The downside of a United Technologies breakup

Split gives company strategic flexibility, but leaves firms vulnerable to economic cycles

In breaking itself up, United Technologies is trading one set of investment risks for another.

The company, fresh off the $23 billion (U.S.) acquisition of Rockwell Collins, said it plans to split itself into three businesses: Jet engines and flight-control systems, Carrier airconditioning and heating business, and Otis elevators.

Chief Executive Greg Hayes had publicly weighed the potential benefits and drawbacks of a breakup for most of this year. Equity investors had pegged the odds of a breakup above 70%, analysts at Melius Research said in a note last month.

UTC shares sold off as much as 6% Tuesday. One explanation is investors had anticipated the breakup and were selling on the news.

Another is that management made an unconvincing case why the businesses will be better off on their own rather than under the umbrella of a wellrun conglomerate.

Splitting the company has a strategic merit to it: the three component businesses differ significantly in their profitability, capital needs and investment horizons and long-term growth opportunities. In theory each business will have more focused management and a more dedicated shareholder base.

A breakup is also fashionable at the moment, largely because of the disaster at General Electric, which has long been compared with UTC. Other sprawling businesses are doing the same thing: DowDuPont is planning to split itself into three companies, while Honeywell has announced several spinoffs since 2016.

Still, UTC strained a bit to explain the benefits for investors beyond the usual rhetoric about strategic and financial flexibility.

Mr. Hayes offered an example on a conference call with analysts: the Otis elevator business would have chosen to preserve its market share in recent years by lowering prices, instead of opting to preserve its profit margins to benefit the larger UTC. That raises the question of future growth at Otis.

UTC also said that all three companies will have investment-grade balance sheets, and the aggregate dividend payment shareholders receive will remain at least constant.

Otis, with about $12 billion in annual sales, could one day be a buyout target, which should help boost valuations, though Carrier could run into antitrust issues with any big deal.

The decision to break up does come with some drawbacks for investors, however.

Under UTC, the dependence of the Carrier and Otis businesses on the cyclical real-estate markets has been cushioned by the less volatile aerospace operations. For instance, UTC shares sold off sharply, but recovered fairly quickly from China-related weakness in the Otis division back in 2015.

Carrier is also vulnerable to trade disruptions.

Carrier has raised prices several times this year to offset the impact of tariffs on steel and aluminum, Mr. Hayes said in a CNBC interview. Mr. Hayes and UTC have earned the trust of investors to pursue such a bold move, and it is likely that the breakup will succeed in the long term. But the deal will increase the focus on the individual businesses, not always in the most flattering way.

The breakup, which will cost as much as $3 billion, shouldn’t leave investors pining for the good old days of UTC.