Northrop Grumman's board approved the spin-off of its struggling shipyards to stockholders after making changes to ease Navy concerns about the deal, Pentagon and industry officials said on Tuesday, NYT reports. But the deal still carries substantial risk for taxpayers.
The new company, Huntington Ingalls Industries, will start with so much debt - US$1.8 billion - that the three largest rating agencies classified much of it as noninvestment grade, or junk.
And 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.
The spin-off 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.
The spin-off, 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.
Northrop'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 US$35 billion in sales last year, and the profit margins from the operations were as low as 4 per cent to 5 per cent.
Analysts at Standard & Poor's wrote recently that Northrop would receive US$1.5 billion from Huntington Ingalls when the spin-off took effect.
The new company sold US$1.2 billion in notes to institutional investors earlier this month, and was expected to take on at least US$600 million in additional debt to pay Northrop and provide US$300 million in working capital.
But while the spin-off 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.
Navy officials said they spent several months in negotiations with Northrop before deciding to support the spin-off.
Sean 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'.
The 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'.
Captain Cate T Mueller, a Navy spokeswoman, said Northrop had agreed not to seek any types of payments from the US$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.
Mr Stackley said the Navy would now finish negotiating contracts for the new company to build an amphibious transport ship and a destroyer.
Northrop, 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 spin-off late last year.
The new company, Huntington Ingalls Industries, will start with so much debt - US$1.8 billion - that the three largest rating agencies classified much of it as noninvestment grade, or junk.
And 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.
The spin-off 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.
The spin-off, 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.
Northrop'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 US$35 billion in sales last year, and the profit margins from the operations were as low as 4 per cent to 5 per cent.
Analysts at Standard & Poor's wrote recently that Northrop would receive US$1.5 billion from Huntington Ingalls when the spin-off took effect.
The new company sold US$1.2 billion in notes to institutional investors earlier this month, and was expected to take on at least US$600 million in additional debt to pay Northrop and provide US$300 million in working capital.
But while the spin-off 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.
Navy officials said they spent several months in negotiations with Northrop before deciding to support the spin-off.
Sean 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'.
The 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'.
Captain Cate T Mueller, a Navy spokeswoman, said Northrop had agreed not to seek any types of payments from the US$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.
Mr Stackley said the Navy would now finish negotiating contracts for the new company to build an amphibious transport ship and a destroyer.
Northrop, 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 spin-off late last year.