Bush Touts Improved Affordability, Enhanced Competitiveness As Drivers In Orbital ATK Deal

Northrop Grumman’s [NOC] proposed $7.8 billion acquisition of Orbital ATK [OA] will drive improved affordability for its customers, strengthen its competitiveness in a number of areas such as space and missile defense systems, and help spur innovation, Wes Bush, Northrop Grumman’s chairman, president and CEO, said Monday on an investor call.

Bush said that the operating environment in space is becoming increasingly difficult and that together Northrop Grumman and Orbital ATK will bring new capabilities. He said the same will be true in areas such as missiles, missile defense, and advanced precision munitions.

The deal is expected to provide $150 million in annual cost savings synergies by 2020 and be accretive to earnings and free cash flow within the first full year after closing. Northrop Grumman said the strong cash flow will be put to repaying debt, internal research and development, maintaining a dividend payout of between 30 and 40 percent of pension adjusted earnings, and share repurchases.

Northrop Grumman Chairman, President and CEO Wes Bush. Photo: Northrop Grumman

Northrop Grumman Chairman, President and CEO Wes Bush. Photo: Northrop Grumman

In an initial analysis of the deal after it was reported by the Wall Street Journal on Sunday but before it was announced, Jefferies aerospace and defense analyst Howard Rubel said Orbital ATK’s capabilities in solid rocket propulsion combined with Northrop Grumman’s strengths in sensors and networks would create “a comprehensive ballistic missile defense solution.

Rubel also said that although the proposed acquisition is counter to the Defense Department’s “informal admonition” against large consolidation in the defense industry, “we think a case for the deal could be argued on the synergies and the ability of another player to bring competition and innovation to the missile defense arena.”

Seth Seifman, J.P. Morgan’s aerospace and defense analyst, also said before the deal was officially announced that Orbital ATK’s abilities in satellites could help Northrop Grumman with its military satellites, and “broaden” it’s capabilities in space and propulsion systems for ICBMs. He also pointed out that both companies have capabilities in composites. Bush said that the composite work is complementary, not overlapping.

Including $1.4 billion in Orbital ATK’s debt, the enterprise value of the pending acquisition is $9.2 billion. The deal is expected to close during the first half of 2018 pending approvals by regulators and Orbital ATK’s shareholders. Both company’s boards have approved the transaction.

Northrop Grumman highlighted the complementary capabilities of the two companies and Bush said there is very little overlap between the companies. Northrop Grumman’s key capabilities are in aircraft such as the Air Force B-2 and B-21 stealth bombers, the Navy E-2D Hawkeye tactical airborne early warning aircraft and high-altitude long endurance unmanned aircraft systems, large space systems like military communications satellite payloads, missile warning satellites, battle management, and a new intercontinental ballistic missile, cyber security technology, radars, sensors and related processing, and large-scale logistics and sustainment.

Orbital ATK, which was created nearly three years ago through the combination of Orbital Sciences and Alliant Techsystems, brings small space systems, including communications and imaging satellites, launch vehicles and propulsion systems, and missiles and munitions, twos area that aren’t core competencies for Northrop Grumman.

Byron Callan, a defense analyst with the strategic advisory firm Capital Alpha Partners, said in a note to clients on Monday that the acquisition could strengthen Northrop Grumman’s classified satellite work with the addition of Orbital ATK’s small satellite business. But, he cautioned, “a looming issue is how commercial remote sensing and commercial models will bear on future DoD space architectures for surveillance and communications.”

Callan also said the competitive environment in the space launch vehicle business makes this aspect of the deal “less compelling” for Northrop Grumman. He does think that Orbital ATK could help Northrop Grumman in the Air Force’s new ICBM competition, the Ground Based Strategic Deterrent.

The increasing competitiveness in the commercial space launch market from companies like SpaceX and United Launch Alliance, a joint venture of Boeing [BA] and Lockheed Martin [LMT], might be a reason the Orbital ATK is selling itself, Callan said.

Northrop Grumman expects its sales this year to be around $30 billion and Orbital ATK is forecasting sales of about $4.6 billion. Ken Bedingfield, Northrop Grumman’s chief financial officer, said both companies have “solid growth prospects.”

If the deal is approved, Orbital ATK will initially operate as a separate segment of Northrop Grumman. At this point, the leadership of Orbital ATK, if it becomes part of Northrop Grumman, hasn’t been announced. Bush said that once the deal closes, Northrop Grumman will look for areas where the two companies are interconnected before considering any organizational realignments.

David Thompson, who leads Orbital ATK, said there wasn’t a bidding process for his company. He said the two companies began talks earlier this year on the potential deal.

Bush said he hasn’t seen anything until now in terms of acquisition that fit strategically and financially, highlighting the complementary portfolios and low interest rates to finance the deal.

Northrop Grumman under Bush has been more focused on organic growth, and has divested once key parts of its business, including its shipbuilding operations, and engineering and technical services unit. The proposed acquisition follows an announcement earlier this month by United Technologies Corp. [UTX] that it has agreed to buy Rockwell Collins [COL] for $30 billion, $23 billion in cash and stock and the assumption of $7 billion in debt.

Seifman said it’s too early to know if the Northrop Grumman deal may spur other defense deals. He pointed out that in the space market, Boeing and Lockheed Martin “may take a closer look at their portfolios,” suggesting that Harris Corp. [HRS], which has capabilities in satellite systems, could find itself in play.

Orbital ATK’s financial advisor on the deal is Citigroup. Northrop Grumman is being advised by Perella Weinberg Partners LP. Northrop Grumman said the debt financing for the deal is fully committed.

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