Despite Great Effort, Litton’s Troubles Persist
When Fred O’Green became only the second chief executive in the history of Litton Industries in October, 1981, he set out to recast the very character of the firm--a 1950s-style conglomerate with its hands in a vast array of industries.
Under a restructuring that included the divestiture of 25 corporate divisions with sales of $1.3 billion, Litton focused itself on three core industries that management considered the best of its high-technology lot.
But that strategy has done little to avert a painful series of recent upsets that have slashed profits, undermined its status as an ethical contractor and left a dent in its reputation for doing top-notch work in defense electronics.
Litton’s experience seems to show that corporations flocking to the 1980s strategy of divesting themselves of extraneous divisions and focusing their operations more narrowly will not necessarily find the panacea that they expect.
Litton was founded in 1953 as a conglomerate, before the term had even been invented. The theory of the conglomerate was based partly on the idea that diversification lessened the risk of everything going bad at once.
“Conglomerates not only still work, they are a natural business form, providing that the public sees value,” Roy Ash, the retired co-founder of Litton Industries, said in a telephone interview. “General Electric has value, and it’s made up of a lot of operations.”
Litton stock is widely considered to be undervalued in the market. Analysts say that Litton’s defense electronics segment alone could be sold for more than the $2.1-billion market value of the entire company.
The company attempted to bolster its stock price last year when it spent $1.3 billion to buy back 36% of its outstanding common stock at $87.60 per share, leaving 27.2 million shares outstanding. But since that buy-back, the stock price has sunk to $76.
Laggard performance, including two consecutive annual declines in net income, is largely to blame. In addition, Wall Street analysts have been consistently downgrading their projections of Litton’s profits in recent months. All three of its core industries--defense electronics, oil exploration services and industrial automation--have experienced difficult business conditions or problems of their own making.
Keeps Getting Worse
“Every quarter it looks like it has gotten a little bit worse,” said John Simon, an analyst at Seidler Amdec Securities. “I have been steadily reducing my estimates.”
Litton, headquartered in Beverly Hills, reported 10 days ago that its net income dropped 76% in fiscal 1986, which ended July 31. The company was stung by big write-offs in its troubled oil exploration services business and its sometimes balky defense business.
In addition, the firm had to cough up $17 million to settle charges that its Clifton Precision special devices division in Springfield, Pa., had defrauded the Navy. Litton pleaded guilty in July to a 325-count indictment that charged that the unit had inflated its cost estimates.
O’Green declined to be interviewed, saying that it would be “inappropriate” while the firm remains under suspension by the Defense Department in connection with the Clifton Precision incident.
The Pentagon suspended Litton from bidding on new contracts, which has caused the loss of “significant business,” the company said. Last month, the suspension against Litton’s largest defense contracting units was lifted, but several units, including Clifton Precision, remained under suspension.
The fraud charges and the ensuing suspension were only the latest trauma that has beset the firm and it will likely be the easiest to correct. More nettlesome will be Litton’s problems in its defense electronics, industrial automation, oil exploration services and microwave oven manufacturing operations.
Main Areas of Growth
The engine of Litton’s internal growth has been its defense electronics business, which consists primarily of supplying the Air Force and Navy with navigation equipment, principally inertial navigation gear that uses mechanical and laser gyroscopes. In addition, it is a major supplier of so-called command, control and communications systems, which the military relies on to direct its forces in battle.
Operating profit at Litton’s advanced electronics sector, which includes the two principal defense electronics units, dropped to $116.8 million in fiscal 1986 from $221.9 million the year before. The principal cause was a $49-million pretax charge taken in the third quarter on the company’s contract to build an air defense system for the Saudi Arabian army.
Litton refuses to disclose exactly what went wrong in Saudi Arabia but completion of the program has been delayed 18 months. Litton has dismissed earlier speculation that the delay was caused by Saudi Arabia’s inability to pay for the system.
Under its fixed-price contract, Litton is apparently bearing the cost of whatever problems it encountered in building the $1.7-billion Saudi system. Significantly, Litton lost a bid last year to build an even bigger air defense system for the Saudi Arabian air force.
The Saudi work is not the only program to have run into hard times. Litton, which ranks as the nation’s 19th-largest defense contractor, depends on a wide variety of small- and medium-sized electronics programs for much of its military work.
Among its larger defense electronics programs is building radar warning receivers, which are devices that alert the pilot of a fighter plane or bomber to the presence of a hostile radar, either in a missile, in another aircraft or on the ground.
Sought Improved Receiver
Litton has had a lucrative contract to build these receivers, which can cost hundreds of thousands of dollars each, for the Air Force’s F-16 fighter. So, in 1981 when the Air Force wanted an improved radar warning receiver for the F-16, it went to Litton and asked for an update called the ALR-74.
The Air Force originally estimated that the ALR-74 would cost $59 million to develop and that the first six years of production would cost $720 million, according to the F-16 program office at Wright Patterson Air Force Base in Ohio.
After years of delay and a decision to build a more capable system, the service now estimates that development of the system will cost $223 million and that the first six years of production will cost $1.2 billion.
On top of the delays and cost growth, the Litton unit failed to pass operational tests in 1984 and did not provide adequate reliability, military officials say.
“When the development models were provided for testing, they came up with a large number of deficiencies,” Maj. Gen. Robert D. Eaglet, F-16 program manager, said in a telephone interview.
Not all of the cost growth and technical problems can be blamed on Litton, Eaglet said, but some can. “An unbiased judge could have put some of the blame on Litton, but other elements of the blame . . . lay on the government,” he said.
Now Has Competition
Last year, the Air Force decided to restructure the entire ALR-74 program and bring in a competitor, Loral Corp., to adapt yet another radar warning system for the F-16. Now, the service is funding both firms and will conduct a “fly-off” next year to see which is the better system.
In retrospect, Litton could have averted much of the problem if it had performed better, Eaglet said. “If it had worked right the first time, we would probably have been putting ALR-74s into the F-16 today,” he said. Robert S. Knapp, Litton director of public relations, said the ALR-74’s early problems have been fixed and that the system now works. He declined to say how much money the company has lost on its fixed-price contract to develop the system.
Such problems have become a wart on the firm’s otherwise excellent reputation for high-technology military work.
“They are very tough, very knowledgeable--businesswise and marketingwise,” a consultant familiar with the firm said. “They are very good at marketing intelligence. It is one of their strong suits.”
Moreover, the defense electronics business could be ready for an upturn. “From this juncture, the profit margins will get better, not worse, in defense,” said Laurence Lytton, an analyst at the investment banking firm of Drexel Burnham Lambert. However, Simon, the Seidler Amdec analyst, said profit margins are bound to suffer because of a generally bad defense-business environment and because the firm lost significant business due to its suspension.
Oil Business Worse
Whatever the business problems are in defense, they pale when compared to the oil exploration services business, which Litton has bet on heavily.
The firm acquired Dallas-based Core Laboratories for $190 million in early 1984, a time when it appeared that the oil services industry was at the bottom of a deeply depressed business cycle. Litton did not know just how much deeper it could go.
Litton took a $110-million pretax charge to earnings in the 1986 third quarter owing to a writedown of assets in its resource exploration group, which includes Core Labs and the Western Geophysical unit in Houston.
Since acquiring Core, Litton has laid off some of Core’s employees and shut down some of its locations, but the company declined to provide specific information about the downsizing of the operation or about how much of the writedown is attributable to Core.
Litton’s resource units provide such services as seismic analysis of geological structures and mineral analysis of drill-core samples. But those are services in little demand in most of the Oil Patch, where little drilling is going on because of the collapse of oil prices since last winter.
“It has been as devastating to . . . (Litton’s) energy division as to any company in the business,” John D. Wisenbaker, former chief executive of Core, observed. “I don’t know who could have predicted it.”
However, analysts suggest that Litton’s timing in acquiring Core demonstrated a lack of savvy.
Price Was a Mistake
“They were at least two years too early,” Simon said. “They could have gotten it cheaper, as we know now. The theory wasn’t a mistake, but the price was a mistake.”
Even Litton co-founder Ash, a supporter of O’Green, said the Core acquisition “did not exactly seem to be in sync.”
Litton’s resource exploration services unit posted preliminary fiscal 1986 sales of $565 million, down sharply from $709 million the year before, which did not include full-year results of Core Labs.
The modest recent rebound in oil prices will do little to turn Litton’s business around. Analysts say that oil prices need to go up to $17 to $21 per barrel from the current $15 range to make a significant difference in drilling activity.
Despite the cyclical problems, Litton believes that its investments in the oil services business will prove themselves in the long run, company spokesman Knapp said. “The world is going to run on oil and gas for a long time,” he said.
Meanwhile, Litton has two other divisions whose sales have not yet caught fire--industrial automation and microwave ovens.
The unit that makes microwave ovens, Litton’s best-known product, is again experiencing significant problems in its long-running battle with Japanese competitors. The operating profit of the unit, based in Memphis, Tenn., fell to $520,000 in 1986 from $10.1 million the year earlier, while sales plummeted 40%.
Tremendous Pricing Pressures
The Japanese are exerting tremendous pricing pressures on Litton. One telling example: A Litton employee complained recently that Litton sells its microwave ovens directly to employees at higher prices than charged by some discount outlets that also must carry Japanese models.
“I’ve examined their prices and I’m not at all impressed,” the employee said. “You’re better off going to Gemco if you want a Litton oven.”
Litton agreed to sell the microwave-oven unit to Whirlpool in 1984 for what analysts believed was about $100 million, but the deal fell through two months after it was announced. Both companies have refused to comment but Wall Streeters say that Litton decided in the middle of negotiations that market conditions were turning up and tried to raise the price. Whirlpool balked, and the deal fell through.
The industrial automation business, made up of machine tools and industrial software operations, has yet to take off. The market remains depressed because of lagging capital investment in the United States.
Litton’s Ingalls Shipbuilding Division in Pascagoula, Miss., is doing well, analysts say.
On Thursday, Ingalls was awarded a Navy contract to build an amphibious assault ship with options for two more. The three ships are worth $1.2 billion of business. Ingalls’ profits jumped 26% in 1986 on a 22% increase in revenue. It remains among the healthiest and most modern U.S. shipyards.
But that bright spot had such a good 1986 that its profits are likely to decline in fiscal 1987, Jack Kelly, an analyst at the Goldman, Sachs financial house, said. Kelly is forecasting a drop in Ingalls’ operating profit to $110 million from $118 million.
Despite Litton’s current woes, few analysts, former executives or competitors fault O’Green for his basic strategy in recent years.
“What did they have to work with?” Kelly asked. “The things they held onto are good businesses, but every business has a cycle.”
Exercising Caution
As long as the current cycle persists and Litton remains substantially undervalued, O’Green appears to be exercising substantial caution.
For one thing, Litton has been sitting on a $1.6-billion cash balance and has not said what it is for, other than to suggest obliquely that it may be tapped for “growth.”
However, it is likely that the cash is a permanent insurance fund to be used if Los Angeles-based Teledyne ever decides to sell its 26% holding of Litton shares. Litton would certainly not want those shares falling into the hands of a corporate raider.
“If you have money, what is it for?” asked Ash, the Litton co-founder. “You either buy your own shares or another company’s. Would they want to be in a position to buy (Teledyne Chairman Henry) Singleton’s shares if they become available? It would seem to me to be a reasonably prudent posture.”
Indeed, as long as Litton’s liquidation value remains substantially above its market value, the company’s principal protection against a hostile takeover is Teledyne’s 26% block of stock.
But aside from the possible calamity of having to defend Litton against a hostile takeover attempt, O’Green has his hands full with the company’s internal problems.
“He is a hands-on manager,” Ash said. “He demands performance, or else.”
