Lockheed to Acquire Northrop in $11.6-Billion Defense Deal

WASHINGTON â€”  In a colossal deal that will leave just three major arms makers in America, Lockheed Martin Corp. announced Thursday that it will pay $11.6 billion for Northrop Grumman Corp., among the most innovative and colorful firms in aerospace history.

The resulting corporation, retaining the Lockheed Martin name and its suburban Washington headquarters, would have estimated revenues of $37 billion a year and nearly 230,000 employees--keeping it far ahead in the defense arena of its two key rivals, Boeing Co. and Raytheon Corp.

Lockheed and Northrop executives lauded the deal, telling securities analysts the historic merger would cut costs by $1 billion annually and make the firm a more efficient international competitor.

But those savings also are expected to trigger job losses in the thousands, though officials of both companies declined to discuss the issue in detail. The Northrop headquarters in Century City, where 475 employees work, is expected to close, the last of four headquarters for prime defense contractors in Southern California.

Northrop shares rocketed $21.125 to $110 in trading on the New York Stock Exchange on Thursday, while Lockheed Martin dropped $4.875 to $99.125. If the deal finally closes as expected later this year, Lockheed would pay about $125 per share in stock for Northrop shares.

The acquisition stunned Wall Street, which was still trying to assimilate the recent flurry of mergers that have included Boeing buying McDonnell Douglas and Raytheon buying Hughes Aircraft. The deal was a well-guarded secret until it was unveiled early Thursday morning before stock trading began.

As a result of the blockbuster deal, Lockheed Martin will be the biggest supplier to militaries around the world and will have thousands of products to offer, including cargo planes, jet fighters, bombers, missiles, satellites, computers and radar systems, among much else. By the time the deal closes, a Lockheed spacecraft will have landed on Mars.

“The merger makes sense for all our constituents: our customers, our employees and shareholders,� Northrop Chairman Kent Kresa said. “We had been planning on a future as an independent company, but there was another alternative--to do this merger--and it was good strategically. So we changed paths.�

Although critics immediately launched an attack on the deal for its anti-competitive effects, some industry experts said the deal was crucial for Northrop and Lockheed.

The recent acquisitions by Raytheon and Boeing have made Lockheed the lesser competitor in both aircraft and electronics markets. Lockheed’s dominance of space, combat jets and launch systems was quickly challenged, sending shivers through the company and pushing it toward the costly deal with Northrop.

For Northrop, the company’s long effort to remain independent had reached the end of the road, after the company failed to make its own acquisitions that would launch it into the big leagues.

“Northrop Grumman was the unfinished business of the industry,� said Robert Paulson, chief executive of Aerostar Capital, an investment firm. “It was too small to be big and too big to be small. This had to happen some time.�

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The merger must go through a lengthy government antitrust review and despite the increased industry concentration that will result, securities analysts expect approval. Risk arbitrage investors gave the deal a high probability of success in trading Thursday.

“On a business-by-business comparison, it’s hard to see how the regulators are going to throw this out,� said Byron Callan, an analyst at Merrill Lynch & Co.

But Callan added that the deal “is going to kick off a much wider debate about the consequences of consolidation,� namely that such huge firms could squelch “the pace of innovation in this market.�

Indeed, Michael Kennedy, a defense industry expert at the Rand Corp., said Thursday that the major technology breakthroughs in defense have been made for decades by fringe companies with little to lose and everything to gain.

“We have gone to a system where there are no fringe producers,� Kennedy said.

PaineWebber analyst Jack Modzelewski lamented, “Is there any competition left any more? Size equals savings--that’s the premise.�

The frenzy of consolidation in the defense industry has exceeded all the expectations of experts and investors in recent years. “Nobody expected this,� said Lawrence Korb, a defense expert at the Brookings Institution. “Everybody expected that we would get down to five or six companies.�

The trend toward ever greater concentration reflects both a further deterioration in the outlook for Pentagon spending and the Clinton administration’s relatively generous policy of reimbursing defense companies for consolidation costs, experts say.

“The path for future defense spending is going to continue on the downward path,� said aerospace analyst Wolfgang Demisch of BT Securities. “It is safer for these companies to be ahead of the curve than behind it.�

Demisch said that much of the 100 million square feet of idle factory space in the defense industry remains, despite the already substantial and painful cutbacks, particularly in California.

As the last captain of Northrop, a company distinguished over the last five decades for its often revolutionary design efforts, Kresa said the decline of the Southern California aerospace industry was inevitable.

“It is unfortunate, but the marketplace just dried up in a way that the amount of research and technology is substantially less,� he said. “And that was the real draw to Southern California, this tremendously rich technology base. That is not being funded.

“As the Pentagon stopped funding breakthrough technology, the main emphasis became production and that migrated to lower-cost states,� Kresa said. “So it is inevitable.�

Northrop, founded by aviation pioneer Jack Northrop, became known for making innovative and gutsy investments throughout its history. The company developed the first flying wing aircraft that lacked a conventional fuselage in the 1940s, the first guided cruise missile in the 1960s, and the first floating ball gyroscope for missile guidance in the 1970s. It pioneered stealth technology to the chagrin of bigger players in the late 1970s. It helped develop the concept of lifting bodies, which use their fuselages to provide lift. It produced the Volkswagen Beetle of jet fighters, the low-cost F-5 series of planes that were sold to poor countries around the world and remain in wide use.

But the company could never quite move to the front ranks of the industry. It was hobbled in part by foreign payment scandals in the 1970s and ‘80s, as well as a series of high-profile problems involving the MX missile. The closest to the top it came was its success in winning the B-2 bomber program in 1981 and its near victory in the advanced technology fighter program in the mid-1980s.

The merger will make Lockheed a powerhouse in the Southern California economy. Lockheed already has 27,000 of its 180,000 employees in California, more jobs than any other state. Meanwhile, Northrop has 15,500 of its 46,500 employees in California, also the most of any state. The combined company will have 42,500 employees in California.

Lockheed President Vance Coffman said that the company expects to increase employment over the long run and that the company is generally growing, but he allowed that there will be “overlap� that will probably cause job losses.

Separately, Lockheed officials told securities analysts that they will cut $1 billion in costs, which translates to anywhere from 5,000 to 10,000 jobs cut. When Lockheed and Martin merged, the company cut 12,000 jobs and closed 12 plants.

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The genesis of the deal came within the last several months, but activity stepped up when Kresa received a call from Lockheed Chairman Norman Augustine on a Sunday two weeks ago.

Exactly what Augustine, who is due to retire Aug. 1, said is not clear, but the call was made after the deals by Boeing and Raytheon threatened to eclipse Lockheed. The deal was quickly formulated from that point.

Northrop management is expected to get rich in the deal, with Kresa getting up to $50 million, according to Wall Street estimates. Kresa, who will become vice chairman of Lockheed after the deal, said he did not know specific figures.

Under terms of the deal, Northrop shareholders will receive 1.1923 shares of Lockheed common stock for each share of Northrop Grumman stock, meaning the value of the deal will depend on the value of Lockheed stock later this year.

After seven years of consolidation, the big players in defense are often a jumble of parts, in which they are rivals on some programs and partners on others. In some cases, prime contractors are fighting themselves.

Northrop’s long fight to sell more B-2 bombers, for example, will be inherited by Lockheed, which had long told the Pentagon to buy more of its F-22 fighters instead.

“People will ask, was it right to permit these mergers?� said former Northrop Chairman Thomas V. Jones, who remains one of the largest individual shareholders in the company. “The measure will be whether these managers of vast resources in the defense industry can establish policies that will support their products fairly and be true to each of their customers.�

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Major Aerospace Mergers

Lockheed Martin’s announcement Thursday that it plans to buy rival Northrop Grumman for $11.6 billion caps four years of aerospace industry consolidation.

Here are the major deals of the 1990s that will leave the United States with just three major players, including Boeing Co. and Raytheon Co.:

* March 1993: Lockheed buys General Dynamics’ military aircraft business for $1.5 billion.

* April 1993: Martin Marietta acquires aerospace business of General Electric for $3.05 billion.

* April 1994: Northrop acquires Grumman for $2.17 billion.

* March 1995: Lockheed completes $10-billion acquisition of Martin Marietta, creating Lockheed Martin.

* May 1995: Raytheon buys defense electronics maker E-Systems for $2.3 billion.

* March 1996: Northrop Grumman buys Westinghouse Electric Corp.’s defense and electronics systems business in a deal worth $3.5 billion.

* April 1996: Lockheed Martin buys Loral for $9 billion.

* December 1996: Boeing completes $3.2-billion purchase of Rockwell International’s defense and aerospace business.

* December 1996: Boeing announces planned $14-billion acquisition of McDonnell Douglas.

* January 1997: Raytheon announces plan to buy defense systems and electronics unit of Texas Instruments for $2.95 billion.

* January 1997: Raytheon says it will buy Hughes defense electronics business from General Motors for $9.5 billion.

* July 1997: Lockheed Martin announces plans to buy Northrop Grumman for $11.6 billion.

Source: Reuters