Critical Mass : Lockheed-Northrop Deal Will Likely Be Last in a Series, Analysts Say

By PAUL RICHTER and JUBE SHIVER Jr.

July 4, 1997 12 AM PT

TIMES STAFF WRITERS

WASHINGTON —

The benefits of the dizzying defense consolidation of recent years are still hotly debated, but supporters and critics seem to agree on one point: The proposed huge merger of Lockheed Martin Corp. and Northrop Grumman Corp. will probably be the trend’s finale.

The wave of mergers that began in 1993 has now winnowed the industry to three behemoth players that are expected to compete on all major defense contracts. Pentagon officials believe the mergers have given the armed forces better products at a cheaper price than would have been the case if a destructive industry shakeout had been allowed to occur.

Yet many analysts also agree that cutting the main players to only two--or one, for that matter--could threaten innovation and price, as well as create concern in Congress. While these analysts acknowledged that this judgment is partly guesswork, they say that cutting the dominant players in the defense industry to two would be too much.

“In the end, these mergers have been the right thing to do for competition, and for cost,” said Daniel Goure, an analyst at the Center for Strategic and International Studies in Washington. But, he added, “this ought to be the end of the road.”

The consolidation wave did not occur by accident but, rather, was set in motion by the conscious design of the Clinton administration in its first year. Fearing that national security--and the economy--would be hurt by a wave of bankruptcies caused by defense budgets that plummeted after the Cold War ended, the administration set out in 1993 to begin a merger wave.

It pushed to ease antitrust rules and began reimbursing companies for their merger expenses. Since 1993, contractors have been entitled to one-third of what their mergers save the Pentagon--a subsidy that has cost hundreds of millions of dollars.

In the view of defense officials, it was far better to have an orderly consolidation into a few large companies than a splintering into small companies that might lack the deep pockets, staying power or skilled staffs to finance and execute big multiyear procurement projects.

Partly as a result of administration policy, the defense industry has consolidated into what one analyst termed “the three gorillas”--Boeing Co., Raytheon Co. and Lockheed Martin.

The Defense Department’s solid support for the trend is one reason why most analysts and several government officials predict that the Pentagon will bless this latest deal. Kenneth Bacon, the chief Pentagon spokesman, said a final decision on the merger will probably take several months.

Antitrust rules call for the Pentagon to offer a recommendation on the national security implications of each deal to the antitrust regulators at the Department of Justice and the Federal Trade Commission.

The announcement of the deal brought warnings from some quarters that combining Lockheed and Northrop would stifle competition and drive up prices in certain areas.

For instance, Lockheed is the prime contractor on the Air Force’s new F-22 fighter, and Northrop is secondary contractor on the Navy’s newest fighter models, the F/A-18 E and F.

“I think, in the long term, you are going to end up with a classic duopoly that will raise the cost of procurement,” warned Lawrence Korb, a former defense official now with the Brookings Institution.

Analysts from Rand Corp. think tank in Santa Monica, meanwhile, cited a new study showing that in periods of rapid innovation in air power, the smaller, hungrier rivals--rather than dominant firms--have come up with the winning designs. This was the case, for example, in the 1920s and 1930s, when the smaller North American Co. produced the P-51 Mustang fighter, Lockheed developed the P-38 Lightning, and Republic Aviation offered the P-47 Thunderbolt.

The Defense Department and other analysts, however, see a different picture, one in which combinations not only give them partners with greater financial strengths, but also sop up excess manufacturing capacity.

This was the case in 1992, when the Army fought off the FTC’s plans to block the acquisition of Stamford, Conn.-based Olin Corp. by Alliant Techsystems Inc. of Hopkins, Minn. The regulators believed the combination would raise the cost of 120 millimeter ammunition by as much as 23%, but the Army countered that the purchase would reduce excess capacity and save the government money in the long run.

The Army’s view prevailed.

Yet there can come a point of too much consolidation--and many experts believe that with this deal, the defense world will have reached it.

With three companies competing in almost every area, there is less risk that the two firms will effectively collude to divide up the market between them in a way that raises costs and slows innovation.

Or as Goure, the defense analyst, puts it, with three major companies, “you’ve got to be paying attention; with two, you’ve got to really watch it.”

He also cautioned that the political fallout of a further combination could be huge.

Big defense contractors wield vast power in Congress under any circumstances. If there were only two firms, “you begin to upset everyone’s political tolerance,” Goure said.

A spokesman for Lockheed Martin was more blunt. A merger between any of the remaining three companies “would be pretty difficult to do,” James Fetig said. “I don’t think the government would allow it. It’s just not realistic.”

Deal Developments

* Lockheed Martin announces it will pay $11.6 billion for Northrop Grumman. A1

* Northrop Grumman workers are upbeat yet concerned upon learning of the acquisition plans. D5

* The merger would further polarize the giants and mid-size companies. D5

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Defensive Maneuver

Capping the dramatic consolidation that has characterized the aerospace industry since the end of the Cold War, Lockheed Martin Corp. said it will acquire Los Angeles-based Northrop Grumman Corp. for $11.6 billion. A look at the firms:

Lockheed Martin

* Headquarters: Bethesda, Md.

* Chief executive: Norman R. Augustine

* Employees: 180,000

* 1996 revenue: $26.9 billion

* 1996 earnings: $1.3 billion

Northrop Grumman

* Headquarters: Los Angeles

* Chief executive: Kent Kresa

* Employees: 46,600

* 1996 revenue: $8.1 billion

* 1996 earnings: $234 million

Second-Largest Deal

Lockheed Martin’s planned acquisition of Northrop Grumman would be the second-largest aerospace industry marriage after December’s McDonnell Douglas-Boeing merger. Largest aerospace/defense industry mergers:

*--*

Rank Target Buyer Announced 1 McDonnell Douglas Boeing Dec. 17, 1996 2 Northrop Grumman Lockheed Martin July 3, 1997 3 Lockheed Martin Marietta Aug. 30, 1994 4 Signal Cos. Allied. May 15, 1985 5 Rockwell International’s Boeing Aug. 1, 1996 space and defense business 6 General Electric’s Martin Marietta Nov. 23, 1992 aerospace division 7 Grumman Northrop March 10, 1994 8 General Dynamics’ Lockheed Dec. 9, 1992 fighter jet division

Value, in Rank billions 1 $13.4 2 11.6 3 5.2 4 5.1 5 3.1 6 3.1 7 2.1 8 1.5

*--*

Top 10 Then and Now

Rapid consolidation has given the top two players in the aerospace industry double the percentage of contracts held by the two largest contractors five years ago. Top players in 1991 and 1996, by share of Defense Department contracts:

1991

McDonnell Douglas: 5.9%

General Dynamics: 5.7

General Electric: 3.6

General Motors: 3.2

Raytheon: 3.0

Northrop: 2.4

United Technologies: 2.0

Martin Marietta: 1.9

Lockheed: 1.9

Grumman: 1.7

The top 10 held 31.3% of the $136.6 billion in defense contracts.