Pentagon Will Back Defense Mergers Outside Top Five Companies, Carter Says
Feb. 9 (Bloomberg) --- The Pentagon expects U.S. defense contractors to acquire others or divest units and will welcome such moves provided the top five or six suppliers don’t consolidate, the Defense Department’s top weapons buyer said.
“Far from being discouraging” to mergers and acquisitions, “we are actually quite welcome to that because we expect industry to make adjustments,” in response to a slowdown in U.S. defense spending, Ashton Carter, undersecretary of defense for acquisition, technology and logistics told Bloomberg Television.
Still, the Pentagon will not approve transactions that will result in a consolidation of the major defense contractors such as Lockheed Martin Corp., Boeing Co., Raytheon Co., Northrop Grumman Corp., or General Dynamics Corp., Carter said in an interview yesterday ahead of a speech in New York today.
The growth of the base U.S. defense budget through 2016 is forecast to average no more than the rate of inflation. Overall defense spending, including war costs, has risen 72 percent between 2000 and 2008. Defense Secretary Robert Gates has targeted $78 billion in cuts through 2016 for federal deficit reduction and another $100 billion in efficiencies savings, two- thirds of which will be shifted to weapons accounts, Carter said.
‘Economic Efficiency’
As a result, there will be consolidation, spinoffs and different levels of the industry will behave in different ways, he said. “There are small businesses, there are parts suppliers which may grow in this time and that’s good,” Carter said. Those transactions “could be in the interest of economic efficiency” and the Pentagon would welcome them, he said.
The current structure of the U.S. defense industry was shaped in 1993 when then-Defense Secretary Les Aspin told company executives the Pentagon could not sustain several suppliers in each sector and encouraged them to merge in order to better utilize capacity.
The Defense Department today is “down to about five or six very large prime contractors who bid on many, many of our jobs and, in the interest of competition, we are not interested in seeing further consolidation and reduction in that number,” he said. “But with that exception just about everything else is on the table.”
Chief executive officers of the top two U.S. defense companies have said they don’t foresee consolidations similar to the 1990s.
‘Not Desperate’
Lockheed, the world’s largest defense contractor, is under no pressure to make up for a projected slowdown in U.S. military spending through acquisitions, Chief Executive Officer Robert Stevens said in a November interview.
“We are ambitious and we will continue to look” for acquisitions “but we are not desperate,” Stevens said in an interview with Bloomberg News in Washington.
Boeing Co., the No. 2 defense contractor, doesn’t see large acquisitions, Dennis Muilenburg, chief executive officer of Boeing’s defense unit, said in a December interview.
Chicago-based Boeing’s 2010 defense sales of $31.9 billion are second to Bethesda, Maryland-based Lockheed Martin, which reported revenue of $45.8 billion for the last year.
The Pentagon asks for “transparency” in all cases of mergers as well as spinoffs of units, to ensure that “the spun- out entity is going to continue to serve the department in the long-term way,” Carter said.
Northrop Shipbuilding
Northrop Grumman, which is looking to spin off its shipbuilding business, is talking with the U.S. Navy to ensure the standalone unit has sufficient financial backing, two people familiar with the talks said in December. Los Angeles-based Northrop is the Navy’s largest shipbuilder.
The Pentagon will expect suppliers as they are making moves, such as spinoffs, “to give us all the financial information we need to make our determination,” Carter said. He declined to comment specifically on Northrop’s proposal.
In addition to Carter’s speech, the Pentagon has launched a review of defense suppliers that “will go sector-by-sector, and tier-by-tier, to assemble a long-term picture” of what policies will help the department fulfill its requirements, Deputy Defense Secretary William Lynn told an industry group Jan. 30.
“This detailed review will inform our budget decisions, our acquisition decisions, and our industrial policy,” Lynn said. “It will also help us determine what stake the department has in mergers, acquisitions, and industry consolidation.”
‘Pretty good pace’
Aerospace and defense industry mergers and acquisitions are “growing at a pretty good pace,” said Stuart McCutchan, editor of Defense Mergers and Acquisition, an on-line publication based in South Riding, Virginia. He said he expects 2011 “to be a big year.”
Defense companies of all sizes completed 255 transactions totaling about $24 billion last year, the most since 2007 when the industry completed 362 deals valued at $43.4 billion, according to data compiled by McCutchan.
The high point was deals worth $65.9 billion in 1999 as the industry was responding to the Clinton administration’s direction that major consolidation was necessary as post-Cold War defense budgets dropped.
“My guess is that Mr. Carter is trying to get in front of any prospective surge in consolidation activity,” McCutchan said. “What the Pentagon fears most is financial instability caused by imprudent activity” that leaves less corporate money for expenditures on research and development and equipment, he said.
To contact the reporters on this story: Peter Cook in Washington at pcook6@bloomberg.net; Tony Capaccio in Washington at acapaccio@bloomberg.net; Gopal Ratnam in Washington at gratnam1@bloomberg.net
To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net
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