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Best Defense?

Northrop extends its deadline for purchasing TRW. But TRW management seems to have its own plans.

6May

Talk about war games.


Last week, embattled defense contractor TRW Inc. reportedly set a Friday deadline for suitors interesed in buying the company's aeronautical-systems unit.


TRW's apparent deadline-setting undoubtedly come in response to Northrop Grumman Corp.'s earlier announcement that it was extending the May 17 expiration of its pending exchange offer for all outstanding shares of TRW stock. Northrop's new drop-dead date for TRW management: May 31, at midnight.


Whether TRW accepts Northrop's offer remains to be seen. TRW management claims that Northrop's $6.7 billion bid for the company is too low. By putting its aeronautical-systems unit on the block -- and threatening to separate its auto parts and defense companies -- TRW management may well be trying to put the squeeze on Northrop.


Indeed, a number of companies, including United Technologies Corp., Honeywell International Inc., Goodrich Corp., and L-3 Communications Holdings Inc. are thought to be interested in acquiring the TRW unit, which makes engines, flight controls and other airplane parts. TRW's target price -- $1.6 billion to $1.7 billion -- seems fairly steep, considering the unit generated $1.1 billion in revenue last year.


Then again, few takeover battles have generated as much animosity -- or focused as much on personalities -- as Northrop's bid for TRW. The $6.7 billion stock offer was occasioned by the sudden departure of TRW CEO David Cote in February -- to take on a bigger job running Honeywell. In fact, news reports paint a picture of a Northrop directors' meeting galvanized by word of Cote's defection, and approving an immediate bid for his former company.


One party with a keen personal interest is new Northrop COO Ronald Sugar, who knows TRW intimately from his days as finance chief, and later COO, of the Cleveland-based company. Sugar left TRW in June 2000, apparently after it became clear that he was being passed over for the corner office in favor of Cote. At Northrop, Sugar has joined CEO Kent Kresa and CFO Richard Waugh, who have collaborated on 17 deals over the past eight years.


TRW chairman Philip Odeen brusquely rejected Northrop's proposal, calling it "an opportunistic attempt...at a time when TRW's stock price was temporarily depressed" after Cote left. The response turned Northrop's bid hostile and set the stage for competitors to consider launching their own offers.


While management changes may not stimulate acquisition bids very often, major negative news events of any kind can make a company vulnerable, and temporarily cheaper to boot. Cote's departure knocked TRW's stock price down 7 percent the day it was announced.


In Northrop's case, evidence suggests that this bit of opportunism was less price-driven than strategy-driven -- in keeping with the company's efforts to build its space and satellite-related work. For one thing, Northrop almost certainly expected to have to fight to acquire TRW when it launched its initial offer. Ohio, TRW's state of incorporation, has among the strongest antitakeover laws in the United States. (Los Angeles-based Northrop has since filed suit against the state, claiming the laws are unconstitutional.)


>p> For another, Northrop had quietly targeted TRW as early as 1999, according to the company's Securities and Exchange Commission filings. Back then, says one filing, TRW ignored a letter from Kresa suggesting a merger. And last October, when Kresa and Cote met in person, the TRW chief apparently spurned another overture.



Battling Arms-Makers

However much TRW would like to remain independent, a defense-industry tussle for the company is likely. TRW chief Odeen, co-opting Northrop's own proposal to sell or spin off TRW's automotive business after doing a deal, announced plans to spin off the auto arm within the year. That move aims to reduce debt and ratchet up the company's value, both for Northrop and its rivals. Finding a buyer for the debt-laden auto unit could be tough, though. "We would think about who might be so rash as to buy the automotive business," declares Gimme Credit's Carol Levenson.


Buying TRW intact and assuming its debt would more than double Northrop's debt load, to $10.3 billion. Automotive analyst Suzanne Murtha of Boston-based Strategy Analytics says the sale of the auto business may depend on "how much of the debt is offloaded onto it." So disposing of the unit could be even thornier for Northrop, which will surely try to pare debt through the unit's sale.


At a March presentation to the Washington press corps -- a coming-out event for Sugar, Kresa's heir-apparent -- Sugar discussed how Cote's surprise move to Honeywell raised concerns at Northrop about "the stability of management and the future of the franchise" at TRW.


But Sugar emphasized that Northrop is "certainly not going to acquire TRW at a price that does not offer a value for our shareholders." Still, suggests analyst Paul Nisbet of JSA Research Inc., "I imagine that all along Northrop has had a higher price they would pay." Why does Nisbet think Northrop bid for TRW? "My guess is that Cote was a thorn in the side of any potential deal," he says. "They didn't want him, because they just wouldn't have gotten along."


So far, TRW has not announced if it received any bids for its aeronautical systems unit. Northrop managers and investment bankers may, in fact, revise the current offer to acquire TRW for the $6.7 billion in stock (plus the assumption of $5.5 billion in debt). Northrop management began conducting due diligence in mid-May, and is expected to continue going over TRW's confidential financial data through at this week. If Northrop does raise its bid, then TRW's maneuverings may be well-received on the home front -- that is, by the company's shareholders.

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