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United Technologies Corporation (NYSE: UTX) Memo w Click to buy NOW! w m o w c .d k. rd oName:cu-trac Haroon Masood College/School: McIntire School Year: 3 Year

Important Company Financial Data

Price: $80.11 Avg Vol: 4.03M Div. Yield (ttm): 2.70% Market Cap: 73.42B P/E (ttm): 13.85 Return on Equity (ttm): 22.68% 50W Range: 70.71 – 87.50 EPS (ttm): 5.78

Thesis / Key Points  UTX regaining market position in narrow-body aviation market: UTX, through Pratt & Whitney’s new Pure Power geared turbofan engines, is regaining significant market share in the high-growth narrow-body commercial aerospace sector. The geared turbofan technology is a highly advanced engine architecture patented by Pratt and Whitney. Geared turbofan engines are more appealing to airlines than any other commercially viable aircraft technology because they significantly improve fuel-efficiency, reduce engine noise and decrease engine emissions. In the narrow-body aerospace market, the geared turbofan has achieved widespread success even before its official launch. Through over 3,700 hours and 11,000 cycles of testing, the engine technology has outperformed its competitor, the Leap-X from GE and Snecma in all material categories. Perhaps, the strongest quality of Pratt & Whitney’s geared turbofan technology is its long-term improvement potential. While traditional turbofan technologies are reaching their performance limits due to architecture constraints, the geared turbofan technology is only touching the surface of its capabilities. This reality is illustrated through GE and Snecma’s eventual downward adjustment for the fuel- burn improvement expectations of the Leap-X engine from 16% to 15% and Pratt & Whitney’s upward readjustment of fuel-burn improvement from 13% to 16% for the engines they agreed to produce for Airbus’ latest narrow-body aircraft, the A320neo. In a short time, Pratt & Whitney has secured close to 33% market share as per order book size in the narrow-body market. Once airlines see the engine in real-life operating scenarios, they will have little reason to select competitor engines.  UTX can regain market share in wide-body market with scaled geared-turbofan technology: UTX intends to regain its dominant position in the wide-body market by producing a scaled version of its geared turbofan engine in the narrow body market for the wide-body market. This engine, which is called the PW1095G, will be used by Pratt & Whitney to bid for the upcoming Boeing 777x, which will be released in 2019. Pratt & Whitney will bid aggressively for this contract because it knows that its engine is technologically superior to the engines of its competitors. In fact, my calculations indicate that each PW1095G engine is worth close to $5.0 million more than the engines of competitors based on fuel costs savings alone. This is equal to 35% of the market rate for engines in the wide-body market today. I think Pratt & Whitney can structure its bid in competitive ways to reduce the perceived risk of its technology. If it wins the bid for the 777X aircraft, it will immediately gain a strong presence in the wide-body aircraft market because competitors do not have a commercially viable engine to compete with the geared turbofan technology.  Cross-firm restructurings offer potential for cost-reduction synergies UTC is undergoing restructuring efforts to unify business units with similar strategic goals and capabilities. The unification of its Carrier and Fire & Security businesses is one example of these restructuring efforts. These firm-wide cost-savings will not only unlock value for the firm in the short-term, but also prepare UTC for a post-recession period of economic growth. Many of its business should experience robust growth in coming years as economic activity in emerging economies picks up.

Misperception  Decline of Defense Business: The U.S. Department of Defense (DoD) announced that it would cut spending by approximately $500 billion dollars over the next 10 years. According to Deloittes’ 2011 Defense and Aerospace Outlook, this means that the DoD will cut defense spending by approximately $24 billion to $50 billion each year over the same period. The market worries that the impending U.S. defense budget cuts will materially impact UTX because it receives 20% of its revenues from the defense sector. I built a regression model to test this assertion. My regression model indicated that 96% of the variation in Change V -X ie F w e D r P

United Technologies Corporation (NYSE: UTX) Memo w Click to buy NOW! w m o w c .d k. UTX’s defense revenues could be explained by variation in actual U.S. defense spending. It also revealed, ocu-trac however, that defense budget cuts would immaterially impact UTX because they would only suppress annual UTX revenues by $0.4 billion to $0.8 billion, which is close to 0.7% to 1.4% of 2011 UTX revenues.  Uncertainty about UTX’s future in commercial aviation: The market perceives that UTX will become irrelevant in the high-growth commercial aerospace market because of the strong hold that GE and Rolls Royce have had in this market over the past few decades. I believe that UTX has a great opportunity to reposition itself in the commercial aerospace as a stronger player with its highly advanced geared turbofan technology. The engine has been received well in the narrow-body market and will be a huge success in other markets due to its technological superiority over engines from competitors.

VAR  Michael Ryan (Rolls-Royce Financial Analyst) stated at a presentation to our class that the PW1095G, the engine Pratt and Whitney proposed for the Boeing 777X has the potential to be highly attractive because its superior fuel efficiency will benefit Boeing greatly. Naturally, superior fuel efficiency offers Boeing the ability to produce an aircraft that offers lower fuel costs to airlines, thus strengthening Boeing’s competitive position. More importantly though, it reduces the weight of fuel per aircraft, thus offering airlines the ability to either carry more cargo, carry more passengers or travel further distances.  Dean Roberts (Rolls-Royce Director) stated that he anticipates Pratt and Whitney to aggressively approach the bid for the 777x because a stronger position in the wide-body market is critical to the company’s strategy

How It Plays Out I view UTX as a company that offers shareholders an advantageous asymmetric risk-return profile. It is a stable, dividend paying company that has the potential to unlock considerable value for shareholders in a 1-2 year time period through its repositioning in the commercial aerospace industry and its cost reduction efforts. To understand the growth opportunity that the commercial aerospace industry provides, consider the following. Air traffic is anticipated to grow by approximately 5% each year over the next 20 years. Thus, total aircraft deliveries are expected to be approximately 34,000 over the same period. If UTX successfully repositions itself in the commercial aerospace market with its new geared turbofan technology and gains even 30% market share, it will gain access to approximately $5.2 billion dollars in additional revenues per year (with a $10 million average engine price). This is approximately 10% of 2011 UTX revenues. Since UTX has a negligible position in the commercial aerospace industry today, a successful repositioning of the wide-body market is thus, bound to drive up the stock price.

Risks / What Signs Would Indicate We Are Wrong?  Geared turbofan technology faces technological problems upon market entrance: Since UTX has been outside of the commercial aerospace engine market for a long period of time, it will be very difficult for the company to re-enter the market if its geared turbofan technology experiences technical difficulties.  Restructuring efforts fail: UTX’s restructuring efforts are needed if the company wants to capitalize on economic growth. We should watch out for a failure to produce synergies through restructurings.

Signposts / Follow-Up Company Description  Official launch of geared turbofan [NYSE: UTX] offers products and services for the global technology in narrow-body market building systems and aerospace industries. UTC consists of  Boeing’s engine selection for its 777x 6 smaller companies: Pratt & Whitney, Otis, Sikorsky, UTC aircraft Aerospace Systems, UTC Climate Controls and Security and  Changes in cost base due to restructuring UTC power. Through these companies, UTC offers products efforts 1 year down the line ranging from air conditioners to aircraft engines to elevators to power plants. As of 2011, UTC’s highest revenue grossing businesses were Pratt & Whitney, a leading airplane engine manufacturer; Otis, a leading provider of elevators and escalators and Carrier, the world’s largest air conditioner manufacturer. Change V -X ie F w e D r P

United Technologies Corporation (NYSE: UTX) Memo w Click to buy NOW! w m w o . (Page .ofc Exhibit/s) do ck cu-tra Exhibit 1: PW1095G Incremental Value From Cost Savings

Exhibit 2: Regression Model Results

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United Technologies Corporation (NYSE: UTX) Memo w Click to buy NOW! w m o w c .d k. ocu-trac

Exhibit 3: Boeing Commercial Aircraft Delivery Estimates

http://www.boeing.com/commercial/cmo/pdf/Boeing_Current_Market_Outlook_2012.pdf