It's both rocket science and a no-brainer.

By Geoffrey Smith
September 18, 2017

One of the U.S.’s biggest defense contractors is positioning itself to be the country’s go-to for nuclear arms.

Northrop Grumman is buying Orbital ATK, a specialist in rocket engines and space flight technologies, for $7.8 billion (plus $1.4 billion in debt). The deal puts the defense tech company in a strong position as it bids for the right to upgrade the U.S.’s ground-based arsenal of Minuteman III nuclear-armed missiles, a procurement program with a value estimated at over $60 billion over its expected lifetime. The Minuteman is a Boeing ba product that has been the backbone of the U.S.’s first-strike nuclear capability for the last 45 years. The Department of Defense expects to choose a single contractor to design and make a new generation of missiles in 2020. Last month, it shortlisted consortia led by Northrop and Boeing, eliminating Lockheed Martin’s lmt bid.

Read: U.S. Air Force Awards Contracts to Boeing and Northrop for ICBM Replacement

Goldman Sachs analysts noted after the Defense department’s announcement that Northrop Grumman noc already had “the best-positioned product set of any defense company we cover,” citing its traditional strength in military drones and radar equipment. It reckons Northrop will be the fastest-growing big defense name over the next 5–10 years.

Zach Fryer-Biggs, Senior Pentagon reporter for defense specialist Jane’s, called the acquisition “a rational move.”

To a degree, the deal will give Northrop greater certainty over its rocket engine supply. It will also be able to strip out costs that will help it bid more competitively. Northrop said in a presentation that it will be able to generate $150 million in annual cost savings by 2020. Fryer-Biggs pointed out that Orbital also offers some other useful enhancements to its portfolio, such as an electronic warfare business that makes, among other things, counter-measures for aircraft.

Read: How to Defend Against Russia and China: Missiles, Missiles, and More Missiles

However, Fryer-Biggs also noted that the deal is “a little unusual.” For starters, Northrop hasn’t been noted for big acquisitions in seven years under CEO Wesley Bush. Instead, it has concentrated on returning cash to shareholders through buybacks and dividends; earnings per share have risen nearly 40% since the last quarter of 2014, while the quarterly dividend is up 43%. In all, it paid out $2.2 billion to shareholders last year, more than its entire free cash flow.

At the same time, Northrop has also sharpened its focus on being “an almost pure play” on defense, whereas over one-third of Orbital’s revenue comes from civil applications.

Read: Boeing and Lockheed Martin Are the Big Winners in Trump’s Defense-Heavy Budget

Lastly, the price paid by Northrop—$134.50 a share—is some 22% above Orbital’s closing price Friday, and Orbital had already risen over 20% this year, thanks to expectations of a windfall from the Trump administration’s pledge to overhaul the strategic arsenal. For that reason, Northrop shares edged up only 0.3% in early trading Monday, suggesting that, while the deal made lots of sense over the long term, the price is pretty full and the buyer has less practice than some at integrating new businesses, especially big ones.

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