Why 30 years of defense consolidation may be coming to an end
After three decades, defense may no longer be a buyer’s market.
This week, the Federal Trade Commission filed an antitrust lawsuit seeking to block Lockheed Martinit is
$4.4 billion plans to acquire rocket maker Aerojet Rocketdyne, arguing that it “would allow the combined company to use its control over Aerojet to harm Lockheed’s rivals in a way that would significantly lessen competition on several markets for products essential to national defence”.
Aerojet Rocketdyne, itself a merger in 2012, is the last major independent US manufacturer of rocket and missile engines. Its direct competitor, Orbital ATK, was acquired by Northrop Grumman in 2018.
Dozens of large companies played in the US defense industry in the 1990s. Today, there are a handful of mega-conglomerates. With few exceptions, even mega-deals like the 2019 United Technologies RTX tie-up 1.18%
and Raytheon were licensed.
This latest development seems to confirm that the same will not be the case under President Biden, FTC Chairwoman Lina Khan and Attorney General Merrick Garland. They promised a different, tougher approach to antitrust more generally, torpedoing high-profile deals such as the $30 billion combination of insurance brokers Aon and Willis Towers. The Pentagon is also increasingly led by critics of consolidation, such as Undersecretary of Defense Kathleen Hicks.
Investors were still caught off guard by the FTC’s decision, which sent Aerojet shares down about 19% on Tuesday. The company is not really Lockheed’s competitor, but its supplier: it derives around a third of its revenue from the larger company, for example by supplying Atlas rockets and Thaad missiles. The Northrop-Orbital deal, which was a very similar case of vertical integration, was cleared with the usual “driving remedies”. If the FTC wins its Aerojet case, the drastic divestiture required would likely make the acquisition unpleasant.
The new approach is consistent with antitrust authorities’ goal of moving beyond the single focus on “consumer welfare” popularized by the “Chicago School” of economics in the 1970s and take into account issues such as the market power of firms over suppliers. Aerojet is often the only supplier of “critical propulsion technologies” that could potentially be closed to Lockheed’s competitors.
Sam Weinstein, a Cardozo law professor and former antitrust attorney during the Obama administration, pointed out that the lawsuit received support from both Republican FTC commissioners as well as the two Democrats. “This is a strong case that goes to the heart of what mainstream antitrust considers good use of resources,” he said.
Research suggests that the Pentagon won’t necessarily get better prices by discouraging consolidation among its contractors. In fact, being able to rely on Lockheed’s track record might have enabled Aerojet to bid more aggressively, just as Northrop-Orbital used its combined might to become the sole bidder for the first phase of the Intercontinental Ballistic System of $85 billion from the government. For that reason, Lockheed’s gains from the deal were unclear: Its shares rose 4% on Tuesday as investors predicted that money earmarked for the deal could be paid out as dividends and redemptions instead.
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Of course, Lockheed can still choose to challenge the decision. More generally, consolidation strategies were already stretched thin: as Capital Alpha Partners analyst Byron Callan points out, there aren’t many good acquisition targets left beyond specific segments.
But there were still a number of mid-sized defense stocks buoyed by deal potential. This was part of the recent Aerojet stock buyout deal. Likewise, the eventual sale of Mercury Systems to a big contractor, which was being peddled by activist investors, now seems less likely.
Defense stocks, known for being annoyingly reliable dividend payers, may have gotten even more boring.
Write to Jon Sindreu at [email protected]
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