The Lockheed Martin Acquisition of Aerojet Could Still Happen

In this clip from "Wheeling & Dealing" on Motley Fool Live, recorded on Feb. 4, Motley Fool contributor Lou Whiteman discusses the aerospace giant's bid to buy Aerojet Rocketdyne (AJRD) for $4.4 billion and shares why now might not be the time to buy.

Lou Whiteman: Let's start out. We're going to take you all the way back in time to December 2020, where that handsome young man wrote something about Lockheed Martin (LMT -0.87%) is going to buy Aerojet Rocketdyne for $4.4 billion. Just to give you the characters involved. Lockheed Martin is the world's largest pure-play defense contractor. It is everywhere from the F-35 to all things. But they are also, and it's important to this deal, they're big in space, they are big on missiles, and they're big in missile defense. Aerojet Rocketdyne, meanwhile, is one of two major U.S. makers of rocket engine, scramjets propulsion system. Their products go into all of those missiles, space launches, things like that. The other one, Aerojet's largest competitor was Orbital ATK (OA), which was a Fool recommendation taken out by Northrop Grumman (NOC -1.64%) back in 2018. Now, that's very significant. Both that, A) there's only one independent here, and B) the other one went under Northrop's control very recently. As that handsome young reporter said at the time, given the concentration of propulsion system providers, regulators are likely to take a hard look at this deal. We knew going in that this was going to be a tough swallow. Lockheed's thought, and it was probably a pretty good thought was, well, they let Northrop buy Orbital ATK, which quite frankly was a much better company and a much more important company. Northrop put in place some restrictions that it said would ensure that Orbital's propulsion systems could be used by Northrop competitors. Boeing (BA -0.44%) quite famously said that's not happening. There was a clear pathway based on the Orbital deal of how this could get done, but there was also signs before it was announced that they were going to be grumbling. We fast-forward. All that's happening and the deal was originally set to close late last year. That didn't happen. They pushed it back and said we're still good. But then just recently, January 25, you can see the press release, the FTC will sue to block Lockheed Martin's proposed acquisition. This is how it works. Again, without getting too far in the weeds, a regulator can't say "No, no deal." All the regulator can do is go to court and argue its case. The regulator has a pretty good track record here, not perfect. This is how deal lawyers get rich, Toby. But this is a big deal. You don't normally see it get there and the FTC isn't going to go there unless they think they have a good case. Most interesting part about this because, let's be honest here, national security is all over these things. Well, the Pentagon is not the antitrust regulator that matters here. If the Pentagon wants to see something happen or doesn't want to see something happen, the FTC will tend to find a reason to go along with them. The Pentagon here, and I highlighted it, haven't communicated our analysis of the FTC, we defer questions to the FTC, which is an interesting way of saying we don't want to say what we think, but we're also not going to fight the FTC here which is really big because, arguably, Aerojet Rocketdyne wasn't in great shape on its own, and if you could figure out a way to get them in a deeper pocket and still preserve competition, I think the Pentagon would have gone for that. And so, I think it's very interesting that the Pentagon just kind of [says] "You do you." Where are we now? Because we're at a standstill. Markets think the deal is dead. Aerojet Rocketdyne shares are down almost 20% year-to-date, 32% below the cash offer price right now, so that is significant. It's trading in the high 30s now. The cash offer price was 56. Lockheed Martin has until late February to respond, so far they are not doing that. They're just taking their time with this. I think part of that is is because Aerojet Rocketdyne is in really bad shape. In the days since the FTC moved, Steel Partners' (SPLP -0.11%) Warren Lichtenstein, who is a great activist, a very smart person, he launched a proxy battle to replace four Aerojet Rocketdyne directors along with CEO Eileen Drake, who is an air force veteran, a long time holder, Steel owns about 4.9%. This is a battle of the money versus operations and I'm not sure how it's going to go. Here's Warren Lichtenstein's problem. The FTC logic almost eliminates any other major buyer. If you're not going to let Lockheed Martin buy this because Boeing, Raytheon (RTN), some of these other missile players wouldn't have access, you're not going to let one of those other players buy it because Lockheed Martin will say, "Hey, Saint, in theory, a smaller company, a BAE Systems (BAES.Y 0.67%), L3Harris (LHX 2.36%), Leidos (LDOS 0.22%) could buy it, I think, in part because they don't really have a missile business." However, Aerojet Rocketdyne is a commoditized business. It's a very complicated commodity, it's not easily replaced, but it is a low-margin business. Lockheed Martin was going to pay more than two times sales for that low-margin business in part because of the synergies, because it uses those products. Even for the same reason a BAE or an L3Harris could get a deal past regulators, probably that's the same reason they're not going to want to pay as much for it, so it's darned if you do, darned if you don't. Private equity is a wildcard. Again, with these margins, someone could take them out, and I think that's probably what Lichtenstein would hope for here. But, again, this is not a high-growth or a high-margin business so it doesn't necessarily fit the private equity playbook the way others would. If you're an Aerojet Rocketdyne shareholder who had been offered $56 in cash a few months ago, it probably would've been best to take it because it is hard to imagine, even if you find another bidder here that is going to come in at that level. I should say that Lockheed's silence could indicate that they are still talking with the Pentagon. If you could put on a tinfoil hat and say the Pentagon is saying we defer to the process and Lockheed is so far being quiet. There were rumors that Lockheed put together a last-minute change in their consent degree offer. Maybe this gets settled and maybe it still goes through, but I certainly wouldn't invest right now assuming it does. Bigger picture. What does this say about defense M&A? This is a huge deal that isn't going to get done. In the previous administration, we had two major ones. I already mentioned Northrop and Orbital ATK, but we also have Raytheon and the [Raytheon Technologies' (RTX -0.72%)] United Technologies aerospace business. Two massive deals. We are in a new administration that we knew that going in, and I think we confirmed that, that's not to say politics, good, bad, whatever, but it is a different set of eyes than the ones that let those through. I think we assumed that and now this is the litmus test and it shows that this is a tougher administration to get deals done. That said, Aerojet Rocketdyne is a special case due to just the unique product they bring. This isn't a case of a defense IT company buying another defensive IT company. This is an irreplaceable independent asset. I don't think you can read too much into it. I think defense IT, in particular, remained wide open, and if it's a hardware deal, I think it comes down to these parts of the military right now like shipbuilding, where they are very sensitive about the number of vendors. There's others that, quite frankly, they're not really worried about the number of vendors. I think a blow-by-blow deal gets through. If history is a guide, we're going to see a lot more private equity activities because every time the strategics are taken out of the market, you see private equity happily step in, be it Carlyle (CG 1.02%), etc., a lot of these really good private equity firms that do defense. That's where we stand. They should have tried to get this done six months sooner, arguably, if you believe in the political card. We'll see.