Lockheed's M&A Rocket Science

Mergers are getting pretty complicated.

What's a little complication among dealmakers when it means less taxes?

Lockheed Martin agreed on Tuesday to essentially sell its information-systems division to Leidos. Except that it's not really a sale, because that would likely incur taxes. So instead, Lockheed is splitting off the IT division, which provides technology for things like air-traffic management and biometric scanning, and then combining it with Leidos. 

Getting Busy

Lockheed has announced a significant takeover and divestiture in the last 12 months.

Source: Bloomberg

This crafty structure, known as a Reverse Morris Trust, lets Lockheed claim a $1.8 billion cash payment with no extra tax strings attached. 1 It can use that money to pay down some of the debt it took on to acquire helicopter maker Sikorsky from United Technologies last year -- a $9 billion deal which in itself was pretty tax-efficient. 2

It's just the latest example of slicing and dicing among companies looking to shed less-desirable businesses and pick up new growth assets -- while avoiding the tax boogeyman whenever possible. This month has actually been the strongest January since 2005 for U.S. targets in terms of deal volume, though it doesn't feel all that busy compared to the flurry of activity at the end of last year. The biggest transactions so far have all involved some sort of breakup or tax-savvy gambit. 

Not Too Shabby

M&A activity feels slower, but this has been the biggest January for deals since 2005.

Source: Bloomberg

There have already been at least two inversion deals announced whereby U.S. companies will move their legal addresses to countries with less onerous tax codes: Johnson Controls' combination with Tyco International and Waste Connections' merger with Progressive Waste. While Shire's planned purchase of hemophilia drugmaker Baxalta isn't an inversion, the Dublin-based acquirer will be able to eke out savings by dropping the target's tax rate down closer to its own. Shire also found a way to give Baxalta shareholders some cash without jeopardizing the tax-free nature of the company's spinoff from Baxter International.   

This type of maneuvering is likely to continue across all industries, especially the inversions. Despite all the political rhetoric of late, many lawmakers still disagree on how to curb them. At least for this year, it seems there's little chance of Congress enacting changes to the tax code that would prevent the tactic.

Leidos' move to effectively double its revenue by acquiring Lockheed's business may also drive some of its peers to more dealmaking. CACI International was at one point the top contender for Lockheed's information-systems division, before getting beat out by Leidos, Reuters reported. CACI has already been on an acquisition spree of late, agreeing just last month to buy L-3 Communications' national security solutions business for $550 million. The prospect of increased competition could inspire it to fire up its dealmaking efforts. That's not rocket science -- even if the deals are.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. Perhaps too crafty in this case. Lockheed shares slumped as much as 5 percent as the Sikorsky deal and divestiture of the IT business muddied the waters for investors on the company's growth prospects. 

  2. Analysts initially said United Technologies would have to spin off Sikorsky or do a Reverse Morris Trust to avoid a massive tax bill. The business was acquired by United Technologies in 1929 so a sale would have resulted in a significant capital gain. Lockheed  had to pay up for Sikorsky, but it found a way to mitigate the problem by making a joint election to treat the transaction as an asset purchase. This resulted in a tax benefit with an estimated present value of $1.9 billion for Lockheed Martin and its shareholders.  

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net

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