Lockheed Martin snaps up Titan

Tale of two companies

Lockheed Martin Corp.

Bethesda, Md.

President & CEO: Vance Coffman

Employees: 125,000

2002 Revenue: $26.6 billion

2002 net earnings: $500 million

Top 100 rank: 1

Ticker: LMT

Recent major federal contracts: Coast Guard Deepwater modernization, $11 billion; Federal Aviation Administration En Route Modernization, $490 million; Postal Service Automated Package Processing System, $970 million.

Titan Corp.

San Diego

Chairman & CEO: Gene Ray

Employees: 10,600

2002 Revenue: $1.392 billion

2002 net loss: $271.5 million

Top 100 rank: 16

Ticker: TTN

Recent major federal contracts: National Security Agency Enterprise Architecture and Decision Support, $533 million; Special Forces Command Enterprise Integration Technology, $190 million; Naval Air Warfare Center Aircraft Division test and evaluation, $188 million; Air Force Electronic Systems Center services contract, $103 million.

Lockheed Martin has "used acquisitions as their vehicle over the years to maintain their position as market leader in multiple areas. ? You can't just stand pat in a consolidating environment." ? John Allen, co-chief executive officer of Windsor Group LLC

Henrik G. de Gyor

Analysts see more major deals ahead

Lockheed Martin Corp.'s planned purchase of Titan Corp. for $2.4 billion, the company's second major deal in less than two months, has turned up the heat in an already hot mergers and acquisition market.

"The message the big acquirers have sent is that they're going for size," said John Mahoney, senior vice president of equity research with investment bank Raymond James of St. Petersburg, Fla. "They want the big bites."

As examples, Mahoney pointed to General Dynamics Corp.'s $1.5 billion purchase of Veridian Corp. earlier this year, Computer Sciences Corp.'s deal with DynCorp for $950 million, and Northrop Grumman Corp.'s hostile, but ultimately successful, acquisition of TRW Inc. last year for $7.8 billion.

The four purchasers are among the 10 largest federal contractors in the 2003 Washington Technology Top 100, while the companies acquired were among the top 25.

Next on the shopping list for these large integrators could be Anteon International Corp., ManTech International Corp. or CACI International Inc., Mahoney said. He also said other prospective buyers could include the Boeing Co., Raytheon Co., L-3 Communications Corp. and Electronic Data Systems Corp.

The dwindling number of large companies available for purchase could significantly increase their selling prices, analysts said.

The Lockheed Martin-Titan deal, announced Sept. 15, comes just six weeks after Lockheed Martin and Affiliated Computer Services Inc. agreed to swap divisions. Lockheed Martin gained ACS' federal unit for $658 million, while ACS took over Lockheed Martin's commercial IT business for about $107 million.

In the Titan deal, Titan shareholders may choose to receive $22 per share in cash, an equivalent amount of Lockheed Martin common stock or a combination of the two. Lockheed Martin assumes about $580 million in debt held by Titan.

The acquisition is expected to close in the first quarter of 2004, subject to approval by Titan shareholders, government regulatory reviews and other closing conditions included in the merger agreement

The Titan deal is particularly significant for Lockheed Martin, said Cynthia Houlton, senior analyst with RBC Capital Markets in New York. Of companies that size, Titan most closely mirrors the needs and interests of the Defense Department, she said.

"They do a lot of R&D work, also a lot of product development. They're pretty unique compared to most of the other defense contractors over $500 million," she said.

Titan, based in San Diego, has been concentrating its efforts on defense, intelligence, homeland security and NASA contracts.

In 2002, the company won the National Security Agency's Enterprise Architecture and Decision Support program, was awarded a Special Operations enterprise network management and engineering services contract, and started developing a new, low-cost unmanned aerial vehicle for the Navy. At the same time, the company also discontinued its commercial venture in wireless communications.

The acquisition fits well with Lockheed Martin's defense manufacturing business, said Mahoney, while also moving the company toward higher-value services business.

Secretary of Defense Donald Rumsfeld's transformation strategy for the military makes defense contracts less about the size of the weapon systems and more about their accuracy, he said. The transformation strategy also places greater emphasis on battlefield communications, one of Titan's particular strong points.

Buying Titan also ensures that Lockheed Martin stays king of the hill in the defense and government sectors, said John Allen, co-chief executive officer of Windsor Group LLC, an investment bank in Reston, Va. A company doesn't stay No. 1 on the Top 100 list for nine years, as Lockheed has, unless it takes steps to stay there, he said.

"I do think this is consistent with Lockheed's way of making sure they remain a market leader," Allen said. "They've used acquisitions as their vehicle over the years to maintain their position as market leader in multiple areas. ... You can't just stand pat in a consolidating environment."

Mahoney did question the cost of these megadeals. To get Titan, Lockheed Martin is paying about a premium 16.4 times the estimated 2003 earnings before interest, taxes, depreciation and amortization, just a little higher than General Dynamics' payment of 14.6 times EBITDA for Veridian. But Lockheed Martin could have made several smaller acquisitions and paid perhaps just 10 times EBITDA, he said.

"I would think General Dynamics, Lockheed, Boeing -- their internal merger and acquisition teams -- could be saving a ton of capital by buying six [smaller companies] and being more specific in what they want," he said.

Lockheed Martin is paying a premium roughly more than 30 percent of Titan's closing price per share of $16.96, said Anita Antenucci, managing director of Houlihan Lokey Howard & Zukin, an investment bank in Fairfax, Va.

Antenucci said Lockheed Martin is paying more of a premium for Titan than General Dynamics did in its deal for Veridian, but that the higher price for deals of this magnitude makes sense. There are relatively few acquisition targets of this size in the government space, especially that offer benefits such as a work force with a large number of security clearance holders, she said. Also, low interest rates continue to make acquisitions accretive to earnings despite the high multiple, she said.

Mahoney also questioned the structure of the deal from Titan's point of view, downgrading its stock to "underperform."

"Titan doesn't have a lot of upside potential" in the deal, Mahoney said. The company's stock, which had been trading in the $15 to $16 range, jumped to about $21 per share on the acquisition news. If problems arise during due diligence that causes Titan to back out, the company would have to pay $60 million. There is no similar penalty if Lockheed Martin walks away.

"If this deal falls through, Titan's stock could easily fall back," he said.

Staff Writer Patience Wait can be reached at pwait@postnewsweektech.com.

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