How to address the rising antitrust scrutiny on A&D transactions

Aerospace and Defense (A&D) companies are subject to keen public attention as heightened consolidation will be subject to antitrust regulations.

In brief

• A&D companies who have pursued business consolidation must still foster competition and innovation within the industry.
• The US government’s antitrust agencies provide strict oversight on A&D mergers and acquisitions, adding scrutiny to highly visible transactions.

Last year, the U.S. Federal Trade Commission (FTC) blocked Lockheed Martin’s US$4.4 billion acquisition of Aerojet Rocketdyne, causing a termination of the deal by Lockheed Martin. The block by the FTC is a prime example that antitrust agencies view the aerospace and defense (A&D) industry as highly consolidated — as from 1980 to 2015, the A&D industry has consolidated from approximately 85 companies to just 5 major players (Boeing, Lockheed Martin, Northrop Grumman, Raytheon and General Dynamics).¹ These major players have rapidly consolidated high-demand and primary subsystems that are now causing anti-competitive concerns for the antitrust agencies. In response, A&D companies seeking large acquisitions or operating in a constrained industrial supply base must understand that their efforts to acquire companies may raise scrutiny during the merger review process.

Reviewing historical data shows no observable trend in second request investigations and challenged transactions between the FTC and DOJ across presidential terms.¹⁰ However, we have seen a decrease in the percentage of early termination grants and an increase in the percentage of court proceedings during the last four presidential tenures, which might be supporting evidence that the tough regulatory environment is here to stay.¹¹ Recent actions to combat A&D mergers with antitrust implications have been seen under the Biden administration:

The FTC and DOJ are the primary enforcers of antitrust laws, with departments like the DoD supporting analysis and collating findings for their consideration. Both FTC and DOJ have jurisdiction over A&D mergers, and both can issue filings to block a deal from happening. It is prudent to note that state attorneys also play as “quasi-sovereign enforcers in parallel with the agencies,” but do not influence the outcome of mergers as much as the federal agencies.¹²

The antitrust agencies and enforcers look for these factors in each type of transaction¹³:

• Mergers – How would this transaction affect the consumer and the opportunity for competition?
• Agreement between competitors – Are the companies in this transaction acting together to limit competition and set prices?
• Agreement between manufacturers and dealers – Does this transaction involve “tie-in” agreements that affect consumer choices?
• Monopoly – Does this transaction create a monopoly by way of exclusion or inhibiting the capabilities of other companies?

The process

The FTC webpage outlines steps when filing a merger. First, all parties must file with the FTC and DOJ. The parties must meet the filing thresholds and pay a filing fee to file. After filing, the case moves into a waiting period where the FTC and DOJ:

1. Grant or deny early termination
2. Determine whether the case contains all the necessary information
3. Grant clearance to one of the agencies to further review the case

The merger may proceed if an agency reviews the case within 30 days and does not request additional information. However, if the agency determines they need additional information, they will make a second request — putting the case into an extended waiting period. After a second request is issued, the case will either be approved to proceed or challenged.¹⁴

The following diagram is an illustration of the merger review process using FY2010–FY2018 data from the respective HSR annual competitive reports:

The exact clearance process has yet to be disclosed to the public. However, trends show that A&D mergers generally fall under the purview of the DOJ (per 2002 clearance guidelines published by the antitrust agency).¹⁵ The DoD also provides input to facilitate the decision-making process, but the power to initiate the complaint and make decisions remains with the FTC and DOJ. The agencies’ clearance process uses collective expertise to flag mergers that reduce competition without a reasonable business justification.

Most mergers are granted early termination, and about 10% to 15% are approved within the 30-day waiting period. The chart referenced above reveals that transactions over US$1 billion are more likely to be reviewed by an agency, increasing the odds of a challenge. The risk of a challenged merger is that the approval timeline is extended, increasing the amount spent on resources to execute the merger. However, it is worth noting that most challenged transactions are resolved via consent orders or a deal restructuring.

Proactive, strategic mindset can mitigate deal risk

Navigating the new antitrust environment brings challenges that necessitate strategic and agile approaches to target identification, acquisition and risk management. M&A is still effective for A&D companies looking to grow or expand their portfolios. For example, companies may focus on satellites, tactical missiles, fixed-wing aircraft and other relatively favorable categories to avoid antitrust scrutiny due to market consolidation. Whatever path A&D companies choose, some actions and behaviors can mitigate the risk of pursuing deals that will ultimately get blocked by the federal government.

Conclusion

To summarize, A&D companies believe market consolidation is necessary to sustain the defense industrial base, while the federal government still believes too much consolidation is negatively impacting competition by giving companies greater market power. As a result, the antitrust agencies are committed to strengthening merger oversight by addressing resource limitations, increasing new entrants into the market, increasing opportunities for small businesses and implementing sector-specific supply chain resiliency plans.

As a result, oversight efforts by the antitrust agencies have deterred A&D companies from M&A activity. Any extension of the merger approval process could potentially mean millions of dollars in legal fees, advisory fees and information procurement. However, there are strategies companies can take to increase their chances of a successful merger. Companies that are strategic in their selection, agile in their approach, diligent during the procedure and who manage their risk have the highest probability of surviving the merger filing process.