Northrop's TRW Bid Could Trigger Arms Race Northrop's TRW Bid Could Trigger Arms Race
Feb 23 8:20am ET
By Arindam Nag
NEW YORK (Reuters) - Defense contractor Northrop Grumman's announcement of its plan to take over TRW at a modest premium to its share price is likely to set off a bidding war for the aerospace and auto parts company, industry observers said on Friday.
Northrop Grumman said it would offer $47 in its own shares for each share in TWR, just two days after its shares slipped following the high profile departure of its chief executive David Cote.
The announcement of its approach to TRW was unveiled in a 'bear hug' fashion with Northrop publicizing its letter written to TRW management.
But TRW's shares stayed above the $47 level from the start on Friday, opening at $49.15 and ending the session up $10.50, or 26.38 percent on Thursday's close, at $50.30 on the New York Stock Exchange.
While Northrop kept the door open for a possible higher offer, analysts and investment bankers said the rest of the defense sector were back at their tables going through their files on TRW.
"I don't think the industry is going to sit still while one important player makes a run at TRW's aerospace assets," said William Alderman of Alderman & Company, a merchant bank specializing in aerospace mergers & acquisitions.
Most industry observers said Lockheed Martin , Boeing , Goodrich and General Dynamics were potential predators for TRW.
What makes TRW an attractive target now is the massive cost savings program that the group has gone through, recreating a company that could get rerated by analysts on the upside.
GROWTH PROSPECTS
Its best growth prospects are in its space, defense and information systems. U.S. government's defense spending is forecast to grow at the rate of five percent for the next 10 years, adding $160 billion in incremental spending.
Most analysts believe TRW stands a good chance of picking up contracts in the areas of missile defense, space systems, lasers, unmanned systems and homeland security.
People familiar with TRW's management told Reuters that although its shares have underperformed some of its rivals in recent years, there has always been a strong interest in TRW's defense operations.
What makes a rival offer more likely, are the obstacles that confront Northrop.
Northrop, which has grown rapidly over last few years with the help of a surfeit of acquisitions, will have to look for a buyer for TRW's automobile business quickly.
Analysts and bankers say that if it does not convince Wall Street that it has a ready buyer for the business its shares could take a beating on fears of dilution in its earnings.
"Northrop has proved to Wall Street that they are smart, aggressive buyers. But what they have not shown yet is the willingness to do proper housekeeping," said Jon Kutler of merchant bank Quarterdeck Investment Partners.
Experts say that Northrop's bigger challenge would be to keep the process of integrating its recent acquisitions -- nearly $10 billion in the last two years -- and work on the TRW deal as well.
Northrop management would not only have to keep a hawk's eye on costs but would also to have maintain key customer relationships and prevent valuable executives from being poached by rivals.
ANTI-TRUST CONCERNS
Some of Northrop's potential difficulties got reflected in the market on Friday. Its shares fell to a low of $104.81 before recovering to $109.95, still nearly seven percent lower than its previous close.
Credit rating agency Moody's Investors Service also echoed similar sentiments by saying it could downgrade its debt to junk status.
But before jumping in with a rival offer, potential bidders would have to do their maths on whether they can rein in costs of making TRW products.
"If you can maintain the technology and keep costs low then you will succeed in being an industry supplier forever," said Alderman.
Another key issue is competition. Analysts and bankers say offers from General Dynamics and Goodrich could face less scrutiny from Washington than combinations of TRW with Boeing or Lockheed Martin would evoke.
"We would point out that with Lockheed and Boeing there would likely to be considerable anti-trust concerns about overlap in military space operations that TRW has," Merrill Lynch said in a note to investors.
An easy way for most rival bidders to trump a Northrop bid is to offer some cash for TRW shareholders who have seen their company's shares fall from as high as $63.75 two years ago. Most analysts believe the shares should now be valued between $55 and $58.
Another possibility that could draw out in the next few weeks is TRW unveiling a break-up plan on its own.
If broken up, the company's defense business would attract higher value and would be rated alongside the likes of Lockheed Martin and General Dynamics.
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