INDUSTRY AWAITS DoD VERDICT ON GD-NEWPORT NEWS DEAL

Defense Daily, Feb 22, 1999 by Vago Muradian

Executives throughout the defense industry, as well as Wall Street, are impatiently awaiting the Pentagon's verdict on General Dynamics' [GD] proposed $1.4 billion acquisition of Newport News Shipbuilding [NNS] which would have major repercussions for the U.S. shipbuilding industry.

"It's all in DoD's hands," one Wall Street source told Defense Daily. "If the Pentagon wants efficiency, it should approve the deal because GD is the most efficient operator in the shipbuilding industry. But if they want to maintain competition in the future, they may want to reject it."

Newport News last week disclosed a stunning offer by GD to acquire all of Newport News' $600 million in debt and outstanding common stock shares for $38.50 per share. But GD's offer was tied to a number of conditions, in particular whether the government would approve the transaction.

Newport News, which is in the process of acquiring Avondale Industries [AVDL] under a $470 million deal, added that GD's offer would be considered carefully and could be accepted if the government will guarantee antitrust approval.

One day after Newport News announced GD's offer, the Pentagon on Friday recommended that the Justice Department not oppose Newport News' acquisition of Avondale. But if Newport News accepts the Avondale deal it would make it virtually impossible to conclude the proposed GD transaction. At the same time, if Newport accepts the GD offer it would have to break the Avondale purchase.

If approved by the Pentagon--as well as government antitrust regulators--the marriage between GD and Newport News would give GD control of four of the nation's six major shipyards, creating a nearly $5 billion giant that would receive more than 70 percent of the Navy's annual shipbuilding dollars. GD, with its recent acquisition of National Steel and Shipbuilding Co., owns three of the nation's leading yards including submarine-maker Electric Boat and destroyer- maker Bath Iron Works.

The deal also would realize a long-standing strategic objective by GD to acquire Newport News and guarantee its place as the Navy's premier shipyard (Defense Daily, May 2, 1996).

The combination also would unite the nation's only two submarine and nuclear-capable shipyards, and give GD access to Newport News' lucrative work as the nation's only carrier yard.

Some analysts explained that the transaction, despite the competition questions it may raise, is unavoidable given how little is being spent on submarine procurement.

"The shipbuilding industry has evolved into a series of duopolies for destroyers, for subs, for amphibs and for auxiliary vessels," Loren Thompson, the chief operating officer at the Lexington Institute, told Defense Daily. "This transaction would eliminate the duopoly for submarines, but that is something that couldn't have been preserved without much higher levels of demand. Let's be clear about this, there are is no New Attack Submarine in 2000 and there is only one a year after that. You just can't sustain two fully-capable nuclear submarine builders on one submarine a year, or less. It's just too expensive."

According to sources, GD CEO Nicholas Chabraja discussed his Newport News offer with senior Navy officials before submitting it to the rival submarine and carrier maker, although it remains unclear whether service officials gave him any assurances.

Other sources stressed, however, that Chabraja would not have made the offer without the blessing of the Navy.

"He's a tough guy, but he's very customer-oriented," one source told Defense Daily. "He would never do anything the customer doesn't want."

But even if Navy officials did indicate approval for the deal, the purchase must be blessed by Pentagon acquisition chief Jacques Gansler who has been an ardent advocate of competition. Last year, Gansler opposed the planned $11.6 billion merger between Lockheed Martin [LMT] and Northrop Grumman [NOC] on competition grounds, and also ordered that the single Navy-blessed team vying for the service's DD-21 contract be broken up.

At the time, Lockheed Martin, and the nation's two destroyer makers--GD's Bath Iron Works and Ingalls Shipbuilding [LIT]--had teamed to pursue the DD-21 future destroyer effort. Raytheon [RTNA/RTNB] objected claiming it was locked out of the competition by not having a qualified shipbuilder of its own with which to team, and Gansler ordered that two, new teams be formed. Currently, Lockheed Martin is teamed with Bath, while Raytheon is allied with Ingalls.

Although it remains unclear how Gansler will rule on the merger, the industry and financial communities are looking forward to a speedy ruling.

"Everyone wants the Pentagon to make this decision in a hurry," the Wall Street source said. "No on wants another Lockheed-Northrop in which a decision is made after long months of silence."

In the case of Lockheed Martin's failed merger with Northrop Grumman, the Pentagon decided last March to oppose the transaction after having scrutinized it for eight months. Four months after the government voiced its opposition--claiming that the union would have created a vertically integrated giant that would have stifled competition and innovation in virtually every key defense market-- Lockheed Martin called off the deal.