Lockheed Martin Corp. executives are deciding what they can sacrifice to get the government to bless their $11 billion purchase of Northrop Grumman, but there is one place they draw the line: They want to keep Northrop Grumman's Linthicum division.
Unfortunately, that facility -- the Electronic Sensors & Systems Division, or ESSD -- was also the primary target of government antitrust investigators who told Lockheed Martin last week that they see major problems with the combination of companies.
The regulators fear that the resulting corporation would have too much dominance in areas of military electronics.
"One option was we would just outright reject the proposal; another was to have them divest the electronics part of it," said a government official. "Now the ball's in their court."
That second option was not much better than the first; electronics compose some $4 billion of the acquisition.
To hang onto the most crucial portion -- ESSD -- Bethesda-based Lockheed Martin is now considering divesting a number of smaller units not only of Northrop Grumman, but also of Lockheed Martin itself, sources say.
Those include the Northrop Grumman electronic warfare operation in Rolling Meadows, Ill.; the portion of Northrop Grumman's Melbourne, Fla., division that works on the Joint STARS battlefield surveillance plane; and even parts of the Sanders unit of Lockheed Martin in Nashua, N.H.
Sanders is a highly regarded electronics business that employs 4,700 workers.
That Lockheed Martin apparently would consider parting with some portion of Sanders is a sign of how much the company covets ESSD.
But such a concession may not be enough to satisfy the government, in part because the antitrust complaints are coming from an unusual source.
The Pentagon, which buys more goods from Lockheed Martin than from any other weapons maker, appears to have turned tail on the giant corporation it helped create.
"They're changing the rules of the game right in the fourth quarter of play," said Ahmed M. Metwalli, a Lockheed Martin senior vice president.
Much has been written about the government's new get-tough approach to corporate consolidation, but experts say the Justice Department and the Federal Trade Commission have long been skeptical of massive mergers in the defense industry.
It was always the Pentagon's enthusiasm that helped the deals sail through.
Prodded by Defense Department warnings in the early 1990s that post-Cold War military spending would no longer sustain the industrial base, Lockheed Martin Chairman Norman R. Augustine led a wave of change by assembling his giant company from more than 20 separate entities.
Now, new Defense Department leadership appears to be drawing a line on mergers and consolidation, setting a precedent with ramifications no one yet understands.
"This has implications far greater than this simple merger, implications throughout the defense industry," said Brett Lambert of DFI International. A new Pentagon hard line would affect the way all companies organize themselves as the era of mergers settles out, he said.
Lockheed Martin last July announced plans to buy its former rival a deal that involves a stock swap valued at more than $8 billion and the assumption of about $3.3 billion in Northrop Grumman debt.
Military and Justice Department officials told company executives on March 6 of a profound skepticism about the deal's impact on overall competition in the industry.
Analysts and insiders had been prepared for the government to demand up to about $500 million in divestitures, but the requests went much further.
"We had the fear there would not be enough competition," said a government official. "Theoretically, I'm sure they can probably come back with another proposal and the discussions will continue. We stressed there's no time line on our part."
The regulators told the companies that they had considered seeking more modest divestitures, along the $500 million-or-less line, but found that unsatisfactory.
Sources said the regulators might settle for about $1.7 billion in divestitures. But even that would probably kill the deal from Lockheed Martin's point of view -- not because of the dollar amount, but because it represents major electronics portions of the company.
One of Lockheed Martin's biggest motivations in making the offer for Northrop Grumman was to position itself in the field of military electronics, which is considered the top growth sector of the defense industry.
Northrop Grumman builds the B-2 bomber and a sizable portion of the Boeing Co.'s F/A-18 E/F Super Hornet Navy fighter plane. It also has a big business making commercial airplane parts for Boeing.
But the company recognized some years ago that the future lies in electronics, and its purchase in 1996 of the former Westinghouse operation in Linthicum cemented its position as a major force in the field.