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Defense Mergers, Buyouts Loom


This week may come to be seen as the beginning of a new wave of consolidation and cost-cutting in the defense industry, one whose effects may be felt for decades.

Lockheed Martin announced the coming departure of some 600 executives, 25 percent of its leadership team. And rumors surfaced that Boeing might buy Northrop Grumman.

The last major wave of mergers was set off by a now legendary event known as the defense "last supper." This is how Lockheed's former CEO and chairman of the board Norm Augustine described it in a piece he wrote in 2006 for Defense News:

"The invitation received by about 15 defense industry chief executives in 1993 to drop by the Pentagon for dinner was signed by Defense Secretary Les Aspin. It was, as the saying goes, an invitation one simply couldn’t refuse. The events that took place that evening forever changed the character of the U.S. defense industry."

Deputy Defense Secretary Bill Perry made a grim presentation to the CEOs. What resulted? As Augustine put it: "General Electric Aerospace merged with Martin Marietta, which combined with Lockheed. McDonnell Douglas joined Boeing. Grumman joined Northrop. When the dust had cleared, there were only a few firms left standing." Augustine believes that consolidation was the only way to reduce overhead and maintain a healthy industrial base, though he regrets the huge numbers of people who were let go.

The Boeing-Northrop rumor surfaced at a conference on defense companies put on by Reuters. As my colleague Andrea Shalal-Esa reported, the head of Boeing's defense business, Dennis Muilenburg, said he was “not going to rule out or rule in any options." He said defense budget pressures do, "at times lead to potential consolidation."

Northrop Grumman was offered by some at the conference as a likely target for Boeing, especially given its substantial amount of work on the Joint Strike Fighter program, which Boeing lost out on. But Northrop CEO Wes Bush told the Reuters event he "would not forecast on the near-term horizon any large-scale activities."

Today, enter Loren Thompson, the defense consultant and analyst at the Lexington Institute. Loren speculates about the possible course of a Boeing-Northrop merger, and maybe of a Boeing-BAE merger.

BAE would "saddle the Chicago-based company with numerous activities unrelated to its current product lines. Northrop, on the other hand, would be a much cleaner fit -- especially once it dispenses with its under-performing shipbuilding business, as management currently plans."

Before we go any further, a finance expert who closely follows such issues told me this morning that any Boeing-Northrop blending was unlikely. While the Pentagon might not try to stop it, it would, as Thompson notes, "inevitably would raise antitrust concerns. For instance, federal regulators would be unlikely to approve a combination of the two companies' space operations without major divestitures that undermine the business logic of the transaction."

Instead of a merger, Thompson writes that breaking Northrop into salable pieces would probably yield higher prices and “make it easier to minimize antitrust objections."

Boeing, which has not fared well in its defense businesses recently, could gain substantially by buying Northrop because of the F-35. "Its aerospace unit is the principal teammate to prime contractor Lockheed Martin on the airframe, with lead responsibility for the center fuselage and weapons bay. Its electronics unit builds the plane's radar and in partnership with Lockheed is building the plane's electro-optical sensors. Its information unit provides the software and systems engineering for the F-35 mission planning system. And the array of technical services Northrop Grumman provides for the joint fighter is worth many billions of dollars just in the next decade, not to mention when the plane is fully fielded," Thompson writes.

But Boeing has not shown an ability to manage its defense side with much aplomb, or profits. If it has had so much trouble digesting McDonnell-Douglas why would it do much better at digesting another large defense enterprise? Still, this week's action by Lockheed and the merger discussions make it clear defense industry change is afoot. A reminder: Ash Carter, current undersecretary of defense for acquisition, technology and logistics, attended the "last supper" so he is keenly aware of the circumstances then and now. And we have not yet heard talk about a Pentagon eager to see consolidation.

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