Tuesday's announcement of the megamerger between Lockheed Corp. and Martin Marietta Corp. shows that size in the defense industry is the key to survival.
"Any company in this industry will be doing transactions like this," said Jon Kutler, president of Quarterdeck Investment Partners, an investment bank specializing in the defense industry and headquartered in Los Angeles and Washington. "They won't be home-run deals like this, but I can't think of a single company that isn't thinking about this kind of move."The deal by two of the nation's largest defense contractors indicates that the industry is preparing for years of even leaner budgets and more job cuts. Merging operations and cutting out duplicate functions is the fastest way to keep profits up, Wall Street analysts have said.
"Both these companies have been extremely active in looking at opportunities in the past few years," Kutler said.
The deal's announcement received an immediate endorsement from the nation's major credit rating agencies. Standard & Poor's, Moody's and Duff & Phelps all said they were reviewing debt ratings for possible upgrade.
"The new company will be much stronger in its ability to compete for new business," said George Podrasky, a defense analyst with Duff & Phelps in Chicago.
Podrasky said the deal will likely prod other defense companies to consider similar moves. "I'm sure the announcement is causing a lot of CEOs to re-evaluate their strategy."
Lockheed holds a big share of the military aircraft business, such as the F-16 fighter and the F-22 advanced tactical fighter and the C-5, C-130 and C-141 transports, the Trident submarine-launched missile and Milstar satellites.
Martin Marietta builds Titan rockets, external fuel tanks for the space shuttle, helicopter-fired Hellfire missiles and a wide variety of defense electronics.
Both companies have won major federal laboratory management contracts, with Lockheed due to take over at the Idaho National Engineering Laboratory later this year and Martin Marietta running Sandia National Laboratory. They also build elements of secret military spy satellites.
Executives with the aerospace giants acknowledged Tuesday there will be some near-term job cuts in the wake of their $10 billion merger. The combined company will initially employ about 170,000 people - about 77,500 at Lockheed and 93,000 at Martin Marietta - and have annual revenues of about $23 billion.
"Three full factories is better than six half-full factories," said Norman Augustine, chairman and chief executive officer of Martin Marietta. "Failure to change is a failure to survive."
Augustine and his Lockheed counterpart, Daniel Tellep, disclosed they began talking about a possible merger more than five months ago and said the discussions were propelled by both companies looking for ways to consolidate within the industry at a time of declining defense budgets and excess capacity.
Kutler called the deal "a natural marriage" and predicted the new company will move rapidly to cut excess staff, noting that both Augustine and Tellep have done so in the past. Martin Marietta cut more than 9,000 jobs last year in the wake of the company's $3.05 billion acquisition of General Electric Co.'s defense electronics business.
The structure of the deal calls for a stock swap designed to leave shareholders of each with an equal stake in the new company, dubbed Lockheed Martin Corp.
Kutler noted that the megamerger represents a shift from the trend of using cash in defense deals in recent years.
"The use of cash is recognizing a fundamental shift in the industry, with backlogs falling off a cliff," Kutler said. "It's much more efficient to buy with stock and save cash for restructuring."
Lockheed and Martin Marietta combined took in $11.6 billion in defense contracts last year while McDonnell Douglas had $7.5 billion. Kutler said St. Louis-based McDonnell Douglas will not be particularly pressured to find a merger partner.
"McDonnell Douglas has not suddenly become a small company," Kutler said. "Where you'll see consolidation is in more of the second-tier people - companies with annual revenues in the $100 million range, which are the real backbone of the industry."