Will The FTC Try To Unwind Northrop Grumman’s 2018 Merger With Orbital ATK?

On July 22, Politico reported based on anonymous sources that Federal Trade Commission lawyers have concluded Northrop GrummanNOC
violated the terms of an agreement that the agency imposed as a condition for being allowed to acquire the nation’s biggest maker of rocket motors.

If true, that has interesting implications not only because of the more activist antitrust stance the FTC has taken under Chairperson Lina Khan, but also because the agency blocked a merger earlier this year between Lockheed MartinLMT
and Aerojet RocketdyneAJRD
similar to the Northrop Grumman deal it approved in 2018.

The agreement Northrop Grumman accepted in order to close its acquisition of Orbital ATK, known as a consent decree, was designed to prevent the resulting combination from engaging in anticompetitive practices.

Companies often undertake mergers with an eye to becoming more competitive. However, when the proposed transaction gives the enterprise too much power in the marketplace, potentially leading to the creation of a monopoly, that may be a violation of antitrust laws—most notably the Sherman Antitrust Act and the Clayton Antitrust Act.

Northrop Grumman’s merger with Orbital ATK, proposed in 2017, was deemed to have such potential, because it would wed a major producer of missiles with the biggest domestic manufacturer of rocket motors for powering such missiles. It thus could give the acquirer an unfair advantage in competing with other missile producers.

The FTC, which took the lead in reviewing the merger, was principally concerned with Orbital’s role in building large solid rocket motors—the kind used in launch vehicles and long-range nuclear weapons.

At the time the merger was proposed, Northrop and BoeingBA
were positioning to compete for a contract to build a replacement of the Minuteman III ICBM, which would require three stages of large solid rocket motors (“solid” referring to the composition of the fuel used).

The Minuteman replacement program, known as the Ground Based Strategic Deterrent, was critical to maintaining the U.S. strategic deterrent, and would be worth tens of billions of dollars over several decades.

Boeing’s team planned to buy its large solid rocket motors from an outside supplier, of which only two domestic suppliers had survived the post-cold war consolidation of the sector.

The company did not seriously consider the smaller supplier, Aerojet Rocketdyne, because Aerojet had recently moved operations from California to Arkansas. Boeing feared its missile proposal might be scored lower due to risk if it included Aerojet motors.

That left Orbital ATK, the company Northrop Grumman was proposing to acquire. If the merger was consummated, Boeing would have to share competition-sensitive information about its missile proposal with the company against which it was competing for the right to build the Minuteman III successor.

Alerted to this concern, there were two types of solutions that the FTC might have imposed as a condition for letting the merger go forward. One was a structural remedy in which Northrop was forced to divest the large solid rocket motor business as a condition for acquiring the rest of Orbital ATK. The other possibility was a behavioral remedy, under which the deal would be kept intact but Northrop committed to operating in an unbiased fashion in the marketplace.

FTC chose the latter course, which involved more than just a pledge on Northrop’s part: it would have to set up internal firewalls to protect Boeing’s proprietary data from the part of the company competing for the missile contract, and from third parties that might use the data to Boeing’s detriment. The result was a consent decree that the FTC announced on June 5, 2018.

But reaching agreement on the terms of a consent decree was just the beginning of the process. There had to be negotiations between Boeing and Northrop as to precisely what measures would be taken to protect Boeing’s data. The negotiations dragged on for a long time—so long that Boeing eventually concluded Northrop was delaying in order to better position for the missile contract they were both pursuing.

The Politico article says Northrop’s lawyers believe Boeing had sufficient notice of what was in the consent agreement to keep up with Northrop in the competition. Boeing argued it had to suspend work for the better part of a year, and by the time it was able to share data with Northrop-Orbital, it was too late to make the Air Force’s deadline for submitting a viable proposal.

After failing to secure an adequate extension of time from the Air Force, Boeing dropped out of the competition and Northrop Grumman won the Ground Based Strategic Deterrent by default.

There are now rumors in the industry that Northrop Grumman’s performance on the program has been uneven, resulting in delays and lost incentive fees.

Whether the rumors are accurate or not, the way the Northrop-Orbital consent agreement was implemented has reinforced the belief of FTC Chairperson Khan that behavioral remedies aren’t reliable when a proposed merger raises antitrust issues.

Khan said precisely that in a letter to Senator Elizabeth Warren on August 6, 2021: “Both research and experience suggest that behavioral remedies pose significant administrability problems and have often failed to prevent the merged entity from engaging in anticompetitive tactics enabled by the transaction.”

So now, having apparently concluded that Northrop violated the terms of its merger agreement, what should the FTC do? Simply forfeiting any ill-gotten gains arising from the violation isn’t enough, because for all we know, Boeing would have won the missile competition if FTC had not permitted the merger.

On the other hand, forcing Northrop Grumman to divest itself of legacy Orbital business lines at this late date would be hugely detrimental to the company, since those lines have long since been integrated into the framework of the enterprise.

One option might be to compel a divestiture of just those parts of the company engaged in making large solid rocket motors, since that was the main source of concern when the FTC originally reviewed the transaction. That too could be quite complicated, depending on how Northrop Grumman’s propulsion unit is now organized.

One thing is clear though: it makes little sense to leave the Northrop-Orbital combination untouched after (1) concluding that the company may have violated a critical part of its merger agreement and (2) the FTC has blocked a similar transaction between Lockheed Martin and Aerojet Rocketdyne.

That would leave Aerojet at a structural disadvantage in the marketplace, deprived of the functional and financial synergies that Northrop-Orbital now enjoys, and thus driving the market for large solid rocket motors toward precisely the kind of monopoly that the FTC is said to oppose.

All of the companies mentioned in this commentary—Aerojet, Boeing, Lockheed, Northrop and Orbital—have at one time or another contributed to my think tank.