RAYTHEON HAS PAID a high price to perform the last major act in US aerospace-industry consolidation - or perhaps the second-to-last, because the failure of Northrop Grumman's bid to dominate the US defence-electronics industry places a question mark over the company's future direction.
Bids for Hughes started at $9 billion and are reported to have topped $10 billion, before General Motors (GM) accepted Raytheon's $9.5 billion stock-and-debt offer. This represents a substantial premium on Hughes annual revenues of around $6.2 billion, excluding its satellite and automotive-electronics businesses, which are not being sold by GM. The premium may be worth paying to become the leader in defence electronics - the industry's most profitable sector.
Raytheon has paid a similar premium for Texas Instruments' (TI) defence-electronics business, in a $2.95 billion cash deal which was viewed as having strengthened its bid for Hughes, by increasing the value of its stock. GM will take $5.1 billion of the Hughes' purchase price in Raytheon stock, for tax purposes. The company apparently agreed with analysts who ranked Raytheon's stock higher than that of Northrop Grumman, which reportedly made the higher bid.
The emergence of a third major player in the US aerospace industry is of critical importance given the vertical integration which has occurred with Lockheed's merger with Martin Marietta and acquisition of Loral, and Boeing's purchase of Rockwell's defence business and agreement to acquire McDonnell Douglas (MDC). Even Lockheed Martin chairman Norman Augustine is concerned about its effects on competition.
Augustine acknowledges that a creeping loss of competition has occurred because of consolidation. An example is the training system for the Lockheed Martin/Boeing F-22, business which would once have fuelled competition between several companies, but for which only Hughes made a bid. Lockheed Martin's purchase of Loral eliminated one competitor, and MDC had elected not to bid.
Augustine says that such elimination of competition is an unintentional effect of consolidation, and that he would personally be happier with more, rather than fewer, competitors, but consolidation on the scale now being seen in the USA, such as Boeing's $13.3 billion bid for MDC and now the Hughes sale, has competitive effects which are difficult to predict - and avoid.
Raytheon will become the USA's third largest aerospace company, and the leading defence-electronics supplier, edging ahead of Lockheed Martin, with $13 billion in defence-electronics revenues including the TI and Hughes acquisitions. Northrop Grumman will be a distant fourth, with two-thirds of its $8 billion in revenues coming from defence-electronics sales.
The impact on competition will be significant in certain sectors. Raytheon and Hughes are the only US manufacturers of air-to-air missiles, for example, and among the leading suppliers of surface-to-air and air-to-surface missiles, electronic-warfare equipment, air- traffic-control systems and electro-optical sensors.
The US Department of Defense (DoD) is facing a loss of competition in air-to-air missiles. Hughes and Raytheon already compete to produce the AIM-120 Advanced Medium-Range Air-to-Air Missile (AMRAAM) and co-operate to manufacture the Standard naval air-defence missile. Hughes recently beat Raytheon to win the crucial contract to develop the next-generation AIM-9X short-range air-to-air missile.
A merged Raytheon-Hughes provides effective competition for Lockheed Martin in surface-to-air and Boeing/MDC in air-to-surface missiles, Hughes' surface-launched AMRAAM and Tomahawk cruise-missile businesses adding to Raytheon's Patriot air-defence and TI's guided-weapons. The combined company is also likely to dominate the airborne-radar, electronic-warfare and air-defence/ airspace-management markets where Northrop Grumman is hoping for much of its growth.
In most of these areas there are now at least four competitors. After the Raytheon-Hughes merger there will be three - or perhaps only two. While the loss of competition in areas other than air-to-air missiles would be less critical, because independent suppliers do exist, it is questionable whether such companies can muster the resources to compete effectively against the vertically integrated might represented by Lockheed Martin, a merged Boeing/MDC and Hughes combined with Raytheon. TI decided to sell its defence operations because it believed it could no longer do business, or compete, with Lockheed Martin. If other small players, such as ITT, Litton and TRW decide likewise, then the competitive picture could change dramatically.
Some financial analysts believe it possible that Northrop Grumman could end up part of Raytheon within two to three years. The company has increased its emphasis on defence electronics and commercial aerostructures as its military-airframe business has declined with the end of the B-2 programme. A Hughes purchase would have completed its transformation - without it, Northrop Grumman's business could be seen as lacking critical mass.
The DoD, which has yet to make its feelings known about the Boeing/MDC merger, now has the Hughes sale to consider. Its attitude so far has been to let the industry proceed, but the time for laissez faire may be coming to an end.
Raytheon, meanwhile, has to tackle a debt load that will balloon to $11 billion from $3 billion. Analysts are predicting that it will sell or spin off some of its commercial businesses to reduce debt, with its Raytheon Aircraft division among the possibilities.
Source: Flight International
