Pentagon Warns About Defense Deals -- Update

By Doug Cameron 

The Pentagon's chief weapons buyer issued a stark warning about the potential impact of further consolidation among large defense companies, which he said could hurt innovation, constrict the supplier base and inflate costs.

Frank Kendall, the Defense Department's undersecretary for acquisition, technology and logistics, said Wednesday that recent mergers and acquisitions have prompted the Pentagon to consider asking for national security concerns to be among the criteria when such deals are reviewed by competition officials.

Mr. Kendall said he backed the Justice Department's approval last week of plans by Lockheed Martin Corp. to buy the Sikorsky Aircraft unit of United Technologies Corp. for $9 billion, but he said such deals have given rise to policy concerns.

"With size comes power, and the department's experience with large defense contractors is that they are not hesitant to use this power for corporate advantage," Mr. Kendall told reporters. He said his concerns weren't directed at any particular transactions.

Lockheed, the world's largest defense contractor by sales and the Pentagon's biggest supplier, responded to the veiled criticism of its growing influence on a wider range of military programs.

"There is no evidence to support the view that larger defense companies reduce competition or inhibit innovation," the company said in a statement. It said contractors should "continue to be assessed based on the performance and effectiveness of the products and solutions offered, not on the size of their company."

Lockheed's bid to acquire Northrop Grumman Corp. was blocked on competition grounds in 1998, effectively ending a wave of mergers that shaped the current industry.

However, an increase in deal making over the past year has raised concerns at the Pentagon that companies carving out parts of their business to sell to rivals could harm the industrial base and increase barriers to entry.

"If the trend to smaller and smaller numbers of weapon-system prime contractors continues, one can foresee a future in which the department has at most two or three very large suppliers for all the major weapons systems that we acquire," Mr. Kendall said.

He said the Pentagon planned to engage Congress on the issue.

Competition experts said the Pentagon wanted to signal that approving the Sikorsky deal didn't change Defense Department's long-standing opposition to deals involving the biggest defense companies.

"The message is that it's not open season," said Jeff Bialos, a partner at law firm Sutherland Asbill & Brennan LLP, who has worked on a number of defense deals.

Lockheed doesn't make helicopters but supplies weapons and communications systems to Sikorsky and other manufacturers. The company has said it would continue to supply the government with equipment for other helicopters,

The proposed deal concentrates even more of the Pentagon's largest hardware programs with its biggest supplier. The Defense Department generated almost 60% of Lockheed's revenues last year, with other U.S. agencies and export sales adding another 20% each. Lockheed, which makes the F-35 jet fighter, is bidding in partnership with Boeing Co. for another huge contract, a proposed new bomber for the Air Force.

Defense stocks were unchanged after Mr. Kendall's statement, though analysts have long discounted a deal involving any of the five biggest defense companies: Lockheed, Boeing, Northrop Grumman Corp. General Dynamics Corp. and Raytheon Co.

Defense Secretary Ash Carter earlier Wednesday repeated his opposition to mergers between the prime contractors but declined to comment on Lockheed's planned purchase of Sikorsky.

"It was important to avoid excessive consolidation in the defense industry to the [extent] that we didn't have multiple vendors that could compete on programs," he said during a Pentagon press briefing.

Write to Doug Cameron at [e-mail]

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September 30, 2015 18:04 ET (22:04 GMT)

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