Northrop Gains by Subtraction

by: Matthew Potter
July 15, 2010

Category: Acquisitions, BAE Systems, Business Line, Companies, Department of Defense, EADS, Events, General Dynamics, Lockheed Martin, logistics, missile defense, Mississippi, northrop grumman, Northrop Grumman Corp., production program, Restructuring, Services, States, U.S. Navy | RSS 2.0

Northrop Grumman (NOC) announced that they are considering selling their shipbuilding unit or even setting it up as a separate company. This news drove their stock to a recent high yesterday. The company has already separated a major part of their company with last year’s sale of TASC, its SETA branch and now seems willing to give up another part.

As part of the announcement the company also said that it would close one major and two minor yards in Louisiana and transfer all of their work to the Pascagoula yard in Mississippi.

The trend over the last twenty years had been consolidation of the defense industry in the United States. Companies used mergers and acquisitions to build their business and expand their product lines. Part of this was driven by the decline of the U.S. defense budget in the Nineties that led to less major programs and contracts which then supported fewer suppliers. Since 9/11 the large growth in defense spending has seen non-U.S. companies enter the market in large numbers to provide the necessary competition and capability. These companies like BAE Systems (BAE:L) and EADS (EADS:P) often established U.S. subsidiaries or acquired U.S. companies to allow market penetration.

It has been expected that the defense M&A market would start picking up due to the expected decline in the U.S. defense budgets. While there have been some deals this activity has not been at a high level yet.

This move by Northrop to divest its ship building may be a sign that such activity might be picking up. It is clear by the effect on the share price that the market feels this is a good move for the company.

Northrop faces a reduced market as the U.S. Navy finishes some products such as the LPD 17 amphibious assault ships and has limited near term future. The Navy will build the Littoral Combat Ship (LCS) but will choose between Lockheed Martin (LMT) and General Dynamics (GD) for that product. The new destroyer and cruiser were canceled with the focus being on the DDG-51 continuation. Northrop builds that ship along with General Dynamics.

Because the U.S. ship building market looks bleak it might be hard for another defense contractor to acquire Northrop’s group and it might end up as a separate company.

The U.S. defense industry looks like it is entering a phase of re-structuring similar to what happened twenty years ago and which is not unexpected. The questions will be the long term effects on the U.S. economy and industrial base.

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