Defense cutbacks spur industry mergers

August 31, 1994|By David Conn | David Conn,Sun Staff Writer

The leaders of the nation's largest defense contractors were called to a White House dinner in 1992 and given a stark message: the post-Cold War defense cutbacks would only continue, and the industry would do best to weed out its weakest members.

But perhaps even the administration couldn't have predicted the frenzy that would follow. In the past few years, the United States has seen an unprecedented level of consolidation in its defense industry -- 177,000 job losses since 1991 have resulted from a dizzying number of spinoffs, mergers, hostile bidding wars and improbably large new combinations.

Yesterday came the largest merger to date: a proposed $10 billion deal between Lockheed Corp., of Calabasas, Calif., and Martin Marietta Corp., which is based in Bethesda.

The company will be the nation's largest defense contractor and the second biggest aerospace company, behind Boeing Co., most of whose business is in commercial aircraft.

This continuing consolidation of the defense industry has been inspired primarily by the severe defense budget cutbacks.

But several other factors have contributed, including a lack of strong antitrust objections by the government; the Pentagon's willingness to help defray some of the restructuring costs of mergers; and the challenging complexity of today's defense systems.

"These are Darwinian times in our industry," Martin Marietta's chairman and chief executive officer, Norman R. Augustine, said yesterday.

The first stage of the industry's evolution was sparked by nondefense companies such as General Electric Co. and Ford Motor Co., which have divested themselves of their defense divisions. An example was Martin's $3.05 billion purchase last year of the GE Aerospace Division, in Valley Forge, Pa.

Next came the acquisition of smaller players who lacked the scale to survive, including LTV Corp., whose divisions were divided among Loral Corp. and Northrop Grumman Corp.

In April, after Martin allowed Northrop Corp. to win a bidding war over Grumman Corp. -- and apparently soon after Martin started TC talking with Lockheed -- Mr. Augustine described the coming third stage: the very biggest survivors get even bigger. The driving force for these moves, analysts agreed, is the Pentagon's procurement budget, which defense contractors rely on the most. It has dropped 67 percent since its peak during the buildup under President Reagan; it fell to $43.5 billion in fiscal 1995 from $130 billion a decade earlier, measured in constant 1985 dollars.

And analysts expect the trimming and consolidating to continue.

"Certainly this is a part of a process that's been going on for about three years now," said Richard Bitzinger, defense industry analyst at the Defense Budget Project, a nonprofit think tank in Washington.

"And really, frankly, it's market-driven, the market being the defense budget, and specifically the procurement spending" in the Department of Defense.

Government help

Along with applying economic pressure to the industry, the government has eased the way for consolidations by agreeing, at least in theory, to pay for some of the restructuring costs if companies can prove the mergers will save the government money.

Mr. Augustine was one of the first to take advantage of that offer last year. He asked the Defense Department for $350 million to offset Martin's costs related to two acquisitions: the GE Aerospace division, and General Dynamics Corp.'s Space Systems Division in San Diego.

The efficiencies from the mergers will save the government up to $2 billion in coming years, Mr. Augustine told a House committee in July. He added that Martin would not have made those purchases without the prospect of government assistance,

Congress has reluctantly gone along with those payments. Just this month a House-Senate conference committee killed a House amendment that challenged the payments, and the bill is expected to pass Congress. No payments have been made yet, a Pentagon spokesman said.

But the touted savings -- and the requested government reimbursements -- from the Lockheed merger could be even larger.

"This merger in particular I think is really going to pressure that system," said Terry Nyhous, a senior manager in the federal budget policy group of Price Waterhouse, a consulting firm in Washington.

Encouraging signals

At the same time, the Justice Department and the Federal Trade Commission have sent encouraging signals to defense contractors, Mr. Nyhous maintained.

"They're saying, 'Look, it makes sense for them to downsize,' " he said. "It gets rid of excess capacity, makes them more efficient, keeps unit costs down, [and is] more efficient for the government."

Unlike some of the other large defense mergers, the Lockheed-Martin deal probably won't raise many eyebrows in the antitrust community, Mr. Nyhous added. That's because the two companies have few areas of overlap. The most prominent is the manufacture of military satellites. But TRW Inc. still provides competition in that business.

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