Boeing comment sparks talk of mega defense merger

WASHINGTON Thu Sep 9, 2010 8:24pm EDT

Dennis Muilenburg, President and CEO of Boeing Defense, Space & Safety, speaks during the Reuters Aerospace and Defense Summit 2010 in Washington September 7, 2010. REUTERS/Molly Riley

Dennis Muilenburg, President and CEO of Boeing Defense, Space & Safety, speaks during the Reuters Aerospace and Defense Summit 2010 in Washington September 7, 2010.

Credit: Reuters/Molly Riley

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WASHINGTON (Reuters) - A dearth of new programs, prospects for flat or declining defense spending and an aggressive Pentagon cost-cutting drive have revived talk of another big defense merger for the first time in years.

Boeing Co (BA.N) defense chief Dennis Muilenburg startled many this week when he told the Reuters Aerospace and Defense Summit he would not rule out the possibility of a large-scale merger.

"I'm not going to rule out or rule in any options," Muilenburg told the summit on Tuesday. "Obviously, as we see defense budget pressure, that does at times lead to potential consolidation."

For years, industry executives had insisted that a wave of consolidation in the 1990s that winnowed the top tier of the defense sector to five big players had run its course.

Boeing was sending a clear message to shareholders that it would remain flexible heading into this phase of flat and declining defense spending, Richard Aboulafia, vice president of analysis for the Virginia-based Teal Group, told Reuters.

But it could also be sending up a trial balloon to gauge the Pentagon's reaction, he said.

Defense analyst Loren Thompson said weapons demand fell by 50 percent during the last two downturns, spurring earlier consolidation, and the same could happen again this time.

"That means that at least one of the big players will have to exit if we are facing a similar downturn in the years ahead," Thompson told the Reuters Summit.

"There's not enough business to go around," said one former senior military official who now works in industry, but who was not authorized to speak on the record.

Northrop Grumman Corp (NOC.N) would be a good fit with Boeing, although there could be antitrust concerns about the two companies' space operations, Thompson said.

MERGER COULD GIVE BOEING A STAKE IN F-35

"Boeing has a big revenue shortfall on the defense side that it needs to cover. Buying part or all of Northrop could fix that problem, while giving it entry into the Joint Strike Fighter program," Thompson said, referring to the $380 billion Lockheed Martin Corp (LMT.N) F-35 fighter program.

Northrop has a large role on the program, which Lockheed beat out Boeing to win in 2001.

Northrop Chief Executive Wes Bush told the Reuters summit that the defense contractor has no plans to break itself up, rejecting speculation that the planned separation of its $6 billion shipbuilding unit -- the latest reshaping of its portfolio -- could lead to a break-up of the whole company.

Asked about the likelihood of mergers between big defense companies, Bush said: "All companies have fiduciary obligation to shareholders to have an open mind ... But I would not forecast on the near-term horizon any large-scale activities."

Tess Oxenstierna, managing director with Bank Street, told the Reuters Summit that companies regularly reviewed their portfolios to adapt to changing times, but escalating budget pressures could cause more restructuring in coming years.

"What these defense firms are doing now is really defining what is core and what is growth," she said.

LITTLE APPETITE AT PENTAGON?

William Farmer, co-head of the aerospace and defense group at Lazard Freres & Co, discounted the possibility of a large-scale merger taking place.

"From a regulatory standpoint it would be difficult to have something like that," Farmer told the Reuters Summit. "If you listen to the government and the administration, they are not in favor of large-scale mergers and acquisitions."

But at the second tier and below, a big wave of consolidation was already under way, given that companies were facing the first major setback in defense funding since the September 11, 2001, hijacking attacks, he said.

The last big merger in the sector came in late 2001 when Northrop took over the Newport News shipyard, part of the division it is now looking to sell.

In 1998, U.S. antitrust regulators blocked Lockheed's merger with Northrop.

Any attempt at yet another large defense merger will run into similar antitrust scrutiny by the Pentagon and therefore would be unlikely to end up in a deal, L-3 Communications Holdings (LLL.N) Chief Executive Michael Strianese said.

"Whether five companies become four or three, I'll go out on a limb and say I doubt it. There would be concern that there would not be enough competition," he said.

When asked about a possible takeover approach by a larger company, Strianese said: "We always have to be mindful of our obligations to shareholders. We're not up for sale. I'm not going to say never. I don't know what industry peers are thinking."

Deal volumes in the aerospace and defense industry have reached $4.2 billion so far this year, up 45 percent from the same period a year earlier, according to Thomson Reuters data.

That remains far short of the $14 billion worth of deals consummated in 2008, the year when Italy's Finmeccanica SpA (SIFI.MI) bought U.S.-based DRS Technologies for $5.5 billion in the second-largest defense deal of the decade.

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