Will Harris Acquiring Exelis Spur More Defense Firm Consolidation?

In February 2011, Ashton Carter was the Pentagon’s acquisition chief when he told Wall Street investors that the Defense Department expected an uptick in defense firm mergers and acquisitions.

The defense budget was beginning to shrink after reaching record-high spending levels at the peak of wars in Afghanistan and Iraq. Analysts and investors felt consolidation was only natural. So they waited. And waited.

Nearly four years to the day since Carter’s speech, Harris announced Friday that it would purchase Exelis. This comes just nine months after Orbital Sciences and Alliant Techsystems, known as ATK, announced they would combine to create a $4.5 billion aerospace and defense company with 13,000 employees.

The new company formed by Harris’ purchase of Exelis will create an even larger $8 billion tech company with 23,000 employees, according to a Harris statement, making it one of the Pentagon’s top 10 suppliers.

“The combination represents the reemergence of a stronger mid-tier defense sector and may entail more competition for primes in some defense segments,” said Byron Callan, an analyst with Capital Alpha Partners, in a note to investors soon after the deal was announced.

Harris supplies the military with aircraft avionics, tactical radios and many other types of communications, IT and network equipment. On the commercial side, the company has a robust air traffic control business.

Exelis is a major player in the business of command, control, communications, computers, intelligence, surveillance and reconnaissance, know among the arms industry as C4ISR. ITT spun off its defense business in 2011, creating Exelis.

“Once integrated, the combination of Harris & Exelis provides the new company stronger positions in military communications, space payloads and sensors, and information systems, particularly for air traffic control,” Callan wrote. “It [also] may be able to further develop electronic warfare products.”

The two companies both have products in the radio market, an already crowded sector with Army contracts on the horizon.

“They should be able to be healthy moving forward and aggressively go after some of this work,” said Roman Schweizer, an aerospace and defense policy analyst with Guggenheim Securities.

Under the terms of the deal, Harris will acquire Exelis for $4.75 billion is cash and stock. The acquisition, which is expected to close in June 2015, is the largest in Harris’ history, according to a company statement.

“The combination of the two companies’ highly complementary core franchises creates a competitively stronger company with significantly greater scale,” William Brown, Harris chairman, president and CEO, said in a statement. “We are expanding in a market, where we have decades of success and a workforce dedicated to providing our customers with innovative and cost-effective solutions for some of their most complex challenges.”

Larger defense firms have scooped up smaller defense companies over the past five years, particularly those with a cyber and drone technology expertise. But until recently there has been little movement in the middle tier. So could there be more movement?

“That’s the great question,” Schweizer said.

There could be more, but the results of upcoming military competitions and the size of the future defense budgets will all play factors, he said.

“I think there could be more, but it’s really now a question of how some of these competitions may shake out,” he said.

The Pentagon has said it would not support the merger of large defense firms, like Lockheed Martin, Boeing, Northrop Grumman, Raytheon and General Dynamics.

Defense officials, including Carter, have also said that they would scrutinize consolidation of lower-level companies to ensure monopolies are not created in certain sectors. Keeping competition throughout the defense industry has been a major goal of Carter, who is on the cusp of becoming the next defense secretary, and Frank Kendall, the Pentagon’s current acquisition chief.

European aerospace and defense giants BAE Systems and EADS, now Airbus Group, tied to merge in 2012, but the governments of Britain, France and Germany could not agree on the terms of the deal.