In December the worlds biggest military contractor, Lockheed LMT Martin, disclosed plans to acquire Aerojet Rocketdyne AJRD . Aerojet is the number-two ranked builder of rocket engines in the U.S., a key player in military and civil-space markets.
Many observers assumed the deal would receive favorable treatment from regulators, because in 2018 Northrop Grumman NOC was permitted to acquire Orbital ATK, Aerojets main competitor in the domestic market for rocket engines.
Orbitals engine business at the time was considerably larger than Aerojets, due mainly to its near-monopoly in the future manufacture of large solid-fuel rocket engines for launch vehicles and nuclear missiles.
It retains that status as part of Northrop Grumman today. In fact, the only opportunity Aerojet has for building large solids in the near future is its role as a supplier to prime contractor Northrop on a replacement of the Minuteman III intercontinental ballistic missile. Northrop secured that contract in 2019.
Aerojet Rocketdyne provides propulsion for the Terminal High Altitude Area Defense, which intercepts ... [+] fast-moving ballistic missiles.
I should mention that I have had relationships of one sort or another with every company mentioned in this commentary. As a result, I have a fairly good grasp of the interests at stake, and in particular the reasons why Aerojet is eager to become part of Lockheed Martin.
I believe the government should approve the proposed merger, but with conditions. The principal condition should be an enforceable guarantee that Lockheed will act as a merchant supplier of rocket engines to the marketplace once it acquires Aerojet, rather than being allowed to leverage Aerojets product lines to disadvantage rivals.
The Federal Trade Commission imposed a similar constraint on Northrop when it acquired Orbital, in the form of a consent decree. The condition is necessary so that when Lockheed competes against companies like Boeing BA and Raytheon in the future for missile work, it does not receive an unfair advantage due to its ownership of former Aerojet propulsion products.
Perhaps at this point you are asking why the government should approve the proposed transaction at all. Why go to the trouble of having to enforce compliance with a consent decree or some equivalent mechanism when the government could simply block the merger?
Here, in descending order of importance, are my five reasons why it is in the interests of warfighters and taxpayers to permit Lockheed Martins acquisition of Aerojet Rocketdyne. Collectively, they make a convincing case for the proposed transaction.
Aerojet is a fragile enterprise that wont survive as a stand-alone player in the marketplace. At $2 billion in annual revenues, Aerojet Rocketdyne is no industrial colossus. In fact, annual revenues are roughly equivalent to only 35 hours worth of sales at Walmart WMT . Moreover, the highly energetic systems it markets carry much more risk than the products of other industries. Its fragility is compounded by the companys dependence on a federal marketplace where major military and civil-space programs can be derailed by an election outcome.
For example, the biggest new opportunities Aerojet has to sell its engines are (1) a next-generation interceptor for missile defense; (2) hypersonic weapons for the Army, Air Force and Navy; and (3) the successor to the Minuteman III ICBM. None of these programs has an assured future. All will be subject to political wrangling, and even if they were not, Aerojet must depend on the good will of the prime contractors to stay on board. What if Northrop decides to kick Aerojet off the ICBM team? Aerojets future is by no means certain.
A different merger partner could be more problematic. Aerojets management recognizes the fragility of its business, and the need to be part of a bigger, better-resourced enterprise. One way or another, the company is going to be acquired. But the pool of potential suitors comes down to two types of candidates: other aerospace companies that have their own conflicts, and financial buyers such as private equity.
Given the risks associated with building rocket engines, there wouldnt be many suitors even in aerospace. Boeing might be interested, but is in no position to do acquisitions at the moment. Raytheon might be interested, but its Pratt & Whitney unit sold Rocketdyne in 2013 and its missile business would raise the same competitive issues as Lockheeds. Private equity would seek to reduce risk and hasten returns, hobbling innovation. Lockheed Martin at least has a similar culture and technology focus.
Blocking the merger would confer an unfair advantage on Northrop Grumman. As the Wall Street Journal reported on December 23, the proposed merger is more a case of vertical integration than elimination of the competition. If the FTC nonetheless decides the transaction raises too many competitive concerns, then what does this say about letting Northrop Grumman acquire Orbital three years ago? Orbital was a bigger player and arguably better positioned in the engine business. Blocking Aerojets acquisition while letting Orbitals stand would amount to implementing a double standard in antitrust cases.
The proposed merger is sure to reduce government costs. Aerojet does 33% of its business with Lockheed Martin (43% if you include sales to the Lockheed-Boeing joint venture called United Launch Alliance). The way the relationship currently works, Aerojet includes a profit margin in the price it charges for its engines, and then Lockheed adds its own profit margin when it bills the government for the finished product. Under federal accounting rules, this fee-on-fee arrangement would disappear if Aerojet became part of Lockheed. Additional savings to the government would accrue from rationalizing infrastructure and workforcesa necessary step to justify the price Lockheed is paying for Aerojet (roughly two times 2020 sales).
Lockheed-Aerojet could stimulate competition in civil space. The civil and commercial segments of the space launch business these days sometimes seem like a chess game between dueling billionaires. Elon Musks SpaceX and Jeff Bezos Blue Origin increasingly dominate the board, with lesser players dwarfed by the resources the worlds two richest men dedicate to their space passions. But their ardor might flag in the future. The government and private satellite operators need other players whose involvement doesnt depend on mercurial personalities. Combining Lockheed and Aerojet will likely bolster competition at a time when the launch sector would otherwise be facing a shakeout.
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