Northrop’s Electronics Talent Poses a Problem

In an era of shrinking defense budgets, electronics is becoming one of the most important pieces of the military’s arsenal. The reason: America’s military might increasingly depends on communications, intelligence and precision weapons that all need advanced electronics.

It is also far cheaper to upgrade the electronics system of an F-16 fighter jet or a B-2 stealth bomber to state-of-the-art technology than it is to build an entirely new aircraft.

That makes military electronics--especially the substantial capability of Northrop Grumman Corp.--a particularly vital component of the Pentagon’s array of weapons. At the same time, it has brought intense government scrutiny to Northrop’s proposed mega-merger with defense behemoth Lockheed Martin Corp.

In fact, Northrop’s military electronics business--one of the jewels of the Los Angeles-based aerospace firm--may turn out to be a victim of its own success.

Federal officials say they are adamantly opposed to seeing Northrop’s electronics talents combined under the same roof as defense giant Lockheed’s already formidable capabilities. Earlier this week, federal regulators filed suit in Washington to block the $11.6-billion deal.

The Justice Department and the Pentagon are both concerned that the merger would create for Lockheed a monopoly in several critical technologies, including airborne early-warning radars, electronic warfare systems and radar jammers.

“No previous merger has raised so many interrelated problems across so many markets,” Defense Secretary William Cohen said earlier this week.

While total defense expenditures over the next decade continue to decline, all types of spending on military electronics is projected to rise significantly. Today, electronics claims one in every five defense dollars, and by 2007 it will claim one in every four, according to estimates from the Government Electronics and Information Technology Assn., an Arlington, Va.-based trade group.

“There’s no question it’s very important, and it’s gaining in importance as we buy fewer and fewer weapons,” said Paul Nisbet, president of JSA Research, an aerospace research firm in Newport, R.I.

With more than half of the company’s nearly $9-billion annual revenue coming from military electronics--up from just 15% of total sales five years ago--Northrop executives say that the unit is critical to its future.

“There’s no doubt about that,” said Vice President and Treasurer Albert Myers, an engineer by training who spent 15 years in technical management with the company.

Over the next five years, Northrop expects electronics to grow to account for fully two-thirds of its total sales, said company spokesman Jim Taft.

Northrop’s electronics expertise is also critical for Bethesda, Md.-based Lockheed, said spokesman Charles Manor.

“More and more, the electronics are the key part of platforms,” ranging from planes to missiles to ships, he said. “It allows you to upgrade existing platforms and gives you new capabilities without the expense of starting from scratch. It’s clearly a priority of the Defense Department to make leapfrogs with electronics technology to upgrade existing platforms and give them a longer life cycle.”

That was Northrop’s vision in the early 1990s, when military outlays began shrinking, Myers said. So Northrop went shopping, outbidding Martin Marietta for Grumman in 1994, then snapping up the defense electronics arm of Westinghouse Electric Corp. in 1996 and Torrance-based Logicon Inc. last year.

Today, Northrop is heavily involved in the electronics that are embedded in a variety of advanced weapons systems and technologies. The company, for example, builds a flight-control system for jet fighters, the radar for the F-16 combat jet and the early-warning Hawkeye aircraft used aboard Navy carriers.

Other electronics programs focus on avionics, including the gyroscopes used for a plane’s guidance and navigation. The company also designs and builds cockpit fire-control systems for weapons delivery.

The rise of smart weapons is also feeding demand for electronics, Myers said. Bombs and missiles that can find their targets based on navigational input from the airplanes that carry them rely on ever-smaller and more advanced electronic brains.

Among Northrop’s less flashy electronics capabilities are systems for military communications, ground-based radar and air-traffic control. The company also focuses on integrating the various electronics systems that reside in a single plane.

Northrop has hardly abandoned its airframe-building business, but its focus on electronics represents a reasonable financial trade-off, said Roger Threlfall, an aerospace analyst at JP Morgan in New York.

“Generally, you make more money in platforms, but the margins are restrained,” Threlfall said. “Electronics margins are much higher, but that compensates you for a shorter product life cycle. You don’t get a 30-year program on electronics--and some are measured in mere months--but you can also earn a 20% return.”

Some analysts say the government’s objection to the electronics consolidation in a Lockheed-Northrop deal is little more than political posturing. Lexington, Mass.-based Raytheon Co. would still be a formidable competitor to the merged company, and the Defense Department could always steer contracts away from Lockheed if the government worried the firm had too much market power, they said.

“There are other sectors of the defense industry where the [Defense Department] has let the supplier base go down to one supplier,” said Jon Kutler, president of Quarterdeck Investment Partners, a Los Angeles-based investment bank that focuses on the aerospace and defense industry. “That’s why I believe a lot of this is being in the wrong place at the wrong time.”

But that doesn’t take anything away from the growing role of electronics in aerospace and defense, said Merrill Lynch aerospace analyst Byron Callan.

“Philosophically, militaries typically mirror societies,” Callan said. “The role of electronics is an ongoing growth factor in the U.S. society--and most societies around the world--and the same will be true in the military forces.”

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Electronics Growth

The electronics sector is winning a growing share of a shrinking Defense Department budget, making it an increasingly important area for profit-minded aerospace firms. Below are projected budget figures, in billions of dollars (constant 1998 dollars):

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Total Defense defense electronics Percentage Year budget budget of budget 1998 $254.3 $51.6 20.0% 1999 $253.1 $54.2 21.4 2000 $251.1 $54.0 21.5 2001 $249.1 $55.0 22.1 2002 $248.0 $56.2 22.6 2003 $247.0 $57.1 23.1 2004 $246.0 $57.7 23.5 2005 $244.9 $58.1 23.7 2006 $244.0 $58.6 24.0 2007 $243.0 $58.9 24.2

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Source: Government Electronics and Information Technology Assn., a member of the Electronic Industries Alliance