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Sometimes Antitrust Is Rocket Science
With the FTC challenging the Lockheed-Aerojet merger, 30 years of consolidation could be at an end.
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Last Tuesday, the Federal Trade Commission, with support from the Pentagon, challenged the $4.4 billion merger of Lockheed Martin and rocket motor maker Aerojet. Lockheed is the largest defense contractor in the world, with $65 billion in sales, three quarters of which comes from the U.S. government. Aerojet has $2 billion sales, almost all of which goes directly or indirectly to the government. These aren’t direct competitors, Aerojet is a supplier to Lockheed, which means the merger is known as a ‘vertical’ deal, versus a ‘horizontal merger in which rivals mergers. Vertical merger challenges have traditionally been unusual, but that’s changing. In this case, all four FTC Commissioners voted to bring the challenge, which means both Republicans and Democrats objected to the deal.
For thirty years, the defense industry has been on a binge of acquisitions, and this merger was to be the latest iteration of it, with a particular focus on consolidating control of the contract for the newest strategically important weapons system family, hypersonic missiles. Since 2020, the number of firms capable of producing solid rocket missiles consolidated from six to two firms. Nevertheless, this merger challenge was a shock to Wall Street, with Aerojet’s stock dropping by 20% on the news. And there are significant broader implications - positive ones - to the defense base.
Lockheed is what is known as a ‘prime contractor,’ which is to say it signs big deals with the Pentagon for complex weapons, and then subcontracts the component parts with specialty firms to make specific components. In this case, Aerojet produces missile propulsion systems and components for “missile rounds and/or missile systems ("missiles"), missile defense kill vehicles ("KVs"), and/or hypersonic cruise missiles ("HCMs").” Lockheed competes in this market with other primes like Raytheon, Boeing, and Northrop, who also all work with Aerojet.
The FTC objected to the merger because it claims that if Lockheed buys Aerojet, it will then deny its competitors access to Aerojet’s technology, thus giving itself a leg up on key contracts. The FTC noted in its complaint that Lockheed has already tried to prevent other primes from getting access to “Critical Propulsion Technologies,” but did not succeed, because it did not control Aerojet. A secondary claim is that if Lockheed buys Aerojet, it can then focus Aerojet’s designs on only being compatible with Lockheed systems, whereas right now, it is competitively neutral. Finally, Lockheed would also be able to use sensitive data Aerojet has on Lockheed competitors to enhance its bidding strategies.
Lockheed’s argument on behalf of the merger would probably have been that it will be able to efficiently build hypersonic missiles, a new kind of missile technology that China and Russia have moved ahead on. Amusingly, Lockheed CEO James Taiclet discarded that argument to investors on an earnings call almost immediately.
Taiclet offered assurances the company’s hypersonic weapons development strategy remains on firm footing.
“We think we could have gotten a speed and efficiency increase by the partial vertical integration on hypersonics through the [Aerojet] acquisition specifically, but we can still manage it whichever way that deal turns out,” he said.
That’s pretty much throwing in the towel, as far as I can tell.
But of course, the challenge isn’t just about Lina Khan at the Federal Trade Commission blocking a defense merger, it has to do with one of the more powerful areas of governance, the military. And with this challenge, which was sanctioned by the Pentagon, it seems the military has turned on consolidation. And that’s a big deal. When the Cold War ended, the Clinton administration sought to radically consolidate the defense base, with the Pentagon explicitly financing and encouraging a merger wave to shrink the number of prime contractors from roughly 100 to 5. The idea is that the primes wouldn’t oppose reducing defense spending in the post-Cold War environment, as long as they got to make it up in higher margins from less competition.
And since then, mergers have been commonplace. And the effects are clear. As of 2020, nearly two thirds of DoD major weapons system contracts had only one major bidder, and the top 10 aerospace and defense companies accounted for 86 percent of industry revenues. All the signs of monopolization - high prices, poor quality, bad service - are now showing up at the Pentagon. A few years ago, Northrup bought Orbital-ATK, which also made independent rocket engines. Shortly thereafter, despite a consent decree with the FTC, Northrup denied access to rocket engines to Boeing, its competitor for the ICBM nuclear upgrade. As a result, Northrup has a sole source contract, a point highlighted by, among others, anti-monopolist Elle Ekman in the American Conservative.
One result is that the anti-monopoly movement has begun to penetrate the Defense Department, as I wrote last February.
In 2018, the Defense Department released a study lamenting the loss of over 20,000 suppliers since 2000, and observing that “a surprising level of foreign dependence on competitor nations exists” for a whole host of critical products. Just a few months ago, the Pentagon sent Congress a groundbreaking report on how Wall Street is destroying the defense base. “A U.S. business climate,” it read, “that has favored short-term shareholder earnings, deindustrialization, and an abstract, radical vision of ‘free trade,’ without fair trade enforcement, have severely damaged America’s ability to arm itself today and in the future.” Keep in mind that this is not some advocacy group calling for fair trade or criticizing short-term shareholder profiteering, it’s the Pentagon.
Despite the anodyne bureaucratic wording, the level of alarm at how private equity and mergers have weakened productive capacity was evident, with the report asserting that “The number of cases where there is just one – often fragile – supplier is staggering. This is a deterioration from a decade ago when 3 to 5 suppliers existed for each component, let alone several decades ago when the military generally enjoyed dozens of suppliers for each item.”
In 2019, Lucas Kunce and I wrote a piece that went viral in national security circles, titled America’s Monopoly Crisis Hits The Military. Senators Elizabeth Warren and Richard Blumenthal, as well as Rep. Mark Pocan have put pressure on defense mergers. The Biden national security team recognizes problems with defense consolidation, and the current Deputy Secretary of Defense - Kathleen Hicks - told the Senate Armed Services Committee of her concern with consolidation at her confirmation hearing. In July, Biden issued an executive order on competition policy, with specific instructions for the Pentagon on competition, and Hicks is the Pentagon official on the White House Competition Council set up by that order. Moreover, Congress is getting more interested, and has put provisions into DOD authorizing legislation encouraging investigations into the problem of market power in the defense base.
It’s not completely clear to what extent this challenge changes the calculus for defense mergers, but it does seem significant. Here’s the headline in the Wall Street Journal, just a few days ago.