How Lockheed's Early Warning System Crashed

It misread Justice's growing alarm with defense mergers

If only former Lockheed Martin Chief Executive Norman R. Augustine had followed his own advice when he sealed the deal to buy Northrop Grumman Corp. for $11.6 billion last July. Only five months earlier, he had written in an aerospace trade publication that the government should have a "great deal of concern" about prime contractors gobbling up suppliers. And while he and his successor, Vance D. Coffman, may have ignored it, a Pentagon task force studying defense mergers hadn't. It quoted Augustine in a May report warning of the dangers of such vertical integration. "We basically spelled out for Lockheed Martin that any future mergers would not be welcome," recalls task force member Carol V. Evans, a Georgetown University professor.

"FULL-BLOODED COMPETITION." Lockheed is now paying a huge price for its lapse. On Mar. 23, the Justice Dept.--egged on by the Pentagon--sued to block the planned merger with Northrop. Justice argued that the new combo would create monopolies in electronics hardware such as airborne early-warning radar. Worse, the merger would enable Lockheed Martin to rely on its own inhouse parts suppliers and snub rivals. "Our nation cannot afford anything less than full-blooded competition," Attorney General Janet Reno declared.

So how did Lockheed miss all the obvious antitrust warning signs? Two years ago, the government began to grow queasy about the dwindling number of critical arms makers as leading suppliers paired off in mergers, consolidating in a post-cold war world. After Washington approved Raytheon Co.'s purchase of Texas Instruments Inc.'s defense electronics division in 1997, Justice antitrust chief Joel Klein told Congress that future mergers would get close scrutiny. But while the government saw too much concentration, Lockheed Martin saw only the need to expand in size so it could compete with the expanded Raytheon.

In round after round of negotiations, the players ended up talking past each other. The government consistently raised concerns about the merger, but Lockheed Martin believed that it could ease antitrust concerns by spinning off some units or agreeing to a consent decree that would require it to seek outside bids for subcontract work.

Only on Mar. 6, months after the negotiations began, did the Lockheed brass realize their error. The Justice Dept. and the Pentagon dropped a bomb: The merger as planned would not be approved. To satisfy Justice, Lockheed Martin would have to divest $4 billion in the electronics business, far more than the $1 billion that Lockheed Martin thought necessary. Lockheed's and Northrop's response was predictable: The government's demands "undermine the economic viability of the transaction," the companies said in a joint statement.

Could this marriage have been saved? Analysts doubt there was much Lockheed Martin and Northrop Grumman could have done. "Timing is everything," says Andrew F. Krepinevich, executive director of the Center for Strategic & Budgetary Analysis. "They just showed up at the consolidation party one round too late."

For now, Lockheed Martin is mulling a variety of responses, from a new structure for the deal to a court fight to unblock the merger. It will argue that divestitures can solve the monopoly concerns. What's more, the combined company would still be a smaller military aircraft maker than Boeing Co. and smaller electronics supplier than Raytheon. The government would end up with two strong competitors in each arena, rather than one strong and two weak ones, the company will argue in court. Lockheed Martin also plans to claim that its record shows it doesn't favor in-house suppliers. But its argument may be weakened by a recent suit brought against Boeing by Teledyne-Ryan Aeronautical, a former supplier. It claims McDonnell Douglas, now a part of Boeing, breeched a contract to buy airframes for the Apache helicopter and gave the work to a Boeing unit.

But antitrust experts doubt any of Lockheed Martin's arguments will work now. That makes former CEO Augustine prescient--painfully so.

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