Lockheed Martin (LMT 1.15%) has formally pulled the plug on its planned $4.4 billion acquisition of Aerojet Rocketdyne Holdings (AJRD +0.00%), bowing to regulators who opposed the deal instead of engaging in what could have been a protracted court battle.
Lockheed had good reason to want to buy Aerojet: Space and missiles are two areas of emphasis inside the Pentagon, and Lockheed's existing space business has been under pressure from new entrants including Elon Musk's SpaceX. But the Federal Trade Commission (FTC) feared the acquisition would cut off access to Aerojet Rocketdyne's propulsion technologies to other contractors and was prepared to sue to block the deal.
The termination leaves both companies at a crossroads but probably says little about the prospects of further consolidation of the defense industry. Here's what investors need to know now that Lockheed Martin and Aerojet are not getting together.
Image source: Aerojet Rocketdyne.
Lockheed could reinvest the cash in itself
Lockheed Martin CEO Jim Taiclet in a statement announcing the termination argued that the deal "would have benefited the entire industry through greater efficiency, speed, and significant cost reductions for the U.S. government." However, the company is walking away instead of battling it out in the courts.
Lockheed is the world's largest pure-play defense company, with a broad portfolio of assets including helicopters, warplanes, missiles and missile defense, and advanced electronics and sensors. Bringing Aerojet in-house would have helped cut R&D costs and speed development in areas including hypersonics, missiles traveling more than five times the speed of sound, but even after this setback Lockheed should be able to continue to access Aerojet technology for its products.
Given the regulatory pushback, don't expect Lockheed Martin to quickly turn around and try to buy some other large company. But smaller, bolt-on deals are possible. In the near term, Lockheed Martin could use the $4.4 billion in cash it had earmarked for the purchase to instead accelerate share repurchases. Cowen analysts estimate that deploying that cash into stock repurchases would boost earnings per share by about $1 annually. The Aerojet deal, by comparison, was only expected to add about $0.40 per share to earnings.
Lockheed Martin over the past year has been a stock in search of a catalyst, and in the near-term Aerojet was unlikely to lift the company out of the doldrums. For investors the next year to 18 months are most likely to be more about cash return and buybacks while they wait for young programs like a potential new fighter, a refresh of Army helicopters, and new missile technology continue to develop.
Lockheed and Aerojet vs. the S&P 500 data by YCharts
At Aerojet, the focus turns inward
Aerojet Rocketdyne arguably needed the deal more than Lockheed Martin. The company is one of two major propulsion providers and its archrival, Orbital ATK, is owned by Northrop Grumman and has the relative security and deep pockets that come with being part of a larger enterprise.
Given the FTC's stance, it seems unlikely that any major customer of Aerojet can swoop in and buy the company today. It is possible a smaller defense contractor that isn't a significant customer could be allowed to acquire Aerojet, though without the overlapping business that the FTC objected to those buyers might not be willing to pay as much. If a potential buyer -- say, BAE Systems, L3 Harris, or Leidos Holdings -- gets involved looking for a bargain, there might not be much upside to Aerojet shares.
The most likely outcome for Aerojet Rocketdyne is an acquisition by a private equity firm for well less than the more than two times sales Lockheed Martin had agreed to pay.
For now, expect a lot of the focus at Aerojet to be on an internal battle. Activist investor SPH Group Holdings, owner of 4.9% of Aerojet, has launched a bid to replace four Aerojet board members, including CEO Eileen Drake. Aerojet countered by disclosing what it called an "internal investigation" into SPH Executive Chairman Warren Lichtenstein, saying it believes the proxy contest is part of a plan by Lichtenstein to "secure his board position and gain leverage in the context of the Company's internal investigation."
Defense deals aren't dead
Don't expect the FTC's decision to cause defense bankers to go into hibernation. The current administration clearly has a much more skeptical view on consolidation than the prior administration, which greenlighted both Northrop's deal for Orbital and also the megamerger that created Raytheon Technologies. But Aerojet, as the only independent propulsion company, was a special case, and other deals are likely to get a more favorable review.
We could soon get a test of the FTC's resolve, as Mantech International has reportedly reached out to potential buyers. Defense IT companies like Mantech usually have an easier time doing deals because their businesses are more commoditized, and competition in the sector is robust. Deals for equipment makers like Aerojet always tend to face more scrutiny because there are usually only a limited number of vendors that make any one piece of hardware, though acquisitions are possible on a case-by-case basis.
The one thing we know for sure is that Lockheed Martin is not buying Aerojet. Investors need to brace for turbulence at Aerojet, but at Lockheed Martin there is at least some hope the added cash will help boost earnings over the next year and help see the company though its current lull.
