US big guns come out blazing: The Pentagon's defence squeeze has resulted in the battle for Grumman, Larry Black reports

FOR AMERICA's fast-shrinking defence industry, confronting its first public takeover battle in more than a decade, the writing is on the wall: buy or be bought.

All week, following Monday's announcement of Martin Marietta's purchase of Grumman, Wall Street had been speculating about the target of the next big defence takeover, and by Thursday had settled on Northrop, the Californian aerospace firm behind the B-2 stealth bomber and F/A-18 fighter. But the rumour mill had it wrong. After the market closed, Northrop launched its own dollars 2bn bid for Grumman, its fourth attempt in the past two years to acquire a rival contractor.

Northrop's dollars 60-a-share bid, dollars 5 higher than Martin Marietta's friendly tender offer, is not the first time the two have clashed. Two years ago, Northrop was part of the consortium that beat Martin Marietta for control of the missile and aircraft division of LTV Corporation. And it certainly won't be the last.

The decline in the Pentagon's weapons budget - it is barely a third of what it was a decade ago under Ronald Reagan - has prompted an industry consolidation that most analysts believe is only half over. And most agree that those defence contractors that act first to snap up their rivals will have the best chances of survival.

'You wouldn't want to be the last one standing around when they're picking partners,' Martin Marietta's chief executive, Norman Augustine, said early this week. His company - already the world's largest defence electronics firm - has been among the most aggressive, raising dollars 6bn in the past 18 months to buy General Electric's defence businesses and General Dynamics' space systems.

Not far behind is Loral - which bought IBM's government-contracting division earlier this month - Lockheed, General Motors' Hughes division and, of course, Northrop. On the opposite side of the coin are once-dominant companies, such as General Dynamics - America's biggest weapons group in the early 1980s - which has sold all but two of its businesses, and has made it clear that those are also available at the right price.

'Two years ago, a dozen companies competed in six or more markets segments,' Jerrold Lundquist, a specialist with the McKinsey consulting group, said. 'Today they compete in two or three.'

Far from frowning on such apparently monopolistic behaviour, the Pentagon - whose new-weapons budget is dollars 50bn this year - hopes that such mergers will accomplish what would be politically impossible for the government to engineer: the closing of hundreds of surplus factories and the loss of hundreds of thousands of well-paying manufacturing and research jobs.

Closing military bases proved politically suicidal for President Clinton's first Defense Secretary, Les Aspin, but far more jobs have been lost in defence industries in key regions such as southern California, the American South and New England. Waves of redundancies have hit strong and weak arms producers alike. Martin Marietta's current businesses have shed 47,000 jobs since 1987.

'We're not going to try to manipulate the consolidation of the defence industry,' the current Defence Secretary, James Perry, told a congressional committee last September when he was still the Pentagon's senior civil servant. 'But we want to encourage it.'

Indeed, some analysts argue that the rising cost of doing business with the Pentagon is making ever-larger mergers unavoidable. 'Only contractors with sales of dollars 10bn or more can survive in the long haul,' said Wolfgang Demisch, an aerospace analyst with BT Securities in New York. 'We're looking at a growing notion of critical mass.'

There are exceptions to the Pentagon's hands-off policy. Where the shake-out threatens technology considered vital to national security, Washington has shown itself willing to subsidise unprofitable businesses - arguing that it is cheaper, for example, to buy a Seawolf nuclear submarine that the navy does not need than to re-establish production lines that have been closed.

Picking the likely survivors in a once quasi-public business now ruled by the laws of the jungle is not easy, analysts say, but Grumman's unexpected appeal offers at least one insight.

This is that there is an important future for contractors with skills in rebuilding and retro-fitting existing weapons systems, such as Grumman, which earns hundreds of millions of dollars a year putting new electronics in its old F-14 Tomcat fighters. Eking a 'peace dividend' out of America's vast investment during the 1980s means spending almost 20 per cent of the Pentagon's dollars 88bn procurement and research budget on updating, rather than replacing, equipment.

Martin Marietta seems to have secured its place in the post-Cold War food chain, analysts say, if only because its debt makes it a formidable target. But it is still unclear whether Northrop will eat or be eaten.

Martin Marietta clearly wishes that its rival were someone else's lunch. 'The attack by Northrop degrades the entire character of the rational consolidation taking place within the United States' national security industrial base,' the company complains.

(Photograph omitted)