BA Boeing Co

By Doug Cameron 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (September 19, 2017).

Northrop Grumman Corp.'s move to acquire rocket-maker Orbital ATK Inc. reflects the rising competition among defense giants for supremacy in space, a rapidly evolving military battleground.

Space has been shifting from a largely passive platform for surveillance to a more strategic military arena, with countries such as China developing the capability to disable satellites and disrupt communications.

Northrop's proposed $7.8 billion acquisition of Orbital, announced Monday, would help Northrop to produce and launch large and small spy and communications satellites and develop new high-speed weapons and missile-defense systems to deter potential adversaries such as Russia, China and North Korea.

The proposed deal is the largest with a big military space element since Harris Corp. agreed to buy Exelis Inc. for $4.6 billion in 2015.

Northrop is the fourth-largest U.S. defense company by sales after Lockheed Martin Corp., Boeing Co. and Raytheon Co., all of which have been investing in new space-related capabilities.

Northrop, based in Falls Church, Va., makes fuselages and radars for the F-35 combat jet, large military drones, and satellites along with surveillance and communications systems, many of them classified. Dulles, Va.-based Orbital ATK produces space rockets, engines for missiles, and smaller satellites.

Aerospace and defense companies are combining to respond to pressure from commercial and government customers to cut costs, and to vertically integrate their operations and gain more control of their supply chains.

China and Russia have been investing heavily in space capabilities, and Pentagon leaders have expressed concern about the U.S. losing its technological advantage.

The Pentagon is also looking to make U.S. space assets less vulnerable by launching larger numbers of smaller satellites, and pursuing research into new weapons such as hypersonic missiles able to travel at more than 5,000 miles an hour. That would enable them to hit any target on the globe in minutes.

Pentagon officials have been pushing for more, warning of falling behind in space. "The No. 1 problem we face is being outpaced by our adversaries," Air Force Gen. John Hyten, head of the U.S. Strategic Command, said in an August speech in Huntsville, Ala. "The actions we take today will assure continued American dominance, especially in the critical domain of space."

Military budgets in Russia and China have been climbing faster than Pentagon spending, allowing them to close the technology gap with the U.S. However, there is a concerted effort among lawmakers and military leaders to reduce the Pentagon's costs and secure weapons faster and cheaper.

The heightened attention to space-based weaponry mirrors a push in Washington, where both the Trump administration and Congress have signaled the likelihood of spending increases.

Spending on classified military projects, many of them space-focused, has outpaced broader military spending and accounts for more than 10% of the Pentagon weapons and research budget, according to consultant Avascent.

"For fiscal year 2018, the U.S. Air Force has requested approximately $7.75 billion, an approximately 20% increase from fiscal year 2017, for space-related procurement and research, development, test, and evaluation," said Army Lt. Col. Jamie Davis, a Pentagon spokesman, declining to break down the request.

Northrop's proposed acquisition also represents the first test of the Trump's administration's views on industry consolidation as it would increase the company's role in key programs such as a new, long-range bomber.

"Orbital ATK is the fit," Northrop Chief Executive Wes Bush said on an investor call Monday. He noted the company hadn't previously spotted attractive acquisition targets before opening talks with the company earlier this year. Orbital wasn't put up for sale, said CEO David Thompson.

Northrop aims to close the deal in the first half of next year, subject to shareholder and regulatory approvals.

U.S. defense companies are returning to growth after five years of federal-government budget pressures. But big opportunities are scarce and focused on a handful of large programs such as the Lockheed Martin F-35, replacing U.S. nuclear weapons and strengthening its space-based capabilities. Pentagon leaders have discouraged any further consolidation among the largest defense companies since a series of huge deals in the 1990s. However, analysts said Northrop's move could trigger interest in other smaller, space-focused companies such as Harris.

Analyst Cai von Rumohr at Cowen & Co. said he expected the proposed deal to be cleared as there was little overlap between Northrop and Orbital ATK. "The acquisition gives Northrop more options in [Department of Defense] growth segments, such as missile defense," he said in a client note.

The proposed deal puts pressure on other defense contractors to boost their space capabilities, said Philip Finnegan, director of corporate analysis at the Teal Group, a Fairfax, Va.-based consultant.

Mr. Finnegan said it would allow Northrop to offer a broader range of products in areas where the Pentagon is focused, including missile defense and developing smaller satellites.

Deal activity in the defense sector has been focused on the fragmented services business, providing consulting and IT products. Companies with combined aerospace and defense operations have also become more attractive.

United Technologies Corp. plans to buy Rockwell Collins Inc. for $23 billion, a move aimed mainly at tackling competitive pressures in the commercial jetliner market. However, the combination would also create a top 10 global defense company, producing engines for military jets with radios and other communication equipment.

One of the largest defense-sector opportunities is the Pentagon's plan to develop a new, land-based nuclear missile, with Northrop competing against Boeing for a program estimated to cost around $80 billion.

Northrop is already working with Orbital ATK and fellow rocket-engine maker Aerojet Rocketdyne Holdings Inc. on the project. Boeing has also signed up Aerojet and Orbital ATK as partners, and Mr. Bush said on the call that his planned deal wouldn't affect existing programs. "Our industry is characterized by the ability of companies to work together," he said.

Mr. Bush declined to comment on whether the proposed deal had been discussed with the Pentagon, though he pledged to continue working with other large defense companies on large military programs.

The Pentagon had no immediate comment Monday.

Established companies in the space business are also under pressure from new entrants such as Elon Musk's Space Exploration Technologies Corp., better known as SpaceX, which has started launching satellites for the U.S. military more cheaply than rivals.

Such emerging competition led one analyst to question some of the claimed benefits from combining Northrop and Orbital.

"Building boosters and satellites are very different businesses. No one seems to think that Elon Musk is in a world of hurt because he doesn't have his own satellites, but he's got contracts to lift a lot of them," said James Hasik at the Atlantic Council, a think tank.

Northrop agreed to pay $134.50 a share for Orbital, a roughly 22% premium to Friday's closing price of $110.04. Including $1.4 billion in assumed debt, the deal carries a total price tag of about $9.2 billion. Orbital shares closed up 20% at $132.25.

Northrop shares gained 3.4% as the company committed Monday to reducing debt and maintaining a share buyback program. Repurchases have powered the company's stock in recent years.

Buying Orbital ATK would add a company with 13,000 employees and an estimated $4.6 billion in sales this year to Northrop's expected 2017 revenues of around $25 billion. Northrop has about 67,000 employees.

Northrop said it expects the deal to boost earnings per share in its first full year and yield annual cost savings of $150 million by 2020.

--Nancy A. Youssef contributed to this article.

Write to Doug Cameron at doug.cameron@wsj.com

(END) Dow Jones Newswires

September 19, 2017 02:47 ET (06:47 GMT)

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