by Jim Surowiecki
And then there were three. With the
3 announcement of LOCKHEED MARTIN's (NYSE: LMT) proposed $11 billion
acquisition of fellow defense contractor NORTHROP GRUMMAN (NYSE: NOC),
the Pentagon may very well find itself in a situation where it only ever
does aerospace business with three companies: BOEING (NYSE: BA), which
is in the process of merging with McDONNELL DOUGLAS (NYSE: MD);
RAYTHEON (NYSE: RTN), which is putting the final touches on the
acquisition of the defense operations of HUGHES ELECTRONICS (NYSE: GMH) and just closed the acquisition of the defense unit of TEXAS
INSTRUMENTS (NYSE: TXN); and the new, improved Lockheed Martin. If officials
at the Justice Department and the Federal Trade Commission were concerned
about the absence of competition in the industry before, one can only imagine
what they're thinking now.
Nonetheless, early indications are that the Lockheed-Northrop deal will
ultimately be approved, although it seems likely that regulators may demand
that the companies divest themselves of certain sections in which their
businesses overlap. Raytheon, for example, was ordered to sell an important
chip-making operation in order to gain Justice Department approval for its
acquisition of TI's defense unit. And Northrop CEO Ken Kresa has already
acknowledged that the new company may have to sell its electronic countermeasures
-- radar jammers, warning devices, etc. -- business in order to satisfy antitrust
concerns. Lockheed-Northrop will have a dominant position in the defense
Certainly investors seem confident that the deal will go through. After the
agreement was announced, Northrop shares rose $21 to $110, up 24%. Lockheed,
on the other hand, saw its stock drop nearly five points to $99 1/8. The
deal was structured as a straight stock swap plus assumption of debt. Northrop
shareholders will receive 1.1923 shares of Lockheed stock for each share
of Northrop. (Lockheed will also assume Northrop's $3.3 billion debt burden.)
Oddly, this means that as Lockheed's share price drops, the deal becomes
worth less to Northrop shareholders, even as Northrop's price rises.
The deal will create one of the world's largest defense manufacturers, and
will culminate a succession of deals by both companies. Lockheed acquired
the military jets division of GENERAL DYNAMICS (NYSE: GD) in 1993,
merged with Martin Marietta in 1995, and then acquired Loral Corp.in 1996.
Northrop, meanwhile, bought LOGICON, INC. (NYSE: LGN)just three months
ago, and acquired the defense unit of WESTINGHOUSE (NYSE: WX)last
year, two years after buying Grumman. The new company will have more than
$37 billion in revenues and more than 230,000 employees.
In many respects, this merger seems as much the product of necessity as of
desire. Northrop Grumman had done its best to remain independent, and the
company had repeatedly expressed its determination not to be bought out.
But Northrop lost out to Raytheon in bids for both Hughes and Texas Instruments,
and the Boeing-McDonnell Douglas merger promised to make Northrop's size
even more of a competitive disadvantage. In addition, its largest single
project, the B-2 Stealth Bomber, has come under intense scrutiny from
Congressional budget-cutters, and it's not clear how many more B-2s the Pentagon
will be ordering.
Some industry watchers thought Lockheed Martin might have been better off
waiting to finish digesting Loral before embarking on yet another high-priced
acquisition. Still, the Northrop deal was one that was next to impossible
to turn down, particularly in light of Boeing's newfound strength. Acquiring
Northrop allows Lockheed to broaden its business, most notably by beefing
up its radar, missile electronics, and aerospace subcontracting operations.
(Northrop actually works on many Boeing and McDonnell Douglas planes.) That
may help cushion the blow if Lockheed were to lose the contract for the Joint
Strike Fighter, a $170 billion project that is the last important defense
contract of the century. Its lone competitor is, of course, Boeing.
While companies would almost always rather buy a competitor than have to
fight, the recent flood of mergers in the defense industry are as much the
product of new economic realities and state policy as they are of a coherent
strategy on the part of the industry giants. Although the U.S. military budget
remains astonishingly large relative to the rest of the world -- we spend
more than four times as much on defense as any other country -- the end of
the Cold War did bring about a dramatic reduction in the amount of money
the Pentagon spent on the procurement of new weapons. By 1995, weapons spending
had dropped to levels not seen since the Korean War, levels some 60% below
those of the Reagan years.
The Pentagon had always encouraged defense companies to merge in order to
eliminate overlap and the unnecessary duplication of efforts, but the reality
of a much smaller procurement budget led the Defense Department to be more
explicit about its attitude toward mergers. At a meeting in 1993, William
Perry, who was then Deputy Secretary of Defense, told a group of defense
industry executives that unless they joined with competitors, some of them
would be driven out of business. While the Pentagon is almost the definitive
captive market, it is a market that has shrunk considerably -- at least for
contractors -- over the last five years.
The most notable changes include the decline in the number of different weapons
systems the U.S. military uses and the growing standardization of U.S. jets.
Over the next three decades, the Pentagon has said it will buy just three
new fighter aircraft. One of those is the F-18A, built by McDonnell Douglas.
One of them is the Air Force's new F-22, which Lockheed builds. And the third
is the Joint Strike Fighter. By contrast, between 1950 and 1980, the Pentagon
bought more than twenty different jets. It's not that the military has fewer
planes. But it has fewer kinds of planes. And that means that there are fewer
small contracts, the kind that can keep a company like Northrop or Martin
Marietta in business, available.
Were the Pentagon to recommend, then, that the Lockheed-Northrop merger be
rejected because of antitrust concerns, it would represent a startling turnabout
in policy. While the Defense Department presumably wants some measure of
competition in the bidding for its contracts, a desire that will keep Boeing
and Lockheed Martin from merging, it clearly does not feel the need to deal
with the 26 different aircraft companies it dealt with at the end of World
War II. And while some have raised concerns about possible technological
stagnation as a result of the reduction of the number of contractors, there's
actually very little evidence to suggest that smaller companies are necessarily
more technologically innovative. The persistently tenuous nature of military
contracts -- which are subject to cancellation if policy changes -- means
that even the largest companies have an incentive to deliver technologically
At the same time, the Lockheed-Northrop deal fits into a pattern of recent
mergers -- including Boeing/MD and British Telecom/MCI -- that have passed
antitrust scrutiny because they have a greater impact on the global market
than on the domestic market. While Lockheed Martin does most of its business
at home, it's already aggressively lobbying to win contracts in Eastern Europe
where it has a plethora of European competitors. Up to this point, antitrust
regulators have seemed more interested in ensuring that there are strong
American players in the global marketplace than in ensuring there are many
different American companies. By that standard, this new merger qualifies.
In any case, while the antitrust laws remain crucial instruments to prevent
the concentration of corporate power in areas that are essential either to
democracy -- like the press -- or to consumer freedom, it's not clear what
interest would be served by blocking a deal like Lockheed-Northrop, other
than a general bias against bigness. The U.S. government, after all, is the
only consumer in its market, and as such it has much more leverage than any
It's far from obvious that Lockheed Martin's future is now paved with gold.
Boeing, with the addition of McDonnell Douglas, is a serious threat to Lockheed's
core business. And it's not especially clear how the acquisition of Northrop
helps Lockheed Martin deal with that threat directly. Before jumping on the
Lockheed-Northrop bandwagon, it would make sense to replace merger mania
with real analysis.