Northrop Grumman is full on bombers and space after recent divestment
Northrop Grumman (NYSE: NOC) is moving away from the bulk of its IT and service work to fully focus on its portfolio of aerospace and space assets. The deal could reduce earnings per share in the short term, but makes sense from a long-term perspective.
On December 7, Northrop announced a $ 3.4 billion deal to sell its federal IT services and mission support business to Peraton, a company owned by private equity firm Veritas Capital.
The sale represents a $ 2.3 billion share of Northrop Grumman’s $ 35 billion in annual sales, and the company intends to spend a large chunk of the $ 2.9 billion it expects to make. receive after-tax share buybacks to help offset the impact on earnings per share of the transaction.
Still, it’s a good deal for Northrop Grumman. Here’s why.
The status quo was not an option
Northrop selling IT division follows in the footsteps of Lockheed Martin, while moving in the opposite direction of General dynamics. In 2016, Lockheed merged most of its IT assets into Leidos Holdings, creating the largest government services company in the country. In 2018, General Dynamics spent $ 9.6 billion to acquire CSRA to position his company as a solid number two.
Government IT contracts are awarded largely on price, and in this environment, scale is essential. There has been a lot of consolidation among the second-tier players in Northrop’s IT business size range, and Northrop Grumman likely felt pressure to participate in mergers and acquisitions to strengthen the business if it kept it going. internally.
In a statement announcing the move, CEO Kathy Warden said the move was due to capital allocation priorities.
“This divestiture enables us to generate value and reflects our strategy of focusing on growing core businesses where technology and innovation are the main differentiators,” said Warden.
Northrop already has more debt than Lockheed or General Dynamics, in part a legacy of its $ 9.2 billion acquisition of Orbital ATK in 2018. If the choice was to increase further to close deals, or to leave the company and focus on certain key projects, Northrop Grumman probably made the right decision.
Northrop looks to the sky
The basis for this sale was probably laid in the purchase of Orbital, which made Northrop arguably the leading player in space technology. The Orbital deal helped Northrop Grumman win a massive contract earlier this year to develop a new Intercontinental Strategic Ground Deterrent Ballistic Missile (GBSD).
Northrop Grumman is also the prime contractor on an effort to design and build the B-21 bomber, making him the prime contractor on two-thirds of the a $ 500 billion effort by the Pentagon to refresh the country’s nuclear triad during the Cold War era.
The company’s aerospace business goes well beyond bombers. Northrop Grumman is a major contractor for Lockheed Martin’s F-35 fighter program, which could generate more than $ 1,000 billion in revenue for all contractors involved over its lifetime.
The space is expected to provide additional opportunities for Northrop Grumman in the coming quarters. The United States is turning away from the fight against the insurgents to the so-called “great power conflict” with China or Russia. That means fewer boots on the ground in hot spots like the Middle East, and more emphasis on surveillance, both there and in other countries.
Northrop shrinks to get stronger
We are entering what could be a difficult time for defense contractors, with the Pentagon after years of budget growth expecting funding to stagnate in the years to come. Military officials are going to have to prioritize in this environment, and contractors would be wise to focus on what they do best and on areas that should withstand budget pressures well.
Northrop Grumman shares the trade at a premium over other defense premiums. The company operates today at a enterprise value 13.8 times earnings before interest, taxes, depreciation and amortization (EBITDA), compared to Lockheed’s 11.2-fold multiple and General Dynamics’ 10.9-fold multiple.
The argument in favor of this valuation of the premium comes down to the strength of Northrop Grumman’s portfolio and his ability to capture an oversized slice of total Pentagon spending through his ability to meet Washington’s most pressing needs.
Northrop Grumman is declining as a result of this deal, but the portfolio is strengthening. Investors should applaud this compromise.
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