Suit Filed to Stop Merger of Defense Giants

The Justice Department filed suit Monday to block Lockheed Martin’s controversial $11.6-billion acquisition of Northrop Grumman, the largest merger ever challenged by federal regulators.

Defense Secretary William Cohen and Atty. Gen. Janet Reno presented a united front against the two defense giants, asserting that the merger would result in lower-quality weapons and higher costs for taxpayers.

The tough antitrust action signals an end to the era of multibillion-dollar deals once encouraged by the Pentagon that have transformed the post-Cold War defense industry and left just four firms controlling the bulk of weapons sales and defense research.

The suit, filed in U.S. District Court in Washington, charges that the merger would create monopolies in a wide range of critical defense technologies, from airborne radar to defensive systems for jet fighters. The combination also would create serious conflicts of interest, giving Lockheed access to sensitive information on its rivals, the suit says.

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Northrop and Lockheed sharply disputed the assertion that the deal would be anti-competitive and vowed to fight the suit, a process that could take four months or longer. The firms contend that they can jointly save the Pentagon $1 billion annually.

Reno and Cohen, invoking a highly charged allegation at a joint news conference here and offering a preview of the heat that the government will apply to the two defense giants, suggested that the merger would jeopardize the lives of American troops.

“This merger isn’t just about dollars and cents, it’s about winning wars and saving lives,” Reno said.

If the deal is blocked, the Southern California economy may come out better off in the short term. Hundreds, if not thousands, of jobs would be in jeopardy if the two firms combine and move to eliminate duplication. In other recent acquisitions, Boeing and Raytheon aggressively slashed employment in California while protecting jobs in their home states.

But experts are divided on whether Northrop as an independent company can effectively compete against rivals that are far larger and more diversified. It has already told its employees and investors that its best hope is to sell out to Lockheed.

Antitrust experts and securities analysts generally give Lockheed little chance of succeeding in its legal challenge against the Pentagon and the Justice Department.

“The deal’s dead,” said Steven Sunshine, who headed merger enforcement at the Justice Department in the early years of the Clinton administration. “If the Department of Defense, which is the sole customer for these systems, says the deal is going to hurt them, it will be difficult to convince a court otherwise.”

Aerospace analyst Jack Modzelewski of Paine Webber said that he is growing increasingly concerned about the political environment facing defense contractors and that the looming antitrust battle only reinforces the risks ahead.

Modzelewski noted that profit margins at major defense contractors have doubled since 1990, while the number of defense contractors has dropped sharply. For the first time since the 1980s, allegations of overpricing and gouging are occurring. The allegation that the Lockheed-Northrop deal jeopardizes soldiers’ lives only adds to the level of that rhetoric.

“The sloganeering is bothering me,” he said. “It is not favorable for the defense industry.”

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But Charles F. Rule, who headed the Justice Department’s antitrust division in the 1980s, does not fault the government for invoking patriotic symbols in challenging the combination.

“They would be fools not to push all the levers,” Rule said. “Frankly, that kind of flag-waving is one thing [the companies] are going to face if they have to go to court.”

However the antitrust suit turns out, future mega-mergers in defense are out, and even smaller deals between subcontractors may be less likely, said aerospace analyst Wolfgang Demisch of BT Alex. Brown.

“The antitrust weapon is very powerful and a lot of rational consolidation in the supply sector may be just as susceptible as the Lockheed-Northrop merger,” Demisch said. “This may have widespread consequences affecting consolidation.”

In explaining the basis for blocking the deal, Justice and Defense officials said the combination would lead to unacceptable levels of vertical integration, in which Lockheed would control both the weapon systems and the key components in the systems. Such concentration would enable the firm to squeeze out competitors, raise prices and effectively block technological innovation.

In addition, Cohen said the Pentagon’s sources for tactical aircraft would be limited to Boeing and Lockheed if the merger goes through. In addition, Lockheed and Northrop are the leaders in stealth technology. The complaint filed in federal court cites as evidence an internal memo written by Lockheed Skunk Works Chief Jack Gordon to the head of Lockheed’s aeronautics sector, Mickey Blackwell.

“Lockheed Martin would consolidate its dominance of stealth-related technology,” according to the memo dated Jan. 24, 1997.

But officials close to the deal said that the government made serious factual errors in its case and that it is entirely within reason for the two defense firms to win.

Although the government sees the deal as anti-competitive, the two firms issued a joint statement saying that it “will enable an even higher level of competition and innovation that will directly benefit our armed forces.”

The government’s suit is seeking a preliminary injunction, a process that could take four months or longer to litigate. It is highly unlikely that the firms would pursue the case, if they lose at the preliminary injunction stage, according to sources close to the deal.

Northrop shares rose 50 cents Monday to $107.50 after falling as low as $104.13; Lockheed eased 38 cents to $116.63. Both trade on the New York Stock Exchange.