News Analysis - TRW - an acquisition too far for Northrop Grumman?

GRAHAM WARWICK / WASHINGTON DC

Bid has raised a few eyebrows in the USA but only hurdles so far are the TRW board and Ohio's anti-take-over laws

TEXT: Not all of Northrop Grumman's 15 acquisitions over the last eight years have been easy. The merger with Grumman which created the basis for today's company came after a bitter bidding war with Martin Marietta. And Northrop Grumman had to beat off a rival offer from General Dynamics to secure its latest acquisition, Newport News Shipbuilding.

So far, the only declared opponents to the US defence giant's bid for TRW are the latter's board and the anti-take-over laws of Ohio, where the aerospace and automotive firm is incorporated. Northrop Grumman's response has been to challenge the laws in court, while taking its $5.9 billion all-stock offer direct to TRW's shareholders.

Coming so soon after its acquisitions of Litton Industries and Newport News, the company's bid for TRW has raised a few eyebrows in the USA - not because the acquisition makes no sense, but because Northrop Grumman risks the fate of other industry consolidators which have grown too rapidly and had to shed businesses to restore financial performance.

As the currency of its offer for TRW is its stock, Northrop Grumman's reputation as one of the aerospace and defence industry's solid performers is coming under the microscope. President and chief operating officer Ron Sugar says the company "has not got too big too fast", and points to its track record of rapidly and successfully integrating acquisitions.

Except for the period of its blocked merger with Lockheed Martin in 1998-9, Northrop Grumman's enterprise value - its market capitalisation plus net debt - has risen steadily from under $2 billion in 1992 to around $16 billion today. After each acquisition, the company has beaten its cost saving and debt reduction targets, he adds. "We have not stumbled yet. There is no guarantee, but we think we know what we are doing," he says.

Today's Northrop Grumman is the result of a persistent strategy of building and shaping a portfolio of businesses positioned in the "sweet spot" of defence capabilities, says Sugar. "Ten years ago, after the fall of the Berlin Wall, Northrop depended on the B-2. They were not sure if the company had a future," he adds. Kent Kresa, chairman and chief executive, saw a future in intelligence, surveillance and reconnaissance, precision strike and cyberwarfare, says Sugar, and embarked on a series of acquisitions to make that vision a reality.

The strategy has included integrating the acquisitions rapidly to achieve the benefits quickly, while continuing to improve programme and financial performance. "Focus on programme performance and the financials will follow," he adds.

After a "transformational year" which saw the company double its size in 2001 through the acquisitions of Litton, Newport News and the electronics business of Aerojet, the challenge this year is to "integrate and execute", he says, adding that the integration part is ahead of schedule. According to Sugar, Litton is fully integrated, including the stand up of new Ship Systems and Component Technologies sectors, and Northrop Grumman is on track to achieve its promised $250 million in annual savings from the acquisition by 2004. Newport News will be stood up as a new sector by the end of this month, and the company believes it can achieve $200 million in annual savings within the next three to four years.

The Litton and Aerojet integrations have been the most extensive. The company's Electronic Systems sector now has three business units that are a combination of Litton and heritage Northrop Grumman operations. In addition, a new navigation systems unit is comprised entirely of former Litton businesses, while a space systems unit has been formed by merging former Aerojet and heritage Northrop Grumman operations.

If its bid for TRW succeeds, integration would not begin until the end of the year, says Sugar - and the initial plan is to stand the company up as a separate sector, while consolidation opportunities are identified. Northrop Grumman wants TRW for its spacecraft systems, defence electronics and information technology businesses. Acquiring TRW would make the company a satellite prime contractor, add a communications system capability, and bring high-energy lasers for missile defence and information architectures for command, control, communications, computers, intelligence, surveillance and reconnaissance, says Sugar.

Northrop Grumman believes the US Department of Defense, which could block the deal, will see the take-over as pro-competitive and "transformational" - the current buzzword in military circles. "We can take TRW resources and put them with other assets that are in the mainstream of transformation. That is not readily available to TRW now," adds Sugar.

Taking over TRW poses challenges, not least Northrop Grumman's plan to sell or spin off the company's automotive parts business as soon as the deal is done. Automotive accounted for $10.1 billion of TRW's $16.4 billion sales last year. Sugar says the plan is to sell or spin the business "with an appropriate level of debt". TRW is burdened with $5.5 billion of debt, and getting rid of some of that via the automotive business is key to Northrop Grumman delivering on its promise to bring its debt-to-equity ratio back to the current level of below 40% by year-end.

While TRW says the $47-per-share offer undervalues its businesses, Sugar makes clear that Northrop Grumman "will not buy the company at a price that does not offer value". The acquisition fits a strategy that has so far proved to be sound and successful - and it would round out Northrop Grumman's business portfolio. "But we don't need it at any cost," says Sugar.

TRW's board is expected to respond to Northrop Grumman's hostile take-over bid by close of business on 15 March.

Source: Flight International