Northrop to Buy Defense Operations of Westinghouse : Business: The $3-billion deal would shift the L.A. firm’s future from planes to military electronics.

Northrop Grumman Corp. agreed Wednesday to buy Westinghouse Electric’s defense business for $3 billion, transforming Northrop’s identity from airplanes to military electronics and raising its prospects of survival in the relentless consolidation of the defense industry.

The Los Angeles-based company would emerge from the deal with about $8.6 billion in annual sales, ranking it as the third largest supplier to the Defense Department, behind Lockheed Martin and McDonnell Douglas.

The deal would mean that Northrop Grumman’s money in the future is more likely to come from building advanced radar and battle command systems than from the B-2 bomber.

“At this point, we are a different kind of a company, focusing on electronics and systems integration,” Northrop Chairman Kent Kresa said in an interview. “We have significantly changed.”

The deal is a dramatic illustration of the rapidly rising values of defense companies, reflecting investor beliefs that future Pentagon budgets will rebound after a decade of steady erosion.

As the size of mergers and acquisitions has ratcheted up in the defense industry, Northrop has been challenged to keep pace or face the prospect of itself being gobbled up. Now the company has the “critical mass” needed to survive as an independent company, Kresa said.

The acquisition would actually have minimal impact on Northrop’s diverse operations in Southern California, but analysts expect significant cost-cutting and labor-force reductions at the Westinghouse unit, headquartered in suburban Baltimore.

While that operation is highly regarded for its technical capabilities and strong mix of programs, it lost $14 million on revenues of $495 million in its most recent quarter and generally has had profits below the industry average in recent years, analysts said.

It employs 12,000 workers in Maryland, Ohio, Connecticut and Sunnyvale, Calif., where it builds Navy propulsion systems. Best known for its radar, the Westinghouse unit also builds electronic warfare equipment, torpedoes, sonar and air traffic control hardware.

In the interview, Kresa said he moved aggressively shortly after the business was put on the block in early December as part of Westinghouse’s plan to reduce debt left from acquiring CBS for $5.4 billion last year.

Kresa said he met with Westinghouse Chairman Michael Jordan in mid-December and within days made an offer that “fully valued” the operation, which he called a “premier property with world-class people.”

Indeed, the $3-billion price tag is a high-water mark in defense acquisitions since the 1980s. The price represents $1.15 for every $1 of annual sales, surpassing even the top price that General Motors paid for Hughes Aircraft in 1986. At the industry’s nadir in 1990, defense properties were selling for the bargain basement price of 40 cents on every dollar of annual revenue, said Paine Webber analyst Jack Modzelewski.

“It is clear that these properties have had a massive run-up in prices,” he said.

In addition to the $3 billion in cash for Westinghouse, Northrop is absorbing an additional $600 million in pension and health care liabilities. Although Northrop’s pension plan is overfunded, Kresa said there are no current plans to merge the pensions.

Kresa rejected any suggestion that he is paying too much for the unit, saying that the deal would provide attractive tax benefits. He also noted that the Westinghouse operation has $3.8 billion in backlog orders and stands to get another $4 billion in sales from existing contracts.

Investors were less than enamored of the acquisition, which will water down Northrop earnings per share, and bid down Northrop shares $2.75 Wednesday. The stock closed at $62 in trading on the New York Stock Exchange, while Westinghouse shares shot up $1.25 to close at $18.375.

Northrop will finance the deal with a big increase in bank debt, which prompted Standard & Poors and Moody’s Investor Service to place Northrop under a credit watch for possible downgrading. Northrop closed 1995 with $1.4 billion in debt.

After the deal, Northrop would derive 25% of its revenues from commercial, non-defense government and international sales. Northrop would be a key subcontractor to Lockheed, McDonnell and Boeing, while a major force of its own in the aircraft and electronics market.

C. Donald Scales, aerospace consultant at A.T. Kearney, said the Westinghouse deal “reinforces Kresa’s intent to make sure the company doesn’t become a second-rate player in this game.”

Scales said Westinghouse’s operations fit perfectly into Kresa’s vision of focusing Northrop on high-value battle management programs. But while Westinghouse has a solid technical reputation, Scales said it is “bureaucratic,” adding that he “would not be surprised if there were some sizable cuts in the work force coming.”

Kresa said the company has no plans for layoffs and that the existing businesses “were pretty honed down and lean,” but he still raised the prospect of cost-cutting. If Northrop could cut $50 million in Westinghouse costs, it might eliminate any negative effect on Northrop’s profits, he said.

Perhaps more than any other defense contractor, Northrop has gone through a dramatic metamorphosis. Starting as a supplier of cheap jet fighters for export to undeveloped countries, Northrop turned the aircraft industry on its head by winning the contract to build the B-2 bomber in 1981.

It acquired Grumman Corp. last year, which increased electronics from 15% to 30% of sales and boosted its commercial aircraft structures business. Northrop now ranks as Boeing’s biggest supplier.

With the Westinghouse deal, the company will get half its revenues from electronics programs and will go head-to-head with Hughes Aircraft, long the industry’s high-technology leader.

Aerospace analyst Wolfgang Demisch said the acquisition would also raise Northrop’s profile in international markets and would clearly strengthen its ability to survive in the defense industry.

Westinghouse builds radars for Lockheed’s new F-22 fighter, the Lockheed F-16 jet, Northrop’s Joint STAR surveillance plane and the Boeing’s AWACS command aircraft. Hughes, meanwhile, builds the radar for Northrop’s B-2 bomber and the McDonnell Douglas/Northrop F-18 fighter.

Times staff writer James F. Peltz contributed to this story.