Strategic discipline and tightly-focused engineering expertise have helped keep Aerojet Rocketdyne Holdings Inc. (AJRD, Financial) aloft over the turbulent course of 2022. The rocket maker has built a solid niche for itself, one it has sustained despite the presence of the far larger companies that dominate the aerospace and defense industry.
While Aerojet has managed to find success as an independent entity, the advantages of merging with a bigger industry player have become increasingly apparent, both to company management and its investors. Thus, it is hardly surprising the market has reacted enthusiastically to the announcement that Aerojet is poised to be acquired by L3Harris Technologies Inc. (LHX, Financial).
Search for a new suitor pays off
When 2022 began, Aerojet Rocketdyne still expected to complete its planned merger with Lockheed Martin Corp. (LMT, Financial). However, that deal fell apart in January due to strong regulatory opposition, leaving Aerojet independent and without another prospective suitor. However, the company proved reluctant to give up on the idea of merging with a larger company. As I discussed previously, it has been quietly on the hunt for a suitable suitor for the last several months.
Aerojet’s hunt for a buyer ended favorably on Dec. 18 with the announcement that L3Harris Technologies will acquire it for $4.7 billion in an all-cash transaction. Both companies stand to benefit from the deal, as Space News reported on Sunday, mere hours after its terms were made public:
“The acquisition of Aerojet would give L3Harris a greater footprint in civil space, strategic defense systems and precision munitions…Aerojet’s CEO Eileen Drake said the sale of the company to L3Harris will ‘accelerate innovation for national security propulsion solutions while providing a premium cash value for our shareholders and tremendous benefits for our employees, customers, partners and the communities in which we operate.’’’
In a statement accompanying the buyout announcement, L3Harris CEO Chris Kubasik highlighted some of the principal benefits he believes will accrue by bringing Aerojet into the fold:
“We’ve heard the DoD leadership loud and clear: they want high-quality, innovative and cost-effective solutions to meet both current and emerging threats, and they’re relying upon a strong, competitive industrial base to deliver those solutions. With this acquisition, we will use the combined talents of more than 50,000 employees to drive continuous process improvement, enhance business operations and elevate the performance of this crucial national asset.”
The deal, which assigns Aerojet a valuation nearly 7% higher than the $4.4 billion price tag of the aborted Lockheed merger, has the potential to be a highly accretive acquisition for L3Harris. Aerojet’s specialized capabilities in the propulsion and SRM space can complement L3Harris’s existing interests in an expansive range of defense and space-related technologies and systems.
Consummation subject to regulatory approval
As is the case with any significant merger transaction in a strategically important industry, the L3Harris-Aerojet deal will need federal regulatory approval to proceed. Getting the go-ahead from regulators can be a tricky business, as Aerojet knows all too well from recent experience.
When Aerojet and Lockheed first announced their plan to merge in December 2020, they immediately faced stiff public opposition, especially from Lockheed rival Raytheon Technologies Corp. (RTX, Financial). Raytheon filed a formal complaint with the Federal Trade Commission in January 2021, claiming that a Lockheed-Aerojet tie-up would damage industry competitiveness. Raytheon CEO Greg Hayes sought to justify his company’s objection during an industry conference a month later:
"They [Aerojet] are a huge supplier to us, and if that merger actually happens, you don't have an independent supplier on the solid-rocket-motor side. And also, I think it gives us pause as we think about the competitive landscape going forward."
Ultimately, the Lockheed deal fell apart when the FTC lodged a formal objection to the transaction. Having determined the FTC’s opposition represented an insurmountable obstacle, Lockheed withdrew its offer. The probability of a similar negative outcome occurring with L3Harris appears to be far lower, according to industry experts, as Cynthia Cook of the Center for Strategic and International Studies explained on Dec. 19:
“This merger should not trigger the same concerns as the failed Lockheed Martin takeover, as this looks more like a move toward increased diversification for L3Harris rather than one representing increased consolidation for a particular sector.”
While there is undeniably some risk that Aerojet’s L3Harris deal will face regulatory opposition, it is clearly far more limited than it had been with Lockheed.
My take
In my view, the proposed L3Harris-Aerojet merger has quite a lot going for it. The combination will allow Aerojet to survive and thrive in a consolidating industry. It should also prove to be a value-accretive acquisition for L3Harris. This opinion appears to be shared by most Wall Street analysts, though their enthusiasm is generally leavened by a degree of caution due to the inherent uncertainty created by the need for regulatory approval. Cowen’s Roman Schweizer expressed these dual considerations succinctly in note to investors on Dec. 18:
“We see Aerojet as a unique strategic asset with capabilities and product lines in critical, fast-growing areas. We expect a thorough but quick FTC review, given the FTC's recent review of Aerojet's other deal. We expect approval but concede the current FTC is anti-consolidation.”
Aerojet’s $4.7 billion buyout price translates to $58 per share, a 5.7% premium to the Dec. 16 closing price of $54.89. At time of writing, Aerojet was trading at $55.72. In other words, the market has largely priced in the acquisition already. Even so, there remains some limited opportunity for a merger arbitrage play. Ultimately, investors interested in this name will have to weigh the low-probability risk of an FTC rejection against the limited upside present in the current share price.
