New defense giant born

Electronic News, Jan 20, 1997 by Carol Haber

New York--The decade of the massive military mega-mergers ended last week with the announcement of Raytheon's signing of definitive agreements for the acquisition of the Hughes Aircraft unit of General Motors' Hughes Electronics subsidiary for $9.5 billion--$5.1 billion in newly-issued stock and $4.4 billion in debt.

The deal for the defense electronics arm of Hughes Electronics would create a $21 billion Raytheon colossus, with $13 billion in defense electronics, that approaches the realms of Boeing and Lockheed Martin.

No one was surprised, with published reports rampant throughout recent weeks as Raytheon and Northrop Grumman fought it out.

Wall Street has been supportive of such mergers and acquisitions, which left Texas Instruments more focused on its core semiconductor business and is expected to do the same for all the players in this latest transaction, Raytheon, GM and Hughes (EN, Nov. 11 and Dec. 9, 1996; Jan. 13). Shares of Raytheon rose 1/4 to close at 48-3/4 at week's end after rising 1- 1/2 points the day before; Hughes ended the week up 3/8 to close at 63.

In the heated competition, Raytheon, after scooping up TI's defense operation for a "costly" $2.95 billion in cash, came out on top for Hughes, which sought a cash and stock deal from its acquirer. In preparation for Hughes, many said, Raytheon paid cash to TI, easing TI's concern about a huge tax liability by offering that much more cash. That left the road open for the more complicated stock and cash transaction with GM Hughes to follow.

The current backlog for the combined Raytheon company will be about $23 billion, with defense electronics accounting for $18 billion. The Raytheon-Hughes transaction, coupled with Raytheon's recently announced acquisition of the TI defense business, will result in slight dilution to the earnings of the combined company in 1997, as compared to the earnings of Raytheon alone for the same period. The transaction will be minimally accretive in 1998 and increasingly accretive thereafter. The deal, which will take place with certain GM shareholders after the expected spinout of the unit by GM, is expected to close by mid-year.

Raytheon executives predicted 5-10 percent growth in defense electronics as a combined company. "We can project modest growth in U.S. defense electronics, but stronger internationally," they said.

Cost savings were a hot topic. Raytheon said it is determined to achieve 10 percent "cost synergies" over the next two-and-a-half years as a result of this year's transactions. Certain areas are being eyed, including "some combined R&D, materials procurement, marketing, real estate and employment levels." While it is too early to provide any specifics, "It is wrong to assume the 10 percent will all come from employment," executives stressed, addressing a dominant concern. Reports have been circulating that "hundreds" might be laid off. The combined company at present has 2,500 positions to be filled, they said.

Commercial divisions are also being given a "hard look" and the "Business 101" test, executives noted.

Included in the Raytheon-Hughes transaction are some smaller semiconductor operations under the Hughes Aircraft Sensors and Communications division umbrella. They are a Microelectronic Packaging unit in Newport Beach, Calif., and a gallium arsenide unit in Torrance, Calif. Both sell to the merchant and captive markets, a spokesperson indicated. Microelectronic Packaging designs custom microcircuits for thick- and thin-film technologies, while the gallium arsenide unit in Torrance makes monolithic microwave integrated circuits for phased array airborne radar systems. Hughes is known to be strong in this area, complementing Raytheon's reported strength in ground radar.

BT Securities analyst Wolfgang Demisch summed up Raytheon's challenge: "This is a very high-quality enterprise Raytheon is buying for a relatively generous price; the challenge for them is to combine the two businesses as effectively and rapidly as possible with the TI business." Asked about possible hurdles, he added: "To some extent, the company is betting on continued reasonable stability in the military, because radical changes would be troublesome."

Another interesting opportunity presents itself in the breakdown of international business, according to the analyst. Raytheon business is 40 percent offshore in defense, whereas for Hughes and TI, the numbers are much less.

In defense electronics, the combined Raytheon entity should be neck-and-neck with Lockheed Martin and "well ahead" of Boeing, he added.

Mr. Demisch identified some obvious areas for cost cuts, such as duplication of headquarters, accounting, marketing and government liaison functions; after that, missiles and electro-optical may be targeted, he said.

A more subtle benefit of Raytheon's latest transactions may also be the motivation to make a much more wide-reaching assessment of what its core businesses are, Mr. Demisch suggested. "I believe they have indicated strongly that some of their commercial operations, especially those that aren't earning their keep as fully, will undergo severe scrutiny."