The juiciest rumor to come out of the Thomson Reuters aerospace and defense summit this week was speculation that Boeing may be considering a bid for some or all of Northrop Grumman. The head of Boeing’s defense business, Dennis Muilenburg, declined to rule out the possibility of a large-scale merger between Boeing and some other military contractor, and Northrop Grumman is the most likely candidate. Although there have been rumors that somebody like Boeing might make an unsolicited bid for BAE Systems plc since the company’s share price has been trading below three pounds, that would be a more complicated transaction that would saddle the Chicago-based company with numerous activities unrelated to its current product lines. Northrop, on the other hand, would be a much cleaner fit — especially once it dispenses with its under-performing shipbuilding business, as management currently plans.
The problem for Boeing is that a merger with Northrop Grumman fits so well that it inevitably would raise antitrust concerns. For instance, federal regulators would be unlikely to approve a combination of the two companies’ space operations without major divestitures that undermine the business logic of the transaction. In addition, there is little evidence at present that Northrop Grumman CEO Wes Bush or his board is interested in being bought. Bush has been making steady progress in reorganizing the company, and its franchises outside shipbuilding are sufficiently strong to suggest it might be able to improve results even in a period of softening demand. Even if Northrop Grumman management warmed to the idea of a major strategic transaction to speed the enhancement in shareholder value, common sense suggests that shareholder interests would be better served by breaking the company up and selling the pieces to the most motivated buyers. A breakup would also make it easier to minimize antitrust objections.
But Boeing at this point must be regarded as a highly motivated buyer. Its defense operations were hit hard by Pentagon weapons cancellations last year that defense secretary Robert Gates says took $330 billion out of future spending plans. The Boeing business strategy is to maintain two more or less equally-sized technology businesses, one in commercial markets and one in defense markets, on the theory that the markets will often vary inversely like counter-rotating gears and result in reasonably stable revenues over time. That’s a hard thing to accomplish, though, when demand for commercial transports is surging while your defense customer is terminating everything from the Army’s Future Combat System to the Air Force’s C-17 transport to the Missile Defense Agency’s interceptor complex in Europe. In the near term Boeing can fill some of the looming defense shortfall with overseas sales, but over the longer term it will be hard for its military operations to keep pace with surging commercial sales.
Buying some or all of Northrop Grumman would largely fix this problem, because Northrop’s non-shipbuilding businesses are all well-positioned franchises with good forward-looking prospects in market segments that Boeing understands. Assuming shipbuilding goes away and space cannot be acquired due to antitrust concerns, what’s left is military aircraft, defense electronics, information technology and technical services. Not only is Boeing already in all of those businesses, but its strategic plan is to get bigger in several growth markets where Northrop is a key player, like cyber security and unmanned aircraft. Northrop is also a longstanding subcontractor to Boeing on key programs like the F/A-18 Super Hornet and EA-18G Growler. The biggest prize of all, though, and the most powerful reason why Boeing must consider a strategic move, is Northrop Grumman’s enviable role (actually, roles) on the F-35 Joint Strike Fighter program.
Every one of Northrop Grumman’s major business units outside shipbuilding has a strong presence on the F-35 program. Its aerospace unit is the principal teammate to prime contractor Lockheed Martin on the airframe, with lead responsibility for the center fuselage and weapons bay. Its electronics unit builds the plane’s radar and in partnership with Lockheed is building the plane’s electro-optical sensors. Its information unit provides the software and systems engineering for the F-35 mission planning system. And the array of technical services Northrop Grumman provides for the joint fighter is worth many billions of dollars just in the next decade, not to mention when the plane is fully fielded. So buying at least a part of Northrop Grumman is Boeing’s last, best hope to participate in what will one day be the only fighter program that matters to America’s military and many of its allies. That has to be on the minds of Boeing executives as they contemplate how the defense sector will consolidate in the coming downturn.
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