Second-Tier, Niche Firms Are Expected to Survive, Thrive
Lockheed Martin Corp.’s purchase of Northrop Grumman Corp. not only would put an exclamation mark on the ongoing shrinkage of the U.S. defense business, it would also further crystallize the industry into just two distinct groups.
One group is composed of the trio of giants that now casts an enormous shadow over all others in defense--Lockheed Martin, Boeing Co. (which is buying McDonnell Douglas Corp.) and Raytheon Co. (which is buying Hughes Electronics Corp.’s defense business).
The second group includes smaller, mid-size players that continue to thrive in selected aerospace markets, companies such as tank maker General Dynamics Corp., defense electronics producer Litton Industries Inc., the satellite-building unit of TRW Inc., and rocket manufacturer Thiokol Corp.
And the sharp division between the two groups is crucial to anyone evaluating the companies with an eye toward defense stocks, analysts said Thursday, because the shares will be buffeted by vastly different trends.
Lockheed Martin and the other behemoths will be particularly affected by long-term trends in U.S. defense spending, because the companies’ product lines are spread across all areas of the defense budget.
For the smaller players, it’s more a question of whether they can continue to exploit the specific markets where they compete under the huge umbrella of the big three arms makers.
“The second tier can continue to survive, because there’s going to be opportunities in selected niches for those people,” said Mark Biagetti, vice president of First Equity Development Inc., an investment banker in Stamford, Conn., who specializes in aerospace.
Byron Callan, defense analyst at Merrill Lynch & Co. in New York, said the second tier should still prosper because “big companies, no matter how big they get, can’t be everything to everybody. You see that time and again in any industry.”
There’s another factor at work with the smaller firms: They still remain takeover targets, even if the industry’s merger spree has slowed.
“You can expect transactions to occur in the mid-range sector,” said one investment banker who advises aerospace companies and asked not to be identified. “There is still too much capacity in the industry” relative to the decline in defense spending, he said.
Indeed, it’s been the breathtaking plunge in defense spending since the mid-1980s that sparked the merger wave among defense contractors, because there simply hasn’t been enough work from the Pentagon to keep them all running as independent, profitable enterprises.
After the blockbuster Boeing-McDonnell Douglas deal was announced in December, that merger wave largely ebbed this year. That slowdown--together with ongoing concern about whether defense spending will pick up, and expectations that Boeing, Raytheon and the others will need time to digest their new acquisitions--has left many defense stocks trailing the broader market this year.
For instance, the stocks of Raytheon and Lockheed Martin are up 8% and 13%, respectively, for the last 12 months, compared with the 36% surge in the Standard & Poor’s 500 index.
And most defense stocks showed little reaction Thursday to Lockheed Martin’s big announcement, with most showing only fractional change.
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“The big issue for the majors is that the outlook for defense spending hasn’t settled down at all,” Callan said. “There’s concern that defense spending is not going to provide as strong a growth outlook [for the companies] as people were expecting.”
If the Northrop Grumman deal goes through, Lockheed Martin emerges not only as the biggest U.S. defense company but also among the most diversified, with interests that include the nation’s next generation of fighter jets (the F-22s), satellites and rocket launchers.
Boeing, already the dominant maker of commercial jetliners, will stand as a premier defense aircraft maker after the McDonnell Douglas deal, building the F/A-18 fighter jet and the C-17 transport plane. Having already bought Rockwell International Corp.’s aerospace lines, Boeing is also among the key players in space programs.
The other giant, Raytheon, is a leader in radar and other defense electronics, especially with its plans to buy the defense lines of Los Angeles-based Hughes Electronics and Texas Instruments Inc.
Among the smaller players still thriving in certain niches--and still standing as potential takeover targets--are Alliant Techsystems Inc., a leading maker of ammunition; BF Goodrich Co.’s aerospace group, which makes landing gear and other components for military aircraft; and TRW’s satellite-building unit in Redondo Beach.
And many observers expect a major deal involving Woodland Hills-based Litton, which is one of the last defense companies still headquartered in Southern California.
Litton has interests in defense electronics and shipbuilding, and speculation runs high that its shipbuilding lines will be merged eventually with a rival shipbuilder, perhaps General Dynamics.
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A Look at Defense Stocks
Aerospace and defense stocks have badly lagged the general stock market for the last year. Now, Lockheed Martin plans to buy Northrop Grumman and further shrink the industry, but analysts say prospects for the remaining mid-size players are still bright. Here’s what the field looks like:
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Thursday Daily Stock’s % change Company close change last 12 months Alliant Techsystems $55.50 +0.44% +17% Boeing* 55.19 +0.38 +21 BF Goodrich 43.81 unchanged +15 General Dynamics 75.63 +0.69 +17 Litton Industries 49.50 +0.38 +13 Lockheed Martin** 99.13 --4.88 +13 Loral Space 15.19 +0.13 +8 Raytheon*** 53.75 +0.75 +8 Thiokol 71.56 +1.50 +82 TRW 59.00 --0.44 +31 S&P; 500 916.92 +12.89 +36
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* Plans to buy McDonnell Douglas
** Plans to buy Northrop Grumman
*** Plans to buy Hughes Electronics’ defense group
Source: Bloomberg News
