WASHINGTON ― The federal government’s move to block Lockheed Martin’s planned $4.4 billion purchase of Aerojet Rocketdyne could have a chilling effect on future mergers and acquisitions among large defense firms, according to experts.
With the Federal Trade Commission’s lawsuit last week to stop the deal, it rejected a proposed behavioral remedy that would require Aerojet continue to supply missile components to Lockheed’s competitors. That’s being interpreted as a sign regulators will more heavily scrutinize vertical acquisitions, in which a company acquires a supplier.
“Anybody doing a sizable vertical deal has to look at this precedent and recognize, if there’s a real vertical issue, the [FTC’s] predilection may be not to do a remedy, which means it’s an up or down decision,” said Jeff Bialos, an antitrust attorney and former deputy undersecretary of defense for industrial affairs.
In its announcement of its opposition, the FTC argued that if the acquisition between Lockheed, “the world’s largest defense contractor,” and Aerojet, the “last independent U.S. missile propulsion provider” were to take place, “Lockheed will use its control of Aerojet to harm rival defense contractors and further consolidate multiple markets critical to national security and defense.”
Some view the FTC’s tough language as a clear signal to the defense industry.
“It’s hard not to read the complaint any way other than that big vertical transactions will be viewed very skeptically by the FTC, and it seems like it’s pretty clear,” said Jerry McGinn, a Pentagon manufacturing and industrial base policy official in the Obama and Trump administrations.
Brett Lambert, who served as a deputy assistant secretary of defense for manufacturing and industrial base policy in the Obama administration, predicted the decision would reverberate through the board rooms of every prime contractor in the defense sector. Lambert was Northrop Grumman’s vice president for corporate strategy when the company made a similar acquisition.
“Their position is quite clear, and how industry reacts and whether that’s in the best interest of the warfighter and the taxpayer is still unclear,” said Lambert, now the managing director of the Densmore Group, a national security and intelligence consultancy.
An administrative law judge will decide the case in a trial that is scheduled to begin on June 22. In the meantime, the FTC filed the complaint in the U.S. District Court for the District of Columbia to seek a preliminary injunction to stop the deal pending the administrative trial.
The FTC, in 2018, allowed Northrop Grumman’s $7.8 billion acquisition of Orbital ATK. The FTC sought to address anticompetition concerns by requiring behavioral remedies, mandating the combined company provide solid fuel rocket motors on a nondiscriminatory basis to competitors for missile contracts and implement firewalls to ensure the combined company would not misuse information from competitors.
Since 2019, the FTC has been probing “a potential issue” with Northrop’s compliance with those remedies, in connection with a then-pending missile competition, according to company filings. In its latest annual filing, Northrop disclosed that it has reopened discussions with the FTC over the issue.
The company said it promptly complied with the FTC’s original civil investigative demand and that it “has been and continues to be in compliance with the Order,” in line with ongoing “robust actions to help ensure compliance with the terms of the Order.”
The competition is likely the Air Force’s multibillion-dollar Ground Based Strategic Deterrent program to replace the Minuteman III intercontinental ballistic missile. Boeing accused Northrop of holding an unfair advantage in the competition and pulled out, leaving Northrop the competition’s lone bidder and winner.
Regulators in the Biden administration have been most vocal about their concerns about competition in the tech industry, primarily about behemoths like Facebook and Google.
But in August, Federal Trade Commission Chair Lina Khan caught the eye of defense watchers when she sent a letter to one of the Lockheed-Aerojet deal’s opponents, Sen. Elizabeth Warren, D-Mass., where she said behavioral remedies “have often failed to prevent the merged entity from engaging in anticompetitive tactics.”
“While structural remedies generally have a stronger track record than behavioral remedies, studies show that divestitures, too, may prove inadequate in the face of an unlawful merger,” Khan’s letter reads. “In light of this, I believe the antitrust agencies should more frequently consider opposing problematic deals outright.”
Warren had raised concerns to Khan about vertical integration and consolidation in the defense industry, and she noted the FTC’s 2019 investigation into Northrop.
At a Jan. 26 Council on Foreign Relations event, Lockheed’s chief executive, Jim Taiclet, defended the company’s effort at vertical integration with Aerojet, saying the intent was to make the contractor’s development of hypersonic missiles, certain space vehicles and other missiles more efficient.
“The benefit of putting the companies together in a vertical integration ... is that we would bring our engineering power to the propulsion side of those products. We would be able to integrate them faster, test more quickly, take cost out, actually, and we made all those cases to both the Department of Defense and the FTC,” Taiclet said.
The Pentagon hasn’t made its views on the merger public, and those views were redacted from the complaint, which some speculate is a sign DoD would have accepted the Lockheed-Aerojet merger with conditions. That, in turn, has fueled speculation about a diminished role for the Pentagon in antitrust reviews.
“I think what’s interesting ... is the diminution of the role of the customer in decision making,” Lambert said. To Lambert, the Pentagon’s voice as the sector’s main client “should weigh on the scale a bit more” with regulators.
A lead official in those reviews, Deputy Defense Secretary Kathleen Hicks, told lawmakers at her confirmation hearing a year ago she was “concerned” about consolidation in the defense industrial base and that competition is needed to maintain an edge over China and Russia.
“Extreme consolidation does create challenges for innovation,” Hicks said at the time. “We need to have a lot of different good ideas out there. That’s our competitive advantage over authoritarian states like China, and Russia. And so if we move all competition out, obviously, that’s a challenge for the taxpayer. But it’s also a challenge in terms of the innovation piece.”
Still, McGinn said it seems likely the Pentagon would have favored the Lockheed-Aerojet deal because the transaction would have bolstered Aerojet, which has struggled at times as a producer of vital missile parts, and because DoD previously favored the Northrop-Orbital ATK transaction.
“This transaction on the face of it gives Aerojet strong financial footing, being part of a big prime,” said McGinn, now executive director of the Center for Government Contracting at George Mason University. “I’ve anticipated that DoD would recommend approval [of the deal] with a consent decree, and nothing in the reporting has contradicted that.”
A slowdown in vertical integration could mean more companies will be absorbed by private equity firms, experts said.
“In my experience over 30 years, defense companies in private-equity hands tend not to be in the interest of the warfighter,” Lambert said. “Their motive is cash. The typical case is there’s no investment in research, and if you think about the unique nature of the defense industry, these are companies that need to be around for 20 to 25 years.”
Lockheed said it may elect to end the merger agreement or fight the case, and its decision is expected before the end of the month.
If the case goes to court, it’s likely Pentagon leaders will be called to voice their views in public.
“There’s some chance that the parties could persuade the court a remedy is appropriate, and ... you would probably see testimony from the Defense Department ... and that would be factor in the judge’s decision,” Bialos said.
Joe Gould is senior Pentagon reporter for Defense News, covering the intersection of national security policy, politics and the defense industry.