, Russia,
15:14
Speaker 1: the United States, South Korea, Japan. This would create a
15:19
Speaker 1: real alliance against North Korea that would have some bite
15:24
Speaker 1: over time. Well, how likely is that given the current
15:27
Speaker 1: administration and the rhetoric that you've heard, not only from
15:30
Speaker 1: the President but also from the Secretary of Defense. Well,
15:34
Speaker 1: I think what you've seen over the last month is
15:36
Speaker 1: actually the administration, Um, speaking of two minds. When you
15:41
Speaker 1: hear Secretary Tillerson and you hear Secretary Mathis, they really
15:44
Speaker 1: are moving more in the direction of deterrence, containment, working
15:49
Speaker 1: with allies. Um. I'm afraid President Trump's rhetoric has not
15:54
Speaker 1: been particularly helpful. And in fact, in the last two weeks, Um,
15:58
Speaker 1: what we've seen is the North Korean have increased their
16:01
Speaker 1: threat to the United States. It's still far, it's still
16:04
Speaker 1: not you know, it's not today. Um. But nonetheless, we
16:07
Speaker 1: need an alternative track, and I believe that Secretary Tilorson
16:11
Speaker 1: and Maddis actually um uh would are are seeking such
16:15
Speaker 1: a track. Are they finding any willing partners? Well, Um,
16:20
Speaker 1: what we see is that with North ko with North Korea, noticed,
16:24
Speaker 1: the partners are pretty obvious their China, their Russia, their Japan,
16:29
Speaker 1: and their South Korea, UM Secretary Tilerson, that's where he
16:33
Speaker 1: has been. He has been with our partners, working with them.
16:37
Speaker 1: So UH. The the what has really become quite clear
16:41
Speaker 1: now is that the current strategy of heavy handed coercive
16:46
Speaker 1: diplomacy is simply backfiring. UH. This continuing a failing strategy
16:51
Speaker 1: is only likely to cause South Korea and Japan to
16:55
Speaker 1: lose confidence in US leadership, which could create more instability
16:59
Speaker 1: in the region. So the alternative is to work with
17:04
Speaker 1: South Korea, Japan, China again toward a common economic policy
17:10
Speaker 1: on North Korea. Well, I'm sure it's not lost on
17:14
Speaker 1: either the Chinese leadership or indeed the Russian President Vladimir
17:18
Speaker 1: Putin that nuclear weapons, while aimed in a specific direction,
17:24
Speaker 1: you don't necessarily have complete control over such such weaponry.
17:30
Speaker 1: And China and Russia are awfully close to North Korea.
17:33
Speaker 1: Are they not concerned about any fallout from any potential
17:37
Speaker 1: military activity that would hurt them? I think they are. UM.
17:41
Speaker 1: In two thousand, UM twelve and thirteen, I was involved
17:44
Speaker 1: in some talks in Beijing UH at the People's Liberation
17:49
Speaker 1: Army National Defense University where they were openly and explicitly
17:54
Speaker 1: concerned about North Korea's uh nuclear program, and for very
18:00
Speaker 1: much the reasons you suggest, which is um it is
18:04
Speaker 1: um um. North Korea's nuclear weapons don't pose simply a
18:08
Speaker 1: threat to the United States. They pose a threat to
18:11
Speaker 1: all of those parties UM. And in fact, the fragility
18:14
Speaker 1: of the North Korean regime. If if the North Korean
18:16
Speaker 1: regime were to collapse, you have a loose nukes problem,
18:19
Speaker 1: which is going to scare everybody in Beijing as well
18:23
Speaker 1: as in uh, Tokyo or Soul. So you have a
18:26
Speaker 1: situation where the six parties here really have a tremendous
18:31
Speaker 1: amount in common. Uh. They are ready are talking with
18:35
Speaker 1: each other. Um. And what we I think would be
18:38
Speaker 1: very helpful would be to evolve the current set of
18:41
Speaker 1: discussions away from essentially a failed strategy toward a more
18:46
Speaker 1: productive outcome that we could see over the next two
18:50
Speaker 1: or three years. Really um providing stability among the key
18:55
Speaker 1: allies that we need if we're ever going to get
18:58
Speaker 1: a grip on the North Korean problem. Thank you for
19:00
Speaker 1: joining us. Dr Robert Pape is the author and professor
19:04
Speaker 1: political science at the University of Chicago and director of
19:08
Speaker 1: the Chicago Project on Security and Terrorism. Thanks for listening
19:14
Speaker 1: to the Bloomberg P and L podcast. You can subscribe
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Speaker 1: at pim Fox. I'm on Twitter at Lisa Abramo. It's
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