After analysts and pundits digested the news that Northrop Grumman would buy solid rocket booster manufacturer Orbital ATK, most decided that the move was a maneuver to improve their position in bidding for the Pentagon’s anticipated upgrade to the U.S. missile defense network. Orbital ATK, which itself was the product of a recent merger of Orbital Sciences and Alliant Techsystems, has designed and produced a number of different launch vehicles and satellites, primarily for the defense, communication, and space surveillance markets.
While this sort of systems synergy makes sense to Wall Street analysts and defense industry watchers, the proposed acquisition makes very little financial sense. Northrop Grumman agreed to pay $7.8 billion for a company with a book value of only $1.8 billion. This figure didn’t include the assumption of $1.4 billion in debt, which pushes the value of the deal to $9.2 billion. Even worse, the $1.8 billion book value is for goodwill, a term for which accountants assign to the value of previous acquisitions made in excess of book value. So in essence Northrop has validated that the $1.8 billion that Orbital Sciences paid in excess of what Alliant Techsystems was worth, and is throwing another $7.4 billion on top of the pile. Orbital ATK, given its $200 million in annual profit, will take over forty years to pay for the acquisition, not including interest costs. That’s right, Northrop is financing virtually the entire acquisition with debt.
No doubt Northrop thinks it will be able to squeeze some blood out of the Orbital ATK turnip, boosting profits and shrinking the payback period and interest burden. It also hopes the one-stop-shop approach to space and missile systems design will boost its long term prospects for top line revenue, thereby boosting the bottom line further. And the acquisition cements Northrop’s position as the number three defense contractor, fending off rising stars like Raytheon.
I think the real reason for the acquisition is the United Launch Alliance and SpaceX. When the Alliance was announced between Boeing and Lockheed Martin, there was little doubt that Northrop Grumman seethed with envy, knowing they were essentially locked out the space race given that SpaceX dominated the privately-funded space exploration industry (Blue Origin notwithstanding). Only Orbital ATK competed with both groups. Now that Northrop is to buy Orbital ATK, the venerable defense contractor is back in the game.
The additional political clout that Northrop brings to the table will likely boost Orbital’s prospects in the space industry, upcoming layoffs and rightsizing notwithstanding. Elon Musk is probably not worried. But I would bet that Boeing and Lockheed are beginning to sweat.