Northrop Grumman: fight club
Threats are expanding. Defence spending has not
“The technological capacity of our potential adversaries continues to advance,” according to Wesley Bush, the chief executive of Northrop Grumman. The threat posed by Kim Jong Un is alarming, but it is a boon to the US military industrial complex.
On Monday, Northrop, one of America’s big defence contractors, bought specialised aviation and space contractor Orbital ATK at an enterprise value of $9.2bn, all in cash. The one-day premium to Orbital ATK’s stock price was a mediocre 22 per cent. Yet the purchase price is more than double where Orbital traded when it was formed less than three years ago.
A united Republican government in the US along with an increasingly hostile world have sent defence stocks soaring. A consequence of those turbo-charged valuations is firepower for big, pricey takeovers. There is little overlap between Northrop and Orbital.
Northrop’s strength is in fighter jets and electronics. Orbital is known for rocket launch vehicles, missile technology and satellites. Northrop says it can cut $150m out of $4bn in annual costs at Orbital. But Mr Bush conceded the deal premium has little to do with efficiencies, but rather the opportunities from upcoming contracts to upgrade the US nuclear arsenal.
Northrop shares rose about 2 per cent to hover near their all-time high. The stock is up a fifth since the US presidential election. The Trump bump has created expectations that defence spending will rise in future without pushing up near-term profits.
Earnings and free cash flow multiples are around 20 times, steep levels usually reserved for consumer staples. US bank stocks have pulled back from post-election highs as tax cuts and regulatory reform have stalled. Increased defence spending is equally log-jammed. A bet on defence stocks — or the success of a defence takeover — depends as much on heightened belligerence among Washington Republicans as it does on sabre-rattling by North Korea.