By IBISWorld Senior Analyst Maksim Soshkin
Northrop Grumman won the U.S. Air Force’s Long Range Strike Bomber (LRS-B) contract, beating out a joint bid by Lockheed Martin and Boeing. Under the contract, which may exceed $55 billion over its lifetime, Northrop will build the Air Forces’ next-generation stealth bomber, greatly bolstering the company’s position as a defense aircraft manufacturer, while throwing doubt over Boeing’s position. Northrop’s victory is also expected to diminish the near-term chances of further mergers and acquisitions (M&A) between the defense primes. Nonetheless, while this may provide the Pentagon with a more diversified industrial base, M&A activity is still expected to continue in a defense market which will be increasingly composed of a small number of large contracts, putting pressure of companies to merger or diversify.
LRS-B sets industry landscape
In recent years, declining U.S. defense spending and a boom in commercial aircraft sales has caused defense sales of the Aircraft, Engine & Parts Manufacturing (33641a) industry to shrink from 42.9% in 2010 to an estimated 27.8% in 2014. As a result, the number of defense contracts available to manufacturers has declined, with defense contractors become more dependent on a handful of large projects. In particular, the LRS-B became the only available large combat aircraft contract left on the table. With Lockheed Martin set to dominate the US fighter jet market via ramped up production of the F-35, the LRS-B became vital to the continuation of Northrop and Boeings combat aircraft businesses.
In particular, Northrop was in the most precarious position. Before the LRS-B win, the company’s place as a major military aircraft manufacturer was in doubt, making its aircraft business a potential target for acquisition. After finishing production of the B-2 bomber, the company’s Aerospace Systems division’s aircraft operations diminished, focusing on the relatively small UAV market and acting as a subcontractor to Lockheed Martin’s and Boeing’s F-35 and F/A-18 fighter jets programs, respectively. As a result, IBISWorld estimates that Northrop’s share of the Aircraft, Engine & Parts Manufacturing (33641a) industry’s revenue shrunk to below 2.7% overall and 10.0% for the military segment. Consequently, if the company lost the LRS-B contract, it might have had to exit the military aircraft market altogether, potentially selling relevant operations to rivals such as Boeing. However, with such as big contract on its hands the company is expected to once again become a major player in the industry and is unlikely to sell its aircraft manufacturing business.
Forecast
While Northrop’s LRS-B win reduces the chance of it selling of its aircraft production operations, it does not mean that M&A deals will die out. IBISWorld anticipates federal funding for defense to remain relatively flat over the next five years, with the UCLASS UAV and T-X trainer remaining the last significant aircraft contracts open to the industry. With fewer defense contracts to go around some companies will look to exit certain defense markets and instead focus on the booming commercial segment, while others seek to diversify their product mix. For instance, earlier this year, United Technology Corporation agreed to sell it its Sikorsky helicopter manufacturing business to Lockheed Martin for $9.0 billion, in order to focus on its more profitable and less defense-related components business. Moreover, with the F/A-18 and F-15 fighter jet production shutting down by the end of the decade, Boeing will be left without a major combat aircraft model to sell. This may encourage the company to try and buy Northrop’s aircraft business as a way to get the LRS-B, but the Pentagon has already voiced its opposition to further tie ups between the defense primes. Therefore, the largest share of M&A activity is expected from the supply chain, with the more fragmented aircraft supplier base consolidating in order to reduce costs in the face of more cost conscious primes and overall weakness in the military aircraft market.
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