Northrop's Bid to Buy TRW Buoyed by Share Price

By ANTHONY PALAZZO
Staff Reporter

A rising stock price is giving Northrop Grumman Corp. a big assist in its months-long attempt to wrestle an agreement to buy rival TRW Inc.

Cleveland-based TRW is proceeding with its own plan to break itself up and sell itself off in pieces. In the meantime, executives of the defense and auto-parts company have done their best to drag out the process for Los Angeles-based Northrop's hostile all-stock offer. But time seems to be working in Northrop's favor.

"The more Northrop's share price goes up, the more they can offer on a relative basis without costing themselves more money," said Scott Keller, president of Dealanalytics.com, a mergers and acquisitions research firm.

Northrop announced its bid for TRW on Feb. 22, then raised it on April 14. Last week, TRW agreed to open its books to Northrop after the two sides agreed on a standstill pact until Sept. 30, during which time Northrop won't pursue its bid.

It could take Northrop two weeks or more to conduct its due diligence, said spokesman Randy Belote. After that, it will take Northrop "inside of a week" to decide whether to raise its bid, which currently rests at $53 a share. (The bid is worth $6.8 billion in stock, and includes the assumption of another $4.9 billion in long-term TRW debt.)

Belote said he could not predict whether an agreement would be reached before Sept. 30. If TRW makes a deal with another party before then, Northrop won't resume its hostile takeover attempt until June 30, 2003.

"Obviously we had hoped that we would have had access to the non-public information several months ago when we first started the process," Belote said. "However, that wasn't to be so we have to work (the deal) in its own time."

The ball is in TRW's court, said Joe Nadol, a vice president covering the aerospace industry for J.P. Morgan. "If they want to they can drag this process out for some time and proceed with their own plan."

Stock up 11 percent

There's debate, however, on whether TRW would be smart to do so. Since the bid was announced on Feb. 22, Northrop's stock price has risen 11 percent, to a recent price of $121.77. Each time Northrop's price rises, the number of shares it must issue to maintain its bid declines.

"Northrop's currency is becoming more expensive relative to TRW's share price, so they can pay more without issuing additional stock," Keller said. Northrop has the advantage in the negotiations, he said, because "no one else wants to buy TRW."

(No other bidders have been announced, but there are reports that L-3 Communications and U.K.-based BAE Systems have expressed interest in non-auto parts portions of TRW. Northrop is interested in TRW's defense and aerospace assets and has said it would dispose of the auto-parts business.)

Because Northrop's stock is so high, the number of shares it will have to issue in a deal rose only slightly when it upped its bid in April.

Under the old proposal, Northrop would have issued between 53 million and 58.1 million of its shares, according to the "collar," or exchange-ratio limits that Northrop placed on the offer. The collar provided a fixed value of $47 per share to TRW shareholders, as long as Northrop's average stock price stayed within a range of $103 to $113 per share. If Northrop's price were to breach those price limits, the value of the deal would have fluctuated.

In its most recent offer, Northrop raised its price to $53, an increase of 12.7 percent from the original bid. But because its share price is higher, the number of shares Northrop would issue rose only 3 percent. The new collar guarantees the $53 price as long as Northrop's stock remains between $113 and $123, providing for the issuance of 54.9 million and 59.8 million shares in exchange for TRW's 127.4 million shares outstanding.

Looked at another way, under the original offer Northrop's $47 per share offer would have risen by nearly 8 percent anyway, due to the appreciation in its stock price beyond the original bid's upward collar limit of $113.

In the same way, Northrop's rising stock price could increase the value of the bid that's currently on the table if it breaks through the $123 collar limit. Or, it makes it easier for Northrop to raise its bid without risking dilution.

Grabbing contracts

Increasing investor interest in the defense sector has played a role in Northrop's stock rise, as the Bush Administration seeks equipment to mount a non-conventional war on terrorism worldwide. Another factor has been Northrop's success in picking up defense contracts.

In late April, a Northrop-Raytheon Co. partnership was the surprise winner of the $3 billion DD (X) System competition to design the next generation destroyer for the Navy. The deal could be worth up to $60 billion.

The company also is part of the team led by Lockheed Martin Corp. that won the $100 million Joint-Strike Fighter contract last year.

Upcoming competitions could yield additional wins for Northrop, as soon as next week. A Northrop-Raytheon team "has a good shot" at winning a $2 billion bomb-detection contract with the new Transportation Security Agency, Nadol said. Competitors include Boeing Co. and Lockheed Martin.

"We are extremely well positioned not only for (that contract) but a number of other homeland defense initiatives on the horizon," Belote said.

In addition, a Northrop-led team appears to be on track to win the $8 billion Deepwater contract to modernize and upgrade the Coast Guard.

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