I had been asked several times in the press over the past few weeks about the mooted merger between Oshkosh and Navistar, an idea seemingly brought up simply because Carl Icahn now owns something close to ten percent of each company. OK, Carl doesn’t buy companies to run them for the long term, so it’s easy enough to imagine his intent. But each time, when asked what I thought of the merger, I had to admit that it wasn’t the first deal that I would have expected. I could think of a few others, including almost anything involving Force Protection, I would say, if the company wasn’t so fiercely independent.
Not eternally, it seems. General Dynamics Land Systems and Force Protection announced earlier this week that GDLS would be buying the smaller firm for $360 million, or $5.52 per share—about 31 percent above its recent price on the market. That’s a considerable premium, but I’ve already heard some grousing in both directions—that the price wasn’t high enough, and that FP just isn’t a good acquisition for GD. Since I generally don’t comment publicly on transaction prices, at least not without a lot of analysis, I will simply strive to explain why I think that this deal makes sense in principle.
As I’ve commented previously, in this column and in the press and to clients, the military vehicle business is shrinking quickly. When the commandant of the USMC notes that he has 40,000 vehicles, but only needs 30,000, there’s not a lot of room for new programs. That’s before the force structure cuts that we all know are coming, which will also damped enthusiasm for remanufacturing of old vehicles. And yet, there are at least eleven industrial enterprises in the US alone involved with either manufacturing or remanufacturing military vehicles: Oshkosh, Navistar, Daimler (Freightliner), GDLS, FP, BAE Systems, AM General, Textron Land Systems, the Red River Army Depot, the Marine Corps Logistics Base at Albany (Georgia), and MCLB Barstow. It’s pretty inconceivable that all these entities will be left standing after the full extent of the projected declines in spending are felt. After all, in the 2005 Base Realignment and Closure (BRAC) process, the Army itself nominated Red River for closure, and only the BRAC Commission’s hesitation about closing a repair facility during wartime saved it.
So we know that consolidation is coming, that factories will be closed, and that jobs will be shed. The current costs, admittedly, are concentrated amongst those who did yeoman service building vehicles to protect the troops in two wars, but the benefits, if diffuse, will accrue to taxpayers who can reallocate those resources to more efficient future use. For those in the business, this can happen suddenly, in financial distress, or it can happen in an orderly fashion, with plenty of time to sort the assets into their most efficient groupings. GD and FP are choosing the latter path.
All that said, while it was an open secret that plenty of firms had discussed buying FP, the company wasn’t ostensibly being shopped around. GD’s bid was said to have been unsolicited. So why FP specifically? There are at least two reasons.
First, FP has a large installed base of vehicles with relatively loyal customers around the world. The US Marines and the British Army in particular are quite fond of its vehicles, and its Buffalos, the heaviest MRAPs available, are now not just movie icons, but a program of record with the US Army. It’s hardly always the case that the original equipment manufacturer (OEM) captures the future upgrade work on its own vehicles, but the OEM always has a built-in advantage. Even if the government own the technical data package (TDP), there is tacit knowledge in the company, well beyond what’s in the TDP, about how those vehicles work. If the right people in the workforce are retained through the inevitable downsizing, they will form a sustainable competitive advantage in that market.
Second, FP has important technologies, some patented, some simply trade secrets, that bolster the robustness in combat of its products. With this acquisition, preferential access to FP’s armoring products and survivability concepts will accrue to GDLS’s vehicles. This is a bit more than the canard about sticking Navistar engines in Oshkosh trucks, as some Wall Street analysts ventured to the press last month (mostly when grasping at straws to try to sound smart). Engines are relatively modular products that are bought and sold on the open market. Navistar might make sense as a directed subcontractor for Oshkosh’s vehicles, but Catepillar seems to mostly have that role, at the Army’s insistence, and that’s the end of that story. About armoring solutions, military customers are much more flexible, simply because they know what they don’t know. FP’s armor is reasonably modular, in the sense of technology architectures, but the know-how for improving survivability is much more integral and sensitive. There are several companies in the business that are very good at this, but GD is buying one with differential, valuable intellectual assets.
It’s also important to note what this deal is and is not. In this month’s National Defense, Sandra Erwin takes the merger “as further proof that the defense sector increasingly will become vertically integrated as large companies swallow their financially weaker competitors.” The industry will become more concentrated, yes, but not necessarily more vertically integrated. The second explanation above is a matter of vertical integration, but the first is a matter of horizontal integration. Sandra does, however, have an excellent point about the truck business per se. Force Protection was a case study in my book Arms and Innovation: Entrepreneurship and Alliances in the Twenty-First-Century Defense Industry (University of Chicago Press, 2008). Therein, I wrote a bit about this issue, concluding that in the middle of the last decade, the company faced a great market with some great capabilities, but had a tight window for success. In the long run, the large-scale economics of truck production would come to favor larger firms, and FP would have trouble competing on that basis. With this deal, management is concluding that the best deal for shareholders is that 31 percent premium right now.
I don't believe that any of the shareholders are upset about the alliance between FP and GD. In fact I believe that it will be a net positive for the military.
The question is one of fiduciary duty to the shareholders of FP. $125 million in cash, NO DEBT, $115 Million in inventory, 700+ million in backlogs, and absolutely stellar chance to land contracts in Canada and Australia. A great chance for the UK to increase it's fleet of "Foxhounds". Many years of sustaining and upgrading the vehicles. Not to mention, there will be more conflict in the world, only question is when. (I pray this is not so, I have a son in the military, but one must be realistic) This downsizing can change in an instant as it did in 2001, 1965, 1941, 1nd 1917.
I am not an analyst, but I see no less than $7 per share.
I also do not like the deceitful silence surrounding the sale. I believe, if it smells bad, looks bad, it probably is.
Lawyers will be the only ones to make out on this deal, two years from now the company, whoever it is, will be ordered by the court to pay a small settlement to shareholders and all this could be handled now. What ever happened to the honest man that is as good as his handshake.
Posted by: Tom Gwin | 10 November 2011 at 14:19