When spending by the Pentagon fell in the early 1990s, defense contractor General Dynamics Corp. responded with military precision. In short order, it sold off businesses and radically reduced its workforce. That brought a bonanza for shareholders, who saw their stock rise from 12 in late 1990 to 51 two years later. But now the submarine-, tank-, and shipbuilder is learning a lesson familiar to scores of other companies that have spent the last few years downsizing: It's a lot easier to shrink a company than to build one.
All the divestitures have left the Falls Church (Va.) company with its coffers full of cash. Even after a string of recent acquisitions, GD has $700 million in cash and securities, $340 million in annual cash flow, and a microscopic debt-to-equity ratio of 2.2%. And it may reap a $650 million windfall from a recent legal victory over the government for expenses incurred under a contract that was canceled in midstream by the Pentagon. The case is under appeal.
The trouble is, all that loose change earning money market returns is a drag on performance, especially since GD'S remaining businesses, while market leaders, are not exactly fast-growing. Although GD has now changed course--the one-time seller is now on the prowl for acquisitions to bolster its remaining units--progress is slow. Since 1993, annual operating earnings have grown only 14%, to $353 million last year, on sales of $3.6 billion. For the three years ended April 30, the company's 82.92% total return to shareholders was well below the Standard & Poor's aerospace/defense index' 120.62%. And in BUSINESS WEEK's rankings of the S&P 500's best performers, the company came in dead last among its peers.
That's a far cry from the early '90s, when GD bailed out of segments where it couldn't lead. Onto the block went missile, fighter, space-launch, and other units. The sell-off turned GD into a cash piata. For 1991 through 1993, it earned a total return of 455%, compared with 54% for the industry. In 1993, it sent shareholders a $50-a-share, one-time cash payout.
Now, though, the days of such juicy handouts are over. Vice-Chairman Nicholas D. Chabraja, a 54-year-old former litigator who is scheduled to succeed James R. Mellor as chairman on June 1, dismisses the idea of distributing any more of GD's cash hoard to shareholders. Although GD will continue buying back shares, Chabraja, who joined the company in 1992 as a special counsel for restructuring, says it needs to concentrate on bulking up. "To date, acquisitions have clearly been a better use of money," he says.
That makes sense, but finding good deals at good prices takes time. "When you are buying, it's a question of opportunity and availability," notes Chabraja. GD's shareholders look increasingly as if they're tired of waiting. At a recent price of 711/4, the stock is up barely 13% over the past year. According to data from Technimetrics Inc., a New York-based research company, seven of GD's top 10 institutional holders sold shares last year, including Warren E. Buffett's Berkshire Hathaway Inc., which cut its stake from 7.9% to 6.8%. "Wall Street is impatient, properly so," says Chabraja, but "I can't let them run our business for us."
SLOW LANE. Chabraja makes it clear he wouldn't oppose a good offer for the company. But most recent defense mergers have been in the fast-growing aircraft and electronics sectors. With GD focused on the slower-growth tank and sub businesses, Wall Street sources say a deal is unlikely. "Anything's possible, but with the niches they've chosen, there are not a lot of strategic buyers out there," says Jon B. Kutler, principal at Los Angeles-based Quarterdeck Investment Partners Inc.
Once it finds an acquisition, GD's record at improving performance is pretty good. Since late 1995, GD has spent more than $800 million on four acquisitions, including Bath Iron Works Corp. and a pair of businesses from Lockheed Martin Corp. Underperformer Bath dragged down overall margins last year, so GD reorganized steel fabrication and streamlined materials handling. The result: In the first quarter, the marine group saw margins rise from 8.8% to 10.6%. Overall, company margins have averaged 7.6% over the past three years, by far the best in the aerospace/defense sector.
BOTTOM DOLLAR. GD is also working hard to get its share of military contracts. The company's order backlog has doubled since 1995, to more than $10.6 billion. Last year, it won a $217 million contract to build a new amphibious assault vehicle (AAV) for the Marines. Full production of 1,013 AAVs would be worth more than $4 billion through 2014. Bath was part of a team that beat out a powerhouse coalition of Lockheed Martin, Litton Industries, and Newport News Shipbuilding & Drydock Co. to build 12 new LPD-17 U.S. Navy transport ships at $800 million a pop.
But those operating successes aren't enough. To achieve real growth, GD needs to put its cash to work by making more acquisitions. What's on the radar screen? Analysts say picking up Newport News or Litton's Ingalls shipyard would make sense. So would buying more mundane properties such as ammunition suppliers. Another possibility: units that make equipment such as combat systems or electronics now supplied by the government for GD projects. Litton's Sperry Marine, for example, makes navigational radar, and Northrop Grumman Corp. makes steam engines and transmissions that Uncle Sam provides to GD. The company gets no markup on the items, but it would if it made them.
All of this would be consistent with its acquisition strategy so far, which has been to stay close to what GD knows--and pay bottom dollar. When the company bought Bath in 1995, it paid half what the shipyard brought in a private transaction in 1986 during a market peak. At a time when many industry deals are priced at roughly $1 for $1 of sales, GD paid $300 million for $850 million in sales, though in an out-of-favor, slower growth sector than in many recent transactions.
Chabraja says GD could double in size in five years, but adds: "Size isn't what this is all about. It's about profitability." Chabraja had better hope that it's also about growth, or he may find his shareholders beating a hasty retreat.