Northrop Grumman’s board approved the spinoff of its struggling shipyards to stockholders after making changes to ease Navy concerns about the deal, Pentagon and industry officials said on Tuesday. þþBut the deal still carries substantial risk for taxpayers. The new company, Huntington Ingalls Industries, will start with so much debt — $1.8 billion — that the three largest rating agencies classified much of it as noninvestment grade, or junk. þþAnd without Northrop’s deep pockets to turn to, the new company could run into more trouble if it cannot cut costs in building nuclear-powered aircraft carriers, submarines and other ships, analysts cautioned. þþThe spinoff comes as the Pentagon spending is tightening and its shipbuilding budget is becoming less certain. Northrop is the world’s largest military shipbuilder, and General Dynamics is its only American rival in building large warships. There is also a glut of capacity, and some of Northrop’s yards are the least efficient and have had serious quality problems. þþThe spinoff, which is subject to approval by securities regulators, is expected to take place on March 31. Northrop, based in Los Angeles, said its stockholders would receive one share of the new company, in a tax-free distribution, for every six shares of Northrop they hold. þþNorthrop’s chief executive, Wesley G. Bush, has been refocusing the company on more profitable businesses like electronics, robotic systems and cybersecurity. The shipyards accounted for only about one-fifth of Northrop’s $35 billion in sales last year, and the profit margins from the operations were as low as 4 to 5 percent. þþAnalysts at Standard & Poor’s wrote recently that Northrop would receive $1.5 billion from Huntington Ingalls when the spinoff took effect. The new company sold $1.2 billion in notes to institutional investors earlier this month, and was expected to take on at least $600 million in additional debt to pay Northrop and provide $300 million in working capital. þþBut while the spinoff makes sense for Northrop, the Pentagon could have less leverage over the operations if the new company performs poorly. Analysts said the Navy would have to think twice about withdrawing contracts from Huntington Ingalls if that would result in a weakening of the company’s finances. þþNavy officials said they spent several months in negotiations with Northrop before deciding to support the spinoff. þþSean J. Stackley, the assistant secretary for acquisitions, said the Navy reviewed the financial assumptions, including proprietary business projections, and reached an agreement with Northrop that included “appropriate adjustments.” þþThe changes enabled Navy officials “to resolve our concerns about the risk involved to this important segment of our shipbuilding industrial base,” he said, adding that the Navy was confident that the new company was “well postured to build affordable ships into the future.” þþCapt. Cate T. Mueller, a Navy spokeswoman, said Northrop had agreed not to seek any types of payments from the $300 million in working capital at the new company. She said Northrop had also agreed that Huntington Ingalls would receive any performance bonuses or other Navy payments relating to ship contracts it transferred to the new company. þþMr. Stackley said the Navy would now finish negotiating contracts for the new company to build an amphibious transport ship and a destroyer. þþNorthrop, one of the nation’s largest military contractors, announced last summer that it was studying whether to sell or spin off the shipbuilding business, which includes sprawling yards in Virginia, Mississippi and Louisiana, with more than 30,000 workers. But the talks with the Navy heated up after Northrop settled on the spinoff late last year. þþThe debate over the proposal also coincided with concerns by Pentagon officials about how to promote more competition for military contracts. þþAshton B. Carter, the Pentagon’s top acquisition official, warned in February that the largest military contractors would not be allowed to merge. In the same speech, he also appeared to caution Northrop about the spinoff, saying that transparency from contractors was essential “as we review proposals that may result in the creation of weaker stand-alone firms less likely to thrive without the necessary capital structure that their larger parent company is able to provide.” þþNorthrop has said that its top shipbuilding executives will run the new company, which will be based in Newport News, Va. The corporation’s Newport News shipbuilding unit is the only company that builds the Navy’s aircraft carriers, and it splits the work on nuclear submarines with General Dynamics. þþDavid Petu, an analyst at Fitch Ratings, said Tuesday that it could be an advantage for the new company to have its executives focusing only on shipbuilding. Other analysts said it would be easier for them to reinvest the company’s cash in shipbuilding since they would not have more profitable alternatives, as Northrop does. þþNorthrop’s Ingalls shipyard in Pascagoula, Miss., was heavily damaged by Hurricane Katrina, and Mr. Petu said the new company could get in trouble if a similar disaster struck. þþFitch assigned an overall BB default rating to the company, just below the lowest investment grade ratings. Moody’s Investors Service gave it a similar Ba2 rating, and S.& P classified it as BB-minus. þþThe ratings mean that Huntington Ingalls will pay higher interest rates than Northrop would have. The new company recently sold $1.2 billion in senior unsecured notes at interest rates of 6.875 percent and 7.125 percent. þþNorthrop had said it planned to eventually close its shipyard in Avondale, La., and transfer the work to Ingalls. The Navy has sharply criticized the mistakes made on a series of amphibious ships built at the Gulf Coast yards. þþThe company’s most critical work takes place in Newport News, and it also has had problems there. Just last week, federal prosecutors filed criminal charges against a former Northrop Grumman shipyard inspector, accusing him of falsifying weld certifications on a submarine. þþAnalysts said that to succeed, the new company will have to cut costs — and probably more jobs — at the Gulf Coast shipyards. And an even bigger test will be how it manages construction of a new class of nuclear-powered aircraft carriers. The first one, being built now, is projected to cost $11.5 billion. þþ
Source: NY Times
