As expected, Lockheed Martin [LMT] on July 20 said it has agreed to acquire the Sikorsky Aircraft business from United Technologies Corp. [UTX] for $9 billion, adding a helicopter design and manufacturing to its portfolio, but the company unexpectedly announced it is undertaking a strategic review of its government information technology (IT) and technical services businesses with a goal to either spin-off or sell them.
The deal for Sikorsky, which was officially put on the market in June by UTC after a three-month strategic assessment of what to do with the military and commercial helicopter company, was reported and commented on a number of times in the past month with Lockheed Martin apparently willing to bid higher than Textron [TXT] for the business.
Lockheed Martin said that after the tax benefits are factored in, the adjusted deal price is $7.1 billion, with the $1.9 billion tax synergy to be realized over 15 years, Bruce Tanner, the company’s chief financial officer, said on July 20 during an analyst call. The tax benefit and historically low borrowing rates are two of the strategic benefits Lockheed Martin cited about the deal.
Lockheed Martin will finance the deal with about $8 billion in borrowings and $1 billion in cash on its balance sheet. Tanner said that proceeds from the eventual sale or spin-off of the IT and technical services businesses will go toward paying off the debt from the pending Sikorsky acquisition.
UTC is shedding Sikorsky because it doesn’t fit with its core portfolio of building systems and aerospace systems that is tilting toward the commercial market, two business areas the company expects to achieve long-term growth in line with global megatrends favoring urbanization. UTC, without Sikorsky, will still have defense plays through its military engines and aircraft systems work.
Sikorsky is expected to have about $6.5 billion in sales this year, down from an earlier forecast of $7 billion, with the squeeze coming from declines in the oil and gas exploration market. The helicopter company is about 75 percent military and the rest commercial, which equates to about $1.5 billion annually.
Tanner said that with the ongoing downturn in oil and gas markets, Lockheed Martin sees Sikorsky’s commercial helicopter business slipping to about $750 million in annual revenue over the next few years before beginning to regain its footing in the late 2018-2019 timeframe, which is about when the Sikorsky’s military helicopter development programs begin their transition to production.
Tanner also said the near-term prospects are not good for Sikorsky to positively contribute to Lockheed Martin’s cash flow.
“This is a long-term business,” Tanner said. “We’re not buying this business for the next three years. We’re buying this business for the next three decades.”
Marillyn Hewson, Lockheed Martin’s chairman, president and CEO, said Sikorsky is in line with Lockheed Martin’s core business of working on platforms and systems integration, and with governments.
“I think in that sense bringing Sikorsky into our business is just a natural fit for us and [our] ability to bring our strength in running programs and government contracting and all of that expertise to the Sikorsky business,” Hewson said.
Sikorsky’s sales are evenly split between domestic and international customers and both Hewson and Tanner said this international component also plays to Lockheed Martin’s strong, and growing, foreign business base.
Combining Sikorsky’s products with platforms like Lockheed Martin’s F-35 fighter and Littoral Combat Ship allows for a “much more powerful discussion” around bundling products and services for international customers than UTC can have, Tanner said.
In addition to the nearly $2 billion tax benefit, Lockheed Martin expects to achieve about $150 million in annual cost savings synergies through the Sikorsky deal through a combination of supply chain benefits and to a lesser degree facility and headcount rationalization, Tanner said.
Integrating Sikorsky has relatively “low execution risk,” Tanner said, highlighting the platform nature of the business as well as the fact that Lockheed Martin also knows the marketplace and customers well.
Sikorsky’s premier military helicopter program is the H-60 Blackhawk, which is sold to the Army, with other military services buying variants of the helicopter. The company’s major government development programs that are funded and expected to transition to production in 2018 include the CH-53K heavy lift helicopter for the Marine Corps, the VXX presidential helicopter program that also includes Lockheed Martin as a co-prime contractor, and the Air Force combat rescue helicopter program.
Lockheed Martin briefing charts accompanying its presentation on July 20 put the annual global military and commercial rotary-wing market at $30 billion annually.
The deal for Sikorsky, which requires government approval, is expected to close late in 2015 or early in 2016.
UTC said the proceeds it receives from the Sikorsky sale will go toward additional share repurchases to offset the earnings impact related to the divestiture. The company also said its board has authorized a share repurchase program for up to 75 million shares of its common stock valued at about $8.3 billion based on the closing prices of its stock on July 17.
J.P. Morgan is UTC’s financial advisor on the deal.
The Lockheed Martin officials said the company is looking to divest most of its government IT and technical services businesses because the government contracting environment has become very price sensitive and increasingly competitive, making them difficult to work inside of the company’s business model. The company will review a sale or spin-off of these assets, including breaking the businesses into different components as part of the divestiture, Hewson said.
Most of the IT and technical services businesses that Lockheed Martin is looking to shed reside within it’s approximately $7.5 billion Information Systems and Global Solutions (IS&GS) segment. The businesses account for about $6 billion in annual sales and have margins in the mid-7 percent range.
The IS&GS businesses that will be divested include air traffic management, technical services, government and enterprise IT, commercial cyber security, and government healthcare IT. The company will retain the mission IT and services work, including government cyber security, energy solutions, and space and space services. These businesses will likely transfer to other segments, including to Mission Systems and Training (MST), Missiles and Fire Control (MFC), and Space Systems.
The technical services business within MFC will also be divested. The IS&GS segment will be axed.
Hewson said the units to be divested “may potentially achieve greater growth” outside of Lockheed Martin. While the strategic review was just announced, she said the company has been reviewing its infrastructure IT and technical services businesses “for some time now and done quite a bit of analysis” to figure out a way forward.
Capital Alpha Partners defense analyst Byron Callan sees the pending divestiture of most of Lockheed Martin’s IT and technical services work as being in line with a number of previous and planned splits involving Science Applications International Corp. [SAIC], L-3 Communications [LLL], Britain’s BAE Systems, CSC [CSC], and the creation of Vectrus [VEC] from the former Exelis, which is now owned by Harris Corp. [HRS].
Callan said the Lockheed Martin plan raises two questions, the first being whether the divestiture will end up as a combination with another big services firm, which would demonstrate further consolidation in the sector, or lead the likes of the other major defense contractors, Boeing [BA], General Dynamics [GD], Northrop Grumman [NOC], and Raytheon [RTN], to take more serious looks at their portfolios.
Boeing and General Dynamics more recently have shed their commercial cyber security businesses, which were small parts of the overall business.
Lockheed Martin said the pending acquisition and divestitures will not impact its ongoing plans to return cash to shareholders through dividends and stock buybacks. Tanner said the Sikorsky acquisition, depending on when it closes, is expected to be dilutive to earnings in 2016 and then marginally accretive in 2017 before growing in importance to the bottom line thereafter.
Lauren Thompson, a defense analyst and consultant with the consulting firm Lexington Institute, which counts Lockheed Martin as a client, said in an online Forbes column that the Sikorsky deal will reduce Lockheed Martin’s reliance on the F-35, which is expected to account for about 25 percent of overall future sales as production increases, and boost long-term sustainment revenues through support for the Blackhawk and other helicopter platforms.
If the deal for Sikorsky is approved, which Lockheed Martin expects since the acquisition doesn’t consolidate the helicopter industry, the business will become part of the MST segment, operating as a standalone company and retaining the Sikorsky brand.