Giant merger now in doubt Lockheed, Northrop battling the Pentagon and antitrust lawsuit

Cohen denies signaling halt

Analysts predict fight will deter other firms from consolidating

Defense industry

March 25, 1998|By Greg Schneider | Greg Schneider,SUN STAFF

Defense experts are increasingly pessimistic that Lockheed Martin Corp. can pull off its purchase of Northrop Grumman Corp., and worry that the government's antitrust complaints will bring the industry's restructuring to a premature close.

In announcing Monday that the Pentagon supports the Justice Department's suit to block the $11 billion transaction, Defense Secretary William S. Cohen insisted that he was not sending a signal to other companies to stop consolidating.

But observers say the government's dramatic warnings about the evils of size and vertical integration -- which means a company's ability to be its own supplier -- will make the whole industry leery of another anticipated round of mergers and acquisitions.

"It makes the final moves [of consolidation] more difficult than they would have been," said analyst Roger Threlfall of J. P. Morgan Securities.

About $100 billion in mergers have taken place since the Pentagon warned executives in 1993 that post-Cold War government spending would not sustain the military industrial base, according to Stuart McCutchan of the Defense Mergers & Acquisitions newsletter.

The process has created a new landscape with three gigantic corporate leaders -- Lockheed Martin, Boeing Co. and Raytheon Corp. -- but has left a herd of small subcontractors jockeying for position in the background.

The next phase of the restructuring was supposed to consist of the big companies shedding parts and the little companies feeding on those scraps and each other.

"From a certain perspective, the real critical consolidation has yet to occur: the mid-tier, second-tier consolidation," said Renee Gentry, industry analyst for the Teal Group consulting firm.

If the government's hard line on the Lockheed Martin-Northrop Grumman deal spooks the smaller companies, Threlfall said, it could be akin to a medical patient abandoning his antibiotic a few days before the prescription runs out. The "infection" -- in this case, the need to make industrial capacity equal demand -- could still linger.

The consequences of that could not only lead to inefficiencies in the industry, but could open the door for foreign companies to catch up to the United States in defense technology, Gentry said. Europe, especially, is trying hard to consolidate its military suppliers to match the efficiencies of U.S. companies.

Lockheed Martin has told the Pentagon that it is saving $3 billion a year by melding about 20 former companies into one corporation. Adding Northrop Grumman to the mix would add another $1 billion in annual savings, the companies say.

But Cohen said the government took those figures into account and still opposes the merger.

The companies have vowed to fight the government's lawsuit and will file a response within 20 days. At the same time, sources say Lockheed Martin remains open to negotiating outside court.

Given such an apparently intractable Pentagon position, though, observers now say the outlook is grim.

"We think there is a very low probability of success from this point on," Threlfall said.

Gentry pointed out that for Lockheed Martin, "every dollar they have to spend to fight for this merger lessens the attractiveness of the deal. And the nastier it gets with the Pentagon does not help them in future [contract] competitions, either."

One industry expert speculated that Lockheed Martin is the victim of two forces: the Justice Department's determination to signal corporate giants such as Microsoft that it is not intimidated by size, and Cohen's determination to make his mark on the defense landscape.

Being a political victim is uncharted ground for Lockheed Martin. Company Chairman Norman R. Augustine, who will retire this summer. He set the pace for the industry's restructuring and enjoyed a warm relationship with the past several White House administrations.

"Norm Augustine was probably the most respected man in the defense industry, and this [Northrop Grumman deal] was his swan song. I'm so surprised that the company got blindsided on something like this," McCutchan said.

"The only thing I can think," he added, "is that the Justice Department has set out to very publicly slam the brakes on the [consolidation] process. They've certainly done it. No matter what happens with this deal, it'll be the last one in terms of mega-mergers."

Pub Date: 3/25/98

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