United Technologies issued an 8-K today disclosing it is taking an ~$870m pretax charge in 4Q15. This is because it negotiated the end of a royalty payment agreement between Pratt & Whitney Canada and the Canadian and Québec Governments. P&WC will make four annual payments to fully settle P&WC’s contractual obligations. These four payments, which include previously accrued amounts, will total C$1,309 million (approximately US$965 million).
UTC has been negotiating with the Canadian government agencies to effectively “buy” their way out of the royalty agreement. In exchange for R&D and other support from Canada, P&WC was obliged to pay a royalty on its engine programs. This is probably similar to what Airbus has done with EU sources of support. It is also probably what Bombardier is doing even more now. Airbus’ A320 and A330 programs were a roaring success for its state backers.
UTC obviously believes a deal is better value if bought now. This means UTC (and P&WC) are growing ever more confident in their engine programs looking into the future. Moreover, it allows an offset on the gain from the Sikorsky sale. Canada gets accelerated cash over the next four years, which any government likes before its next election. And UTC gets to book higher profits on P&WC’s engine programs into the future.
It is important to understand this is not about the GTF. It is about P&WC’s engine programs. UTC sees their Canadian subsidiary as being very successful looking forward. We believe that P&WC will continue to develop and make investments in its facilities, supported by a solid supply-chain network and strong collaboration with various universities across the country.
Clearly UTC is privy to the P&WC pipeline in a way that Canada is not. This is a big signal of confidence in P&WC by its parent. If UTC wanted to merely offset some of the Sikorsky gain, there could have been other avenues. But UTC selected P&WC.