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General Dynamics Needs Deal to Combat Worst Earnings in 20 Years: Real M&A

General Dynamics Corp. (GD), which posted the smallest sales increase since 1995 last year, may now need acquisitions more than ever as it faces the weakest stretch of profit growth in two decades.

The maker of Gulfstream jets and Abrams battle tanks hasn’t done a billion-dollar deal for a publicly traded company in five years, and is “looking at opportunities” to buy businesses after revenue rose less than 2 percent in 2010, Chief Executive Officer Jay Johnson said last week. Buying flight-simulator maker CAE Inc. (CAE) may boost growth, according to Fifth Third Asset Management, which sold General Dynamics on concern earnings will slump. Shareholder Fiduciary Trust Co. said General Dynamics should buy a company outside defense and aerospace or split up.

A deal may help 64-year-old Johnson recoup some of the money investors lost on General Dynamics in the past year, even as the Standard & Poor’s 500 Index gained 15 percent, according to data compiled by Bloomberg. Without a transaction, analysts project annual profits at General Dynamics will grow less than 10 percent for three years, the slowest rate since at least 1991, as the U.S. government cuts defense spending.

“We don’t see a lot of positive catalysts right now,” said Michael Mullaney, who helps oversee $9.5 billion at Fiduciary Trust in Boston, which owns shares of General Dynamics. An acquisition “could be a shot in the arm as far as earnings. They should focus on industrial names because that’s what they are good at,” he said.

‘Rest Assured’

Rob Doolittle, a spokesman for Falls Church, Virginia-based General Dynamics, said the company doesn’t comment on rumors or speculation about mergers and acquisitions.

“Rest assured, we’re looking at opportunities in the defense space as well as in aerospace,” Johnson said on a conference call on April 27 after the company’s first-quarter earnings announcement. General Dynamics reported a 3.5 percent increase in net income as sales rose less than 1 percent.

The 1.7 percent drop in General Dynamics’s shares in the past year trimmed its market value to $27.4 billion, according to data compiled by Bloomberg. The S&P 500 has gained 15 percent over the same period, while defense and aerospace stocks in the benchmark index for American common equity climbed an average of 9.9 percent, the data show.

Today, General Dynamics rose 0.9 percent to $74.35 as of 11:07 a.m. in New York.

Since Johnson, a retired admiral and former U.S. Chief of Naval Operations who flew combat operations in Vietnam, became CEO of General Dynamics in July 2009, the company has returned 39 percent to shareholders. Rival defense and aerospace companies have delivered a 62 percent gain including dividends to their owners, data compiled by Bloomberg show.

Battle Tanks

Revenue at General Dynamics rose 1.5 percent last year, the smallest increase since a 0.3 percent gain in 1995. Sales declined at its combat systems unit, which sells battle tanks and rockets, the data show.

General Dynamics was dealt a setback in January after U.S. Defense Secretary Robert Gates proposed to cancel its Expeditionary Fighting Vehicle it was building for the Marine Corps. With the government under pressure to cut spending and reduce the military’s presence in Iraq and Afghanistan, Johnson has said the Gulfstream unit will remain its “growth engine.”

For the full year, analysts anticipate that per-share profit will increase 4.7 percent, followed by gains of 7.6 percent and 9.3 percent in the next two years, according to data compiled by Bloomberg. Since at least 1991, General Dynamics has never had a three-year stretch of profit growth that didn’t exceed 10 percent in at least one year, the data show.

‘Buy Growth’

“There’s going to be no growth in defense budgets,” said Brian Ruttenbur, a Nashville, Tennessee-based equity analyst at Morgan Keegan & Co. To replace that, “they’re going to have to go out and buy growth,” he said.

The last deal by General Dynamics for a publicly traded company worth more than $1 billion was its $2.2 billion acquisition of Fairfax, Virginia-based Anteon International Corp. in 2006, according to data compiled by Bloomberg.

Anteon designed, integrated, maintained and upgraded computer systems for government agencies such as the Departments of Homeland Security and Defense. General Dynamics bought business-jet maker Gulfstream in 1999 for $5.4 billion including net debt in its biggest acquisition, the data show.

General Dynamics, which has $2.5 billion in cash and short- term investments, can add as much as $3 billion to its adjusted long-term debt -- which includes pension obligations and operating leases -- and still keep its B3H debt rating, according to Bloomberg’s Company Credit Ratings.

Credit Ratings

The grade is three levels above junk, according to the ratings, which analyze companies based on indebtedness, profitability and other financial ratios. Borrowing more than $15 billion would push the credit rating of General Dynamics to junk level, the ratings show.

The company should use its cash to boost earnings through acquisitions as defense spending slows, said Keith Wirtz, chief investment officer at Fifth Third Asset Management in Cincinnati, which oversees $18 billion.

CAE, which has a market value of $3.3 billion and makes aviation training technology for commercial-airline and military pilots, would be a good fit, according to Wirtz. Sales at the Montreal-based company will increase 11 percent next year, while earnings will climb 16 percent, according to analysts’ estimates compiled by Bloomberg. Both are more than double the projections for General Dynamics, the data show.

‘More Opportunities’

“It would be almost intuitive that they start to do strategic considerations,” Wirtz said. “What they are going to be looking to do is to acquire new technologies and look for companies that will give more opportunities that they don’t already have. CAE might be an example.”

“CAE is not a company that is for sale,” said Nathalie Bourque, the company’s spokeswoman.

CAE advanced 0.6 percent to C$12.56 in Toronto.

Fiduciary Trust’s Mullaney says that General Dynamics should consider a deal with an industrial company that specializes in energy or health care.

“At best, it would be a field which potentially reduces your exposure to government dependency, or puts you into a complementary growth area,” he said. “Anything that helps buffer General Dynamics from being so dependent on government spending would be a step in the right direction.”

It could combine with Thermo Fisher Scientific Inc. (TMO), the world’s largest maker of laboratory instruments, he said.

Laboratory Instruments

The company, which has a market value of $23.3 billion, will increase profit by 56 percent this year -- 12 times the rate projected for General Dynamics, analysts’ estimates compiled by Bloomberg show.

Investors value Thermo Fisher’s stock at almost 22 times earnings, more than twice the level for General Dynamics, according to data compiled by Bloomberg.

Shares of Thermo Fisher gained 1.3 percent to $60.48.

Ron O’Brien, a spokesman for Waltham, Massachusetts-based Thermo Fisher, declined to comment.

While General Dynamics may want to expand its maintenance and repair services for Gulfstream customers, many of those companies are small, privately held businesses, according to Peter Arment, an analyst who rates General Dynamics a “buy” at Gleacher & Co. in Greenwich, Connecticut.

One option would be to spin off the aerospace division because it has been a “drag on this company for a while,” said Fiduciary Trust’s Mullaney. While the aerospace unit had operating income of $860 million last year, a 22 percent increase from 2009, that’s still less than the $1.02 billion it reported the prior year.

Buffett’s Criteria

General Dynamics was also one of more than 40 companies that Bloomberg identified in March that met the acquisition criteria Warren Buffett listed in his annual letter to shareholders.

Buffett typically prefers “simple” businesses with pretax profit exceeding $75 million, “consistent” earning power, and “good” returns on equity while employing little or no debt, according to his report. His takeover strategy has shifted as Berkshire has grown to focus on “capital intensive businesses,” such as power producers and railroads, which require consistent investment in infrastructure and equipment.

Buffett didn’t respond to a request for comment e-mailed to his assistant, Carrie Kizer.

Overall, there have been 8,499 deals announced globally this year, totaling $839.2 billion, a 22 percent increase from the $686.3 billion in the same period in 2010, according to data compiled by Bloomberg.

To contact the reporters on this story: Rita Nazareth in New York at rnazareth@bloomberg.net; Tara Lachapelle in New York at tlachapelle@bloomberg.net; Justin Doom in New York at jdoom1@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Nick Baker at +1-212-617-5919 or nbaker7@bloomberg.net

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