Defense Deal Will Pose an Early Test for Biden Administration -- Heard on the Street
December 23 2020 - 08:23AM
Dow Jones News
By Jon Sindreu
The trend toward concentration in the U.S. defense industry
remains unstoppable -- except, potentially, by the incoming Biden
administration.
Shares in Aerojet Rocketdyne surged this week after the maker of
the rocket engines that took people to the moon in 1969 agreed to a
$4.4 billion takeover by Lockheed Martin, the world's largest
military contractor by sales. Aerojet has been seen as a target
ever since its only direct competitor, Orbital ATK, was bought by
Northrop Grumman in 2018.
The Biden administration will need to decide whether to
greenlight yet another defense deal, after the megamerger of
Raytheon and United Technologies last year.
In the early 1990s there were dozens of major players in the
industry; now there are just a handful. Yet military budgets will
likely stop growing, and the Pentagon needs to retire the remnants
of Cold War defense technology to keep pace with China and Russia.
It may benefit from larger contractors that can bid more
aggressively on risky contracts. Thanks to its purchase of Orbital,
Northrop became the sole bidder for the government's new $85
billion intercontinental ballistic system.
The latest deal would be more a case of vertical integration
than elimination of the competition. Aerojet already gets more than
a third of its revenue from Lockheed by, for example, powering the
Atlas space rockets. Aerojet's chief business is supplying rocket
motors for missiles, including the hypersonic weapons that are now
a Pentagon priority.
But securing the antitrust green light may not be as simple as
many analysts believe. Aerojet also services many of Lockheed's
competitors, especially Raytheon. They may well raise a challenge,
alleging potential price discrimination. The Federal Trade
Commission forced Northrop to "firewall" its solid-rocket motors
operation after buying Orbital.
In the past, officials have disallowed such acquisitions. In
1998, under the Clinton administration, the Department of Defense
blocked Lockheed's plans to buy Northrop for $8.3 billion, a deal
that would have vertically integrated electronics production. And
U.S. regulators recently updated 1984 guidelines on vertical
mergers to make them stricter.
It isn't clear-cut what Washington should prefer. Military
contractors have fattened their profit margins in recent years, but
research suggests this isn't because they raised prices. With
Lockheed and Aerojet, the paradox is that preventing closer
integration on competition grounds could also reduce scale benefits
that the government itself might enjoy.
In any case, the initial gains from integration don't seem
large: Lockheed expects savings from synergies to be less than 5%
of Aerojet's future sales. Its investors may question whether it is
worth paying a 33% premium over the target's share price last
Friday, a price implying an enterprise value of as much as 15 times
2021 earnings forecasts. Most peers trade for under 12.
To be sure, it is an affordable purchase for a company with a
$97 billion market capitalization. It also may expand Lockheed's
capabilities in the new space economy, where it faces competition
from Elon Musk's SpaceX and Jeff Bezos's Blue Origin.
President-elect Joe Biden has suggested he will be less
sympathetic to industry concentration, but it remains to be seen
whether this applies to defense. Many media reports have speculated
that the deputy defense secretary post could be filled by Frank
Kendall, who publicly opposed the Justice Department's decision to
allow Lockheed's purchase of helicopter maker Sikorsky in 2015.
There is at least a chance that the cops will end a decadeslong
merger party.
Write to Jon Sindreu at jon.sindreu@wsj.com
(END) Dow Jones Newswires
December 23, 2020 08:08 ET (13:08 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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