Clouds Darken Over Lockheed-Northrop Deal


Prospects appeared to dim Tuesday for a successful resolution of the antitrust dispute over the proposed merger of Lockheed Martin and Northrop Grumman, sources close to the deal said.

Signaling growing pessimism over the $11.6-billion acquisition, investors sent Northrop shares down $2.88 to close at $110 in trading Tuesday on the New York Stock Exchange. Lockheed shares closed at $116.37, up $1.75 on NYSE.

Justice Department officials had demanded early this week that the companies sharply restructure the merger and divest substantially all of Northrop's electronics operations from the combined company.

The firms came back with a counterproposal late Monday under which they would divest operations with an estimated $1 billion in annual sales. That offer was quickly judged by the government as "non-responsive," and Justice Department attorneys told the companies to come back with additional concessions.

Late Tuesday afternoon, Lockheed issued a statement saying that the offer would eliminate the government's antitrust concerns and "foster competition." Lockheed added that it had "made every effort to work with the government" to resolve the issues.

The government is inching toward filing a suit in federal court to block the deal on antitrust grounds, according to sources close to the talks. But the companies said they are still communicating with the Justice Department, holding out the potential for a resolution.

Northrop and Justice Department officials declined to comment on the latest developments.

"The process is evolving and we will have more to say at the appropriate time," said Lockheed spokesman Charles Manor.

Merrill Lynch aerospace analyst Byron Callan said he believes the deal is unlikely to be approved in anything near the form that shareholders approved last month. Rather, only a more limited exchange of assets may get through regulators.

Justice Department attorneys are giving the firms little room to maneuver. After the agency first disclosed its objections on March 6, the companies sought a month to respond. Last weekend, Justice Department antitrust chief Joel Klein sent a letter to Northrop and Lockheed, saying he wanted to hear back by Tuesday.

The agency's short fuse is making evaluating the financial consequences of various solutions difficult. A spinoff of all of Northrop's electronics business would be a $3-billion to $4-billion transaction that would likely force Lockheed and Northrop to renegotiate the value on their deal.

Northrop shares have fallen 21% from their peak of $139, reached after the deal was announced last July. The drop has resulted in nearly a $3-billion loss to investors.

"I don't think this merger isn't going to happen," said one investor.

Wounded arbitragers and other short-term investors are facing even more downside risk if the deal falls apart. Northrop was trading in the range of $90 to $100 before the merger announcement.

Some experts believe Northrop will be forced to find another suitor if the Lockheed deal falls apart, in part to placate angry shareholders. But it is doubtful regulators would allow alternative deals between Northrop and Boeing or Raytheon, the other major prime contractors in the U.S. defense industry.

An independent future for Northrop also seems fraught with problems. Northrop had committed itself to an independent future before the merger, and company Chairman Kent Kresa defended the switch in strategy last July after the merger agreement was announced as a good deal for shareholders, customers and employees. Can Kresa now convince investors that a switch in strategy makes sense again, one analyst asked.


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