Playing Take-away

With its 11th-hour acquisition of Honeywell, General Electric is engaging in M&A's most dangerous game.
Roy HarrisFebruary 1, 2001

It’s destined to be a textbook study for students of merger-and-acquisition techniques. On a Thursday afternoon last October, Jack Welch caught wind of United Technologies Corp.’s negotiations to acquire Honeywell International Inc. for $40 billion in UTC stock, and charged up his troops to steal the deal. By Friday, the General Electric Co. CEO had personally faxed Honeywell an 11th-hour offer, valued at $45 billion in GE stock.

Unwilling to enter into a bidding war, UTC withdrew, and by Sunday afternoon GE had signed the papers for the biggest acquisition in its history.

Such take-aways are happening a lot lately. One reason is a decrease in acquisition opportunities, says Warren Batts, adjunct professor at the University of Chicago and former Tupperware Corp. and Mead Corp. CEO. As industries consolidate, “the number of possible attractive mergers is diminishing, and those that really change your company are getting fewer and farther between,” he explains.

But a take-away acquisition is fraught with hazards. If, as numerous studies show, most acquisitions actually lessen shareholder value– thanks to overpricing, underanalysis, or poor integration, among other factors–the 11th-hour competing bid is even more vulnerable to disappointment. It’s a merger approach that severely tests valuation disciplines, putting things on a perilously fast track, pressuring bidders to consider the capabilities and motivations of the other suitor–not just the target company–and tempting acquirers to see “winning” as something other than obtaining benefits for their own shareholders.


Defying the odds, some companies have managed to play a superb game of take-away. A classic is considered to be the deal seven years ago that formed Northrop Grumman Corp.– a defense contractor in the M&A news again by virtue of its year-end agreement to acquire Litton Industries Inc.

Back in 1994, acquisitive arms-maker Martin Marietta Corp. had just announced that it had signed a deal to merge with Grumman Corp., marking what appeared to be one more step in Martin’s inevitable path to aerospace gianthood. But the smaller Northrop played David to Martin’s Goliath. Northrop, best known for its B-2 bomber, had been rapidly expanding into the same electronic-warfare areas that had become Grumman’s strength. Seeing value in the neat fit of the two operations, it topped Martin’s $1.9 billion bid with a winning $2.2 billion cash offer.

“Yes, quite frankly, we did have to scramble to decide what to do,” recalls Northrop Grumman CFO Richard B. Waugh Jr. Like GE in the Honeywell case, Northrop was surprised by the near-completion of a deal that had taken place secretly. Northrop, in fact, believed that it had been moving toward its own pact with Grumman when the Martin-
Grumman agreement was disclosed. “It really was a catalyst to get us to think about how serious we were, and what we would have to do to quantify that seriousness,” says Waugh.

What made Northrop’s fight against Martin exemplary? One quality was the vision of Grumman’s defense electronics lines being just what were needed for Northrop’s strategic development. “One characteristic of good mergers is that they’re very focused–with both companies in exactly the same industry, and with the buyer having a good track record,” says Thomas Lys, a professor who has analyzed countless bad and good deals with Merger Week, the executive-education program that Northwestern University’s Kellogg Graduate School of Management has conducted for 23 years.

Another characteristic of a good acquisition is that, like Northrop’s, it’s done with cash. “Stock is typically bad,” avers Lys. “You have a much higher propensity for overpaying.”

Also on the plus side, Northrop adhered to a strict acquisition model. The company takes an unusually disciplined approach to valuation, starting with discounted-cash-flow calculations for the target’s financial performance over five to seven years. Northrop Grumman commits its own operations people to the valuations that are made, offering incentives to produce whatever the projected result is. “We don’t get pie-in-the- sky,” says Waugh, “because the operations guy has to go out and do it.” Having operations people take an early lead in studying Northrop’s targets, and looking for ways to combine merged businesses, translate into success in postmerger integration–a costly stumbling block for so many acquisitions.

Of course, Northrop must do some educated guesswork about whether the target will win various government programs, and other matters. But though temptations may exist to add a strategic or defensive value to an acquisition price, “we don’t do that here,” says Waugh. “Our motto is that if you can’t profile [a corporate characteristic] in the model, it doesn’t exist.”

Although Northrop’s challenge to Martin Marietta was unusually combative for the defense contracting fraternity–“the attack by Northrop degrades the entire character of the rational consolidation taking place,” fumed Martin–Northrop’s goal was never simply to beat out its rival for a prize. “We acquired Grumman at a price where we expected to make more than our cost of capital,” says Waugh. “Had the price gone higher, we would have reached the point where we would not have acquired it.” Lending credence to the claim is Northrop’s subsequent record of skipping deals that bidding wars priced out of sight.


So how does GE’s take-away of Honeywell (which should be consummated in early 2001, barring regulatory obstacles) stack up against Northrop’s grab for Grumman?

M&A experts note that some basic merger rules may not apply to GE, which has an unmatched capacity for internal M&A research. In general, Batts points out, “if you’re a spoiler [of a previous agreement], you may not have all the free exchange of information you’d have if you were negotiating with a friendly company.” (UTC reportedly had negotiated with Honeywell for months before GE jumped in.) But, Batts adds, GE “probably knew what [it was] getting into.” Indeed, company financial analysts had already done some homework. “We have studied Honeywell and about every other company in the world till the cows come home,” Welch told the New York Times.

In terms of business fit, Honeywell–which itself had merged in 1999 with AlliedSignal, then run by CEO Lawrence Bossidy, a Welch protégé–is a good match for GE. “Honeywell’s core group of businesses…are a perfect complement to four of GE’s major businesses,” the GE chief said when the merger was announced. “Not only are the businesses a perfect fit, but so are the people and processes.”

Did GE shell out too much for Honeywell? UTC CEO George David joked to reporters that “it was nice of Mr. Welch to validate our business judgment and to overpay,” but there may be a hint of sour grapes in that remark. While Northrop refuses to include a strategic or defensive value in the price of an acquisition, it’s not hard to see that Welch might have factored such value into the $5 billion premium it paid over UTC’s bid. The take-away will both strengthen GE’s presence in the global aviation business and dim the prospects of rival UTC. And even if GE’s use of stock instead of cash as payment may have resulted in a steeper price, the buyer will account for the acquisition as a pooling, which means it won’t have to record costly goodwill on its balance sheet.

In acquiring Honeywell, GE also acquires earnings growth–something investors like to see at any time, but especially during an economic downturn. Nicholas Heymann, an analyst at Prudential Securities in New York, estimates that Honeywell will contribute at least 4 cents a share to GE’s bottom line in 2001. Last October, the exuberant Welch predicted that Honeywell would add at least 10 cents to annual earnings per share in the first full year of combined operations. And according to a report by Merrill Lynch & Co. first vice president Jeanne Terrile, the acquisition “could provide earnings momentum of the old-fashioned kind, like better margins and more productivity, when more cyclical businesses such as [GE’s] Power Systems slow down two or three years from now.”

Add in the projected cost savings from combining the two companies–Heymann thinks they could amount to as much as $15 billion by 2002–and it looks as if, once again, the 65-year-old Welch has proved to be nimbler than the competition.

But integrating the largest industrial acquisition in history will prove to be a long, costly affair, says Lys, even if the deal manages to slide through government scrutiny without much trouble. Noting that Welch, who boasts he has overseen well over 1,000 acquisitions in his career, intends to postpone his retirement through the end of this year to guide the melding of the two giants, Lys laughs. “A deal of that magnitude is going to take years to integrate,” he says.

For the time being, Wall Street may be suspending judgment over Welch’s last-minute masterstroke. But Lys, for one, already has a verdict: “He shouldn’t have given up his weekend.”

Roy Harris is a senior editor at CFO.


Some take-away deals pursued in 2000

TARGET  BUYER (Agreement Price) RIVAL (Original Price Bid)
Warner- Lambert  Pfizer ($90 billion) American Home Products ($72 billion)
The maker of anticholesterol drug Lipitor was won by Pfizer after it offered a huge premium.
Honeywell  General Electric ($45 billion) United Technologies ($40 billion)
Jack Welch wants to crown his career with this electronic-controls megadeal.
IBP  Tyson Foods ($3.2 billion) Smithfield ($2.7 billion)
Smithfield’s bid upstaged an LBO at the meatpacking company, before Tyson challenged.
Agribrands  Cargill ($580 million) Ralcorp ($450 million)
Cargill’s expansion ends plan for two former Ralston Purina companies to reunite.


The Need For Speed

According to CFO Richard B. Waugh Jr., perhaps the biggest lesson Northrop Grumman Corp. has learned from years of M&A activity is that “time is the enemy.” That’s why the company is trying to put its latest deal–the $3.8 billion agreement on December 21, 2000, to purchase warship builder Litton Industries Inc.–on the fast track. Waugh expects the integration of Litton and Northrop to be complete by the end of the year.

The ability to move the acquisition quickly, first through the government review period, then through the planning and the integration process, is “a huge factor in maintaining the stability of both companies going forward,” says Waugh. Since the deal is sure to eliminate duplicate operations, for example, a management challenge is to keep disruptive “water-cooler talk” to a minimum.

Of course, Northrop is also hoping that no rivals for Litton emerge as Northrop pursues its $80-a-share tender offer, a 29.7 percent premium over Litton’s trading price the day before the December 21 offer. The premium was a warning shot aimed at potential rivals, and in the early going Northrop had succeeded in keeping them away. Northrop’s offer for Litton shares expires February 2, unless it is extended.

While Northrop had been talking secretly with Litton for the better part of last year, negotiations didn’t intensify until Litton decided to put its defense-electronics business up for sale. Doing so would have meant that Litton’s competitors–not to mention potential rival bidders for Litton–would gain access to proprietary information about the company. In such a case, “the value is tainted,” says Waugh, because the data gives other companies “a better understanding of how they compete for business, or their rate structures.” With the deal, Northrop acquires all of Litton, lock, stock, and barrel.

In valuing Litton, Northrop used its standard formula, involving a forecast of Litton’s discounted cash flow after a series of assumptions about its future business in the shipbuilding and defense- electronics areas. Litton’s Navy work was considered a major positive, because naval systems are a growth area within the U.S. defense budget.

Northrop sees its own experience as a prime contractor and systems integrator–most recently on the B-2 bomber for the Air Force–as being transferable to Navy prime contracting as well. For Northrop, explains Waugh, building ships is “a new segment of the industry, but clearly it’s our industry.” –R.H.


Acquisitions done and left undone by Northrop Grumman.

1994:Grumman acquired for $2.2 billion after bidding against Martin Marietta.

1997:Raytheon outbids Northrop Grumman intwo defense-electronics deals, paying $9.5billion for Hughes’s business and $2.95billion for Texas Instruments’s business.

1997:Agreement to buy Logicon for between$600 million and $700 million signed;Lockheed Martin agrees to merge withNorthrop Grumman for $11.6 billion.Northrop’s Logicon purchase closes.

1998:Lockheed deal collapses after U.S.challenge; Logicon integration is costlierthan expected due to complicationsbrought on by pending Lockheed merger.

2000:Britain’s BAE Systems outbids Northropfor Lockheed’s Sanders electronicsbusiness; pays $1.67 billion. Northropsigns agreement to acquire LittonIndustries for $3.8 billion, plus $1.3billion of debt assumption.


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