Northrop Bulks Up Missile Business on $7.8 Billion Orbital Deal

  • Acquisition expands offerings in rocket propulsion, munitions
  • Deal price represents 22% premium over Sept. 15 closing price

Northrop Agrees to Buy Orbital in $7.8 Billion Deal

Northrop Grumman Corp.’s $7.8 billion purchase of Orbital ATK Inc. will expand its space and missile businesses just as the U.S. steps up efforts to defend against a possible strike by North Korea and threats in the Middle East.

The deal cements a turnaround for Northrop, which had been the target of breakup speculation before it scored an upset win in 2015 to build the next U.S. stealth bomber. The transaction, the largest in the defense industry in two years, adds rocket propulsion, missile-defense and satellite expertise to Northrop’s capabilities as a major U.S. weapons maker.

Buying Orbital would make Northrop the fourth-largest Pentagon contractor, displacing Raytheon Co., according to Bloomberg Government. Orbital stands to benefit as the U.S. expands a ground-based missile-defense program that Northrop already supplies with command-and-control systems. U.S. contractors have soared this year on prospects for greater weapons spending under President Donald Trump.

“As we watch what’s happening around our globe, the rather rapid advance of some of our potential adversaries is quite concerning,” Northrop Chief Executive Officer Wesley Bush said on a conference call with analysts to discuss the transaction. “This issue of technological superiority for the U.S. and our allies is a real issue. It’s something that our customers are struggling with.”

Defense Prime

The deal ranks as the largest in the defense industry since Lockheed Martin Corp. bought Sikorsky Aircraft in 2015. Together, Northrop and Orbital got about $14.6 billion from Pentagon contracts last year, about half of their combined sales.

Orbital’s “expansive position in missile defense would solidify” Northrop’s place in a growing market, Cowen analyst Cai Von Rumohr said in a note to clients.

While there is limited overlap between the companies, the tie-up, coming weeks after aerospace manufacturer United Technologies Corp. announced a $23 billion acquisition, will test the Trump administration’s tolerance for consolidation among prime defense contractors. Under Barack Obama following the Sikorsky deal, the Pentagon had signaled that it would frown on such deals because they were reducing competition.

“Given that Northrop already operates in the space field, it is possible that there could be some overlapping activity or increased vertical integration that could prompt regulatory scrutiny,” Robert Stallard, an analyst at Vertical Research Partners, said in a note to clients. “We have also not had a prime contractor acquisition under the current U.S. administration, and so this is a test case as to whether concerns over the scale of the primes is still an issue.”

Cash Deal

Orbital holders will receive $134.50 a share in cash, the companies said in a statement, representing a 22 percent premium over Orbital’s closing price last week. The total transaction is valued at $9.2 billion including the assumption of $1.4 billion in net debt. Orbital jumped 20 percent to $132.45 at 1:56 p.m. in New York. Northrop rose 2.7 percent to $274.31.

Orbital provides the booster rocket that carries a Raytheon warhead for the U.S. ground-based missile defense program. The Pentagon is proceeding with plans announced several years ago to expand the number of interceptors by December to 44 from 36 today.

The move adds a new wrinkle to Northrop’s competition with Boeing Co. to develop the next ground-based missile interceptor system in the U.S., a contract that could be worth as much as $85 billion. Orbital has also designed propulsion systems on Minuteman III missiles in the past.

Orbital “is a leader in solid rocket propulsion” while Northrop “is strong in sensors and networks, enabling a comprehensive ballistic missile defense solution,” Jefferies analyst Howard Rubel said Monday in a note to clients.

The acquisition marks a bold bet on growth for Falls Church, Virginia-based Northrop, which has recently focused on returning cash to shareholders through stock buybacks and dividends. Bush hinted at the change in July, telling investors during the second-quarter earnings call that he was looking for acquisition opportunities to expand the contractor’s business.

Deal Savings

Orbital will operate as a fourth business unit within Northrop following the close of the transaction, expected in the first half of 2018, the companies said. The deal is expected to add to Northrop’s earnings in the first full year after closing, and to yield annual pretax cost savings of $150 million by 2020, according to the statement. It is subject to customary closing conditions, including approval by regulators and Orbital shareholders.

Orbital, which has about 13,000 employees, was formed in 2015 through the combination of Orbital Sciences and Alliant Techsystems. The Dulles, Virginia-based company competes to hoist payloads to space with Space Exploration Technologies Corp.’s Falcon 9 and United Launch Alliance’s Atlas family of rockets.

Global Hawk drone

Photographer: SeongJoon Cho/Bloomberg

Orbital CEO David Thompson could get as much as $15 million in severance, benefits and equity awards, based on the transaction price, if he’s dismissed.

The payout would include $5.94 million in severance and a prorated target bonus of $855,000, according to the proxy statement. He also holds equity awards worth $7.95 million at the $134.50 offer price that would vest early, some of which are prorated and tied to performance conditions, data compiled by Bloomberg show.

S&P Global Ratings and Fitch Ratings said they may downgrade Northrop on the debt burden it will incur through the deal. S&P placed Northrop’s ratings on Creditwatch with negative implications, citing a “significant deterioration” in the company’s metrics. Moody’s Investors Service affirmed its Baa1 and Baa2 senior unsecured debt ratings.

JPMorgan Chase & Co. committed to provide a senior, unsecured bridge facility of as much as $8.5 billion related to the deal, according to a regulatory filing. Northrop said Monday it will seek to maintain a strong credit rating and will use cash flows to help reduce debt.

Bankers from Perella Weinberg Partners are advising Northrop Grumman, while Cravath, Swaine & Moore is the company’s legal counsel. Citigroup is advising Orbital, with Hogan Lovells US as legal adviser.

— With assistance by Michael Sasso, Alicia Ritcey, and Anthony Capaccio

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