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MARCH 8, 2004
Northrop's Heavy Artillery Folding in Litton, TRW, and Newport News Shipbuilding has paid off mightily The ink was barely dry on Northrop Grumman Corp.'s (NOC ) December, 2002, acquisition of TRW Inc. when the company began marshaling its newly acquired troops for their first big campaign. The target was an eight-year contract to build the Pentagon's new Kinetic Energy Interceptor, a Star Wars-like antimissile system that aims to destroy enemy rockets shortly after takeoff. Separately, Northrop and TRW had both passed on the project, thinking they couldn't compete head to head with missile-defense leaders Boeing Co. (BA ) and Lockheed Martin Corp. (LMT ). That changed with the merger. Northrop put together a team of people from six of its seven divisions, including specialists in defense electronics, information technology, satellites, and shipbuilding. A former TRW office in Virginia was put in command of the project, and reinforcements were sent from across the country. The effort paid off: Northrop scored a surprise victory, winning the $4.5 billion contract last December and vaulting the company past its own sales targets. "That award blows away all of our assumptions of revenue synergies," crows Northrop's Chairman and CEO Ronald D. Sugar. Synergy. It has become a dirty word in Corporate America, an elusive goal used to justify hundreds of ill-conceived mergers. But Northrop, based in Los Angeles, is proving that it is possible to acquire a slew of companies and leverage their strengths to land business none of them could have gotten separately. Synergy is becoming more valuable than ever, as military planners move to favor companies that can coordinate the development of complex armaments on their own, without the Pentagon dealing directly with subcontractors. Once known mainly for the B-2 Stealth Bomber, Northrop has become a major player in software and information technology, the largest shipbuilder for the U.S. Navy, the builder of the James Webb telescope -- successor to NASA's Hubble -- and is looking to score big in missile defense systems for commercial airlines. TOEING THE LINE. Northrop has snapped up 16 major companies in the past 10 years, including TRW, Litton Industries, and Newport News Shipbuilding. By now, integrating them into the fold is down to a science. Each must conform to a carefully orchestrated plan of integration listing nearly 400 items, from how press releases should be issued to which accounting software to use. And unlike its big defense rivals at Raytheon (RTN ) or Boeing, Northrop managers haven't stumbled with any of the acquisitions. "They have a long history of drawing a box around what they need and finding it, rather than finding it and justifying it later," says Jon B. Kutler, chairman of investment banker Jeffries Quarterdeck. "When you do that, you avoid a lot of mistakes." Sugar, a defense industry veteran who previously worked at two of Northrop's acquisitions -- Litton and TRW -- now manages a company largely created by his predecessor, Kent Kresa. In the early 1990s, Kresa correctly anticipated that the Pentagon would focus less on tanks and planes and more on space and warfare information technology. Coupling traditional armaments with strength in those fields, he figured, would give Northrop a leg up. After Kresa stepped down last April, he left his handpicked successor, Sugar, to carry on his strategy. "We're very much like an orchestra," Sugar told his employees last September. "We've got all the instruments. Our challenge is to make Northrop Grumman sing." So far, the tune has caught on. Thanks largely to the TRW acquisition, sales at Northrop, No.50 on last year's BW50 -- BusinessWeek's list of the top-performing large public companies -- jumped 52% in 2003, to $26.2 billion. Operating income rose at a similar rate, to nearly $2 billion. Northrop's existing businesses enjoyed a strong 13% increase in sales. One weak spot: Earnings per share dipped 24%, to $4.32, because of noncash expenses related to Northrop's pension fund. But Sugar anticipates a rebound this year, with earnings hitting $5.75 a share. Over the five years ended Jan. 29, Northrop stock has returned investors 13.4% annually, compared with a 3.3% yearly gain in the Standard & Poor's Aerospace & Defense Index. CUTBACKS COMING? Many defense analysts think that Pentagon spending will soon plateau. The next Administration, worried about budget deficits, could even ratchet down Pentagon spending. "If Bush loses, all bets would be off. We'd probably be cutting back on such things as missile defense and ships," says Paul H. Nisbet, an analyst with JSA Research, an independent defense stock research firm. He notes that some Democrats already want to cancel a new attack submarine that Northrop is building with General Dynamics. With 30 planned, at about $2 billion each, that would represent a serious blow. Sugar, nevertheless, is betting on 5%-to-7% growth in military procurement for the rest of the decade, with Northrop's growth exceeding that. "I'd like to tell you the world is getting safer, but I don't see it," says Sugar. The CEO is counting on continuing cross-pollination among Northrop's businesses to fuel earnings growth. The company's shipbuilding business, which it entered by buying Litton in 2001, offers a model. On its own, Litton didn't have the ability to integrate all the components the military wanted on a new class of destroyers. As part of Northrop, however, it had access to software, electronic components, and the stealth technology from its B-2. That worked in its favor as it bid against General Dynamics Corp. (GD ). Northrop moved quickly to integrate the operations at Litton's two poorly performing shipyards into a coherent unit. The Avondale shipyard, in New Orleans, had a subpar safety record and a history of bad labor relations. Ingalls, in Mississippi, had stumbled badly with a late-1990s diversification into cruise ship manufacturing. Under the command of Philip A. Dur, a former rear admiral, Northrop set about fitting the yards into the Northrop mold. He shifted responsibility for key departments such as research and development and quality control to New Orleans, opened contracts with Avondale's unions two years early, and even hiked pay. Once the shipyards were functioning well, the payoff came: The Litton shipyards, along with Newport News Shipbuilding, acquired a year later, have snared two contracts that should keep the company's bottom line afloat for years. In April, 2002, the U.S. Navy chose them to lead a $2.9 billion design for a new class of destroyers and small boats called DD(X). That success was repeated when the company won a U.S. Coast Guard contract worth $11 billion in June, 2002, to modernize its fleet. "It really comes down to individual contracts, as to whether they bid them correctly and follow through on execution," says John E. Pike, director of think tank GlobalSecurity.org. "Boeing bid wrong. Lockheed had bad execution. We haven't seen any one of those problems yet from Northrop." `SPACE CADET'. More big awards could come this year. Northrop is vying for the initial $200 million award for the Space Based Radar, a set of U.S. Air Force reconnaissance satellites, as well as the contract for the new E-10A command and control aircraft. It is also angling to win a competition to outfit commercial airliners to deflect shoulder-fired missiles. Northrop, whose device uses a laser to track and confuse missiles, was one of three companies chosen by the Homeland Defense Dept. in January to explore the technology. Sugar, 55, was drawn to the possibilities in the defense business at a young age. The son of beauty parlor owners, he grew up in southern California and was inspired in grade school by the Sputnik launch. "I became a young space cadet," he says. He earned his doctorate in electrical engineering from the University of California at Los Angeles at 23 and went to work immediately, designing military satellites for the Aerospace Corp., a spin-off of TRW. He spent 20 years at TRW before being passed over for the top spot and jumping to Litton as president. At the time, there was much talk of a merger someday of Northrop, Litton, and TRW. "That was the dream roll-up," he says. "The problem was everybody wanted to be on top when it ended." Northrop, of course, was the one that made it to the top. Now it is up to Sugar to keep it there.  By Christopher Palmeri in Los Angeles, with Stan Crock in Washington
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