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Originally published Monday, September 13, 2010 at 6:00 PM

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With defense deals forecast, speculation turns to Boeing, Northrop

The aerospace industry is bracing for major consolidation among contractors, and speculation is rife that Boeing could lead the way in a colossal merger with Northrop Grumman to create the world's largest defense contractor.

Los Angeles Times

The aerospace industry is bracing for major consolidation among contractors, and speculation is rife Boeing could lead the way in a colossal merger with Northrop Grumman to create the world's largest defense contractor.

The chatter about such a potential combination was sparked last week after a Boeing executive disclosed that the Chicago aerospace and defense contractor is actively looking at potential acquisition opportunities. Neither company would comment.

Defense-industry analysts said a possible merger of the two makes financial sense for Boeing. But government approval of such a deal would be far from certain, they said.

"From a strategic standpoint, the deal makes a lot of sense," said Rick Phillips, managing director at Janes Capital Partners, an Irvine, Calif., aerospace and defense investment bank. "But I don't think it's happening."

That's mainly because federal regulators would raise antitrust issues, he said.

Boeing and Los Angeles-based Northrop are the nation's second- and third-largest defense contractors, behind Lockheed Martin. A merger would put about half of defense work with one giant company, he said.

The speculation was fueled by public comments last week from Dennis Muilenburg, chief executive of Boeing's defense, space and security division.

He said the company was targeting purchases of such businesses as unmanned aircraft, cybersecurity and intelligence and surveillance systems. Northrop already is a key player in those markets.

"We continue to see acquisitions as an opportunity area for us," Muilenburg said at the Reuters Aerospace and Defense Summit in Washington. "It's one of the tools that we use to grow."

After nearly a decade of double-digit growth in Pentagon spending, Defense Secretary Robert M. Gates has said the overall Pentagon budget would climb only about 1 percent annually over the next five years.

And with U.S. combat operations ending in Iraq, many in the defense industry believe contractors will be scrambling for work in the coming years.

"If you let market forces function in the coming downturn in defense spending, then one or two of the biggest companies will exit the business through mergers," said Loren Thompson, a military-policy analyst for the Lexington Institute, a think tank in Arlington, Va. "This is consistent in what we've seen in the past."

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After the Cold War ended two decades ago, military budgets were slashed. The excess capacity in the defense industry resulted in a barrage of mergers.

The number of aircraft makers dropped to three from eight, and the 13 missile manufacturers were reduced to four.

"Mergers and acquisitions are the strategic moves that companies make in a major downturn like the one we are about to enter," Thompson said. "Boeing needs to broaden its business while positioning itself for the future."

Unlike Boeing, which is known for building such conventional military hardware as cargo planes and fighter jets, Northrop specializes in more high-tech products, such as cybersecurity and unmanned-aircraft systems. Analysts see the Pentagon focusing more of its dwindling funds on those areas.

Phillips said a deal may not be so attractive to Northrop's new chief executive, Wesley G. Bush, who took over in January. "He just got the job and has a vision for the company," Phillips said. "I'm not so sure he wants to be working for Boeing all of a sudden."

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