Lockheed Will Be The New Owner Of Sikorsky Helicopters

Over the past few months, we have been exploring the possibilities that existed for Sikorsky Helicopters after United Technologies (NYSE:UTX) announced its intention to divest the helicopter manufacturing division. There was a lot of speculation about whether Sikorsky would be spun-off or sold, with more bets being placed on a spin-off due to the huge tax burden that would accompany an outright sale. Sikorsky is an attractive business and hence several contenders for a potential sale of the division also emerged soon after the announcement was made.

The final result of negotiations is now out. Lockheed Martin (NYSE:LMT) will be the new owner of UTC’s Sikorsky Helicopters that it has purchased at a price tag of $9 billion dollars. Lockheed stands to gain $1.9 billion in tax benefits with the conclusion of this sale. Lockheed Martin will also have access to a greater share of total contracts with the U.S. military as Sikorsky currently claims more than 65% of the Pentagon’s helicopter spending share. ^[1] At the same time, Sikorsky will also provide Lockheed more exposure to the commercial sector. This acquisition will also help Lockheed surpass Boeing to become the world’s largest helicopter prime in the future. Lockheed also announced that it will be divesting its non-military IT and services division by the end of the year to focus more on its core operation of providing platforms. The removal of this business, which has been witnessing a decline in recent years, and the addition of a high growth business like Sikorsky will push the overall revenue growth rate at Lockheed up in the future. Additionally, we anticipate that the cost synergies that will accompany this acquisition will also help push overall margins at Lockheed in the future.

Here are the top insights we derived from the deal between Lockheed Martin and Sikorsky.

Lockheed is getting a great bargain to potentially become the largest helicopter prime in the world

Lockheed and United Technologies have agreed to make a joint election of a standard in the Internal Revenue Code which will effectively treat this deal as an asset purchase for tax purposes. As a consequence of this, Lockheed Martin will receive $1.9 billion of tax benefits upon conclusion of the sale. ^[2] This makes the effective price of the purchase come down to $7.1 billion from $9 billion. While negotiations were still underway, the market estimated Sikorsky to be valued at $8-10 billion. Consequently, at $7.1 billion Lockheed is acquiring Sikorsky at a bargain.

Sikorsky is currently the second largest helicopter prime in the world, trailing Boeing. Sikorsky won four major contracts in 2014, including the U.S. Presidential Helicopters deal. These contract wins are cumulatively valued at approximately $13 billion, and could move Sikorsky, which will now be a part of Lockheed Martin, ahead of Boeing in terms of revenues to become the largest helicopter prime in the world.

Sikorsky acquisition will push overall revenue growth rate in the future, though immediate net impact of total restructuring will be minimal 

Since 2010, Lockheed Martin has witnessed relatively flat revenues.  Consequently, with defense spending in the U.S. witnessing a decline over the past couple of years it was difficult for Lockheed Martin to display accelerated revenue growth. Currently, Lockheed has set a forecast of up to $45 billion for fiscal year 2015. The addition of Sikorsky will increase this forecast by $6.5 billion. At the same time, the non-military IT & services division currently bring in about $6 billion to Lockheed annually. ^[3] As a result, the immediate net impact on revenues will be minimal.

LMT: Total Revenues 2010-2014, as illustrated on Trefis Institutional

However, Sikorsky disclosed in its most recent investor meeting that it expects to grow to $10 billion by 2023 at a compounded annual growth rate of 5%. ^[4] On the other hand, Lockheed’s IT & services division has witnessed declining sales over the past three years. The division witnessed a 5% decline in the 2012-2013 period and a subsequent decline of 7% between 2013-2014. ^[5]

The growth rate of Sikorsky outpaces that of the non-military IT & services division that Lockheed is divesting. As a result, the replacement of a division that was being a drag on overall growth by one which promises impressive growth over the next 10 years will help push overall growth rate of revenues at Lockheed.

Lockheed’s acquisition of Sikorsky will generate significant cost synergies 

Lockheed and Sikorsky already partner on several critical projects. These include the VH-92 Presidential Helicopter, the Combat Rescue Helicopter and the Naval MH-60 Helicopter. ^[2] As a result, the absorption of Sikorsky into Lockheed’s Mission Systems and Training segment will help generate cost synergies for Lockheed. Sikorsky has already been working on becoming a leaner organization with the oil and gas industry witnessing a slowdown. The company confirmed in May 2015 that it would be slashing 1,400 jobs in an effort to prevent margins from declining. ^[6] Overall, Lockheed believes that $150 million will be secured in annual cost synergies through Sikorsky. ^[3]

Sikorsky gives Lockheed exposure into international markets as well as the commercial sector 

One of Lockheed Martin’s key focal oints under the leadership of Marillyn Hewson has been diversification within the scope of their core expertise. Currently, approximately 60% of the revenues are defense revenues earned in the United States. The addition of Sikorsky will give Lockheed exposure into international markets as well as the commercial sector. Within the commercial sector, Sikorsky caters to the oil and gas industry. Given the sluggish growth in the industry recently Sikorsky’s commercial segment hasn’t been able to display growth. However, in the long term, Sikorsky’s commercial engagements will help Lockheed diversify its defense dominated portfolio.

In terms of International markets, Sikorsky’s revenues are derived in equal part from domestic and international operations. The company signed a $3.5 billion contract with Turkey in the first quarter of 2014. This is a major international contract for Sikorsky and involves the delivery of 109 helicopters that will be a version of the Black Hawk helicopters. The options included in the contract could potentially result in orders running in billions of dollars over the next thirty years. ^[7] Other important international contracts include the delivery of variants of the Black Hawk helicopter to Mexico and Tunisia. Sikorsky is also working on building a crucial relationship with India where defense spending is on the rise. The Indian Navy has shown great inclination to purchase the S-70B Seahawk helicopters produced by Sikorsky. If Sikorsky wins a contract to build more than 120 S-70B’s for India, it will set up its first military helicopter manufacturing unit outside the U.S. ^[8] The company is also actively pursuing major contracts with the NATO leaders and Polish government.

Expect more companies in the Industrials & Transportation sector to restructure in the near future 

The industrials & transportation sector has been witnessing restructuring. Companies are realigning their portfolios to become more focussed on the growth of their core operations. General Electric is divesting its financial services operations to become an industrially-focussed company. United Technologies’ sale of Sikorsky is another such example. Sikorsky was the only platform-providing business in UTC’s portfolio, while the other divisions operated as systems providers. Lockheed purchasing Sikorsky was another step in the company concentrating on becoming a platform provider. As an additional step in this direction, Lockheed will also be divesting its information technology and services related businesses in either a spin-off or a sale. Analysts are now speculating that other defense contractors such as Northrop Grumman and General Dynamics could also follow suit and exit their non-military IT businesses. ^[3] Many defense companies entered this business in the first place to counter the impact of shrinking military spending in the U.S. However, the upcoming budget quells the fear of future military budget cuts encouraging companies to realign to their core operations  that offer more synergies than the nonmilitary IT operations.

It is important to note that this deal is yet to be approved by regulators. However, analysts’ expectations are that the few regulatory hurdles that will arise will not prevent the deal from happening.

We currently have a price estimate of $196.95 for Lockheed’s shares, approximately 3% under its market price. However, we will be revising this estimate in light of the recent earnings release by Lockheed Martin.

See our complete analysis for Lockheed Martin

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More Trefis Research

1. 5 Things About Lockheed Martin Buying Sikorsky, Wall Street Journal [↩]
2. Lockheed Martin to Acquire Sikorsky Aircraft and Conduct Strategic Review of IT and Technical Services Businesses, Lockheed Martin [↩] [↩]
3. Lockheed Martin to Buy Sikorsky for $9 Billion, Wall Street Journal [↩] [↩] [↩]
4. Sikorsky Investor & Analyst Meeting, March 12, 2015, United Technologies Investor Relations [↩]
5. Lockheed Martin FY 2014 Form 10K, Lockheed Martin Investor Relations [↩]
6. Sikorsky to Cut 1,400 Jobs as Helicopter Demand Falls on Oil, Bloomberg [↩]
7. Turkey signs $3.5 billion deal for Sikorsky helicopters, Reuters [↩]
8. Sikorsky to Make Naval Helicopters in India, Wall Street Journal [↩]