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Defense Contractors on Cloud 9

Summary:
The backdrop: Money. More than ever before.  The Senate is expected to pass by a wide margin a 0-billion defense bill today. When it comes to extravagant military spending, Congress is relentlessly bipartisan, and all bickering stops, as long as the bacon gets spread to every district and state. “The 1,215-page measure defies a number of White House objections, but Trump hasn’t threatened to veto the measure,” the Washington Post mused. “The bill helps him honor a pledge to boost military spending by tens of billions of dollars.” So who gets this money? It’s going to get spread around, but defense contractors are going to get a chunk of it, and they’ve been on cloud 9 all year. Their shares – fired up by plenty of saber-rattling – have mostly soared from all-time high to all-time

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The backdrop: Money. More than ever before. 

The Senate is expected to pass by a wide margin a $700-billion defense bill today. When it comes to extravagant military spending, Congress is relentlessly bipartisan, and all bickering stops, as long as the bacon gets spread to every district and state.

“The 1,215-page measure defies a number of White House objections, but Trump hasn’t threatened to veto the measure,” the Washington Post mused. “The bill helps him honor a pledge to boost military spending by tens of billions of dollars.”

So who gets this money?

It’s going to get spread around, but defense contractors are going to get a chunk of it, and they’ve been on cloud 9 all year. Their shares – fired up by plenty of saber-rattling – have mostly soared from all-time high to all-time high.

These are some of the biggest defense contractors and their shares year-to-date as of this morning:

  • Rockwell Collins (COL), to be acquired by United Technologies: $130.90, up 40.6% YTD
  • United Technologies (UTX) is gobbling up Rockwell, got beaten down 8% since July, and is the exception: $113.04, up a measly 3.1% YTD
  • Boeing (BA), after implementing a series of big layoffs in the US: $253.51, up 61% YTD
  • Northrop Grumman (NOC): $274.23, up 16% YTD
  • Orbital (OA) jumped 20% this morning to $132.60, up 48% YTD
  • Raytheon (RTN) $183.06, up 26% YTD
  • Lockheed Martin (LMT) $303.74, up 19.8% YTD
  • Honeywell International (HON) $137.50, up 18.4% YTD

Orbital jumped 20% this morning after the announcement that Northrop Grumman would acquire it for $134.50 a share, in a deal valued at $9.2 billion including the assumption of $1.4 billion in net debt.

This deal comes after Wall Street had been clamoring for a breakup of Northrop. For Wall Street, which gets big-fat fees off these transactions, it’s either breakup or acquisition, often in cycles.




And there’s a lot of dough involved. JPMorgan Chase committed to provide a senior, unsecured bridge loan of up to $8.5 billion, according to a regulatory filing cited by Bloomberg. Northrop is being advised by bankers from Perella Weinberg Partners and by lawyers from Cravath, Swaine & Moore. Orbital is being advised by bankers from Citigroup and by lawyers from Hogan Lovells.

This follows an even bigger defense contractor deal earlier this month, when United Technologies announced that it would pay $22.75 billion for Rockwell Collins.

The acquisition of Orbital — which has about 13,000 employees, is into missile technologies, and hoists payloads into space — will expand Northrop’s missile business. Among other things, it is already building the frames for Lockheed Martin’s disastrously over-budget and problem-beset F-35 fighter and won a contract to build the new B-21 stealth bomber.

Orbital “is a leader in solid rocket propulsion,” and Northrop “is strong in sensors and networks, enabling a comprehensive ballistic missile defense solution,” gushed Jefferies analyst Howard Rubel today in a note to clients, cited by Bloomberg.

Both firms combined are now competing with Boeing for a $85-billion contract to develop the next ground-based missile interceptor system. The combined company would be among the big four defense contractors.

The corporate and Wall Street hype about it is fascinating. Here’s what Northrop CEO Wesley Bush told analysts on Monday:

“As we watch what’s happening around our globe, the rather rapid advance of some of our potential adversaries is quite concerning,”

“This issue of technological superiority for the US and our allies is a real issue. It’s something that our customers are struggling with.”

In defense contractor parlance, “our customers” is either the Pentagon or the Intelligence Community. And ultimately the taxpayers.

Consolidation in the defense sector is a great thing for defense contractors. It whittles down competition. There are only a few feeble doubts that regulators will rubberstamp the deal.

“Given that Northrop already operates in the space field, it is possible that there could be some overlapping activity or increased vertical integration that could prompt regulatory scrutiny,” said Vertical Research Partners analyst Robert Stallard in a note to clients. “We have also not had a prime contractor acquisition under the current US administration, and so this is a test case as to whether concerns over the scale of the primes is still an issue.”

This comes at a time when the US gross national debt has reached $20.2 trillion and will likely reach $21 trillion by the end of the next fiscal year, and when budgetary discipline along with more competition in the defense sector would be sorely needed. But that’s something taxpayers can only dream of.

There was nothing in Friday’s lousy economic data that would deter the Fed from further tightening, because, actually, it wasn’t that lousy. Read… What Headlines Got Wrong about Today’s Data Dump




Wolf Richter
Founder, Wolf Street Corp. In his cynical, tongue-in-cheek manner, he muses on WOLF STREET about economic, business, and financial issues, Wall Street shenanigans, complex entanglements, and other things, debacles, and opportunities that catch his eye in the US, Europe, Japan, and occasionally China.

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