For all its fears about the future of the American weapons trade, Wall Street bid Grumman's market value up past the dollars 60-a-share offered by Northrop on Friday, speculating that Martin Marietta will return this week with a higher offer. (Both companies have lined up financing equivalent to a dollars 70-a-share bid.) The market also drove up the share price of dozens of other Pentagon contractors at the end of last week, clearly betting that the pace of consolidation in the industry is accelerating. 'It's time to start picking the winners' among the remaining equipment manufacturers, one New York arbitrageur argued.
After a decade of cuts in procurements budgets that shrank the industry by more than 7 per cent a year, US military spending will soon stabilise, analysts say. President Clinton, in his State of the Union message in January, promised there would be no more reductions in defence.
What will remain after the 'build-down' is complete in 1996 is an industry quite different from that which existed at the height of the Cold War a decade ago. Many of the contractors responsible for big- ticket Reagan-era weapons systems like cruise missiles, bombers and nuclear submarines - companies such as Honeywell, General Electric, and perhaps even General Dynamics - will have abandoned the field, to be replaced by former sub-contractors specialising in electronics, surveillance and equipment refurbishment.
The dollars 50bn decline in annual weapons spending that will have taken place is roughly equal to the combined 1991 defence revenues of nine of the best-known Pentagon contractors: Northrop, McDonnell Douglas, General Dynamics, Lockheed, Grumman, Loral, Hughes, Raytheon and United Technologies. But it will still be a dollars 68bn a year industry - and one divided among fewer than half as many players and less vulnerable to competitive price pressures. Companies that were able to 'shrink both smart and fast' stand to profit handsomely, said the defence-establishment veteran Jerrold Lundquist.
While the Gulf war argued for higher-tech weaponry and smaller armies, US defence contractors have ended up absorbing the lion's share of the Pentagon cuts. And unlike other cyclical, post-war downturns in arms spending, many of the larger manufacturers have been unable to turn for survival to alternatives like commercialisation of their technology, diversification into other industries or sales to foreign buyers.
The companies that are prospering in this environment - Martin Marietta, Loral, Lockheed - have had to 'strip down, shut down, sell, swap or spin off units in order to salvage the profitable from the unprofitable', argued Mr Lundquist. Hundreds of thousands of defence employees have been made redundant in southern California alone.
Most analysts agree this process is perhaps only half complete; businesses that are not leaders in their fields will have to be shut down or sold, leaving only three or four contractors competing for each market segment. The companies that will survive will be those that can assemble a 'critical mass' of profitable businesses with sales of at least dollars 10bn a year, one Wall Street analyst argued.
To both Martin Marietta and Northrop, Grumman represents just such a collection of businesses - some that overlap with their own, broadening their client base (and eliminating a rival); some that complement their own, filling out their product line and helping them dominate a market niche; and many that have little promise, and will be closed.
For Martin Marietta - perhaps the most aggressive predator - the acquisition would both strengthen its commanding position in defence electronics and create what one analyst called a monopoly in space systems. Before bidding for Grumman, the company bought the aerospace businesses of both General Electric and General Dynamics - making it the only US company than can build satellites, launch them and operate them.
To Northrop, Grumman represents an extraordinary fit with its core aviation businesses, military aircraft (it builds the B-2 Stealth bomber and F/A-18 fighter, while Grumman made the US Navy's F-14 Tomcat fighter and Hawkeye airborne command plane) and commercial aircraft (Northrop makes the fuselage for Boeing's 747 jumbo jet, while Grumman does sub-assembly work).
And Northrop, which is less than a quarter of Martin Marietta's size, needs the deal badly. As one New York analyst said, buying Grumman has become 'a real matter of survival'.
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