Saturday, October 16, 2010

Northrop Grumman's New Ships, Inc.

Northrop Grumman announced in July its intention to consolidate its Gulf Coast shipyards and explore strategic alternatives for their shipbuilding business.  CEO Wes Bush stated at the time:

"Recognizing our company’s long-term strategic priorities, we foresee little synergy between Shipbuilding and our other businesses."

The firm filed an information statement regarding the spin off of Northrop Grumman's shipbuilding business to existing shareholders.  It stated:

In anticipation of a spin-off, Northrop Grumman and the company (New Ships, Inc.) are planning to enter into a separation and distribution agreement under which Northrop Grumman will transfer various assets, liabilities and obligations (including employee benefits, intellectual property, information technology, insurance and tax-rated assets and liabilities) associated with the shipbuilding business. The assets and liabilities transferred to the company will be recorded at historical cost as a reorganization of entities under common control. Northrop Grumman is not planning to have any ownership interest in the company subsequent to the spin-off. 

Who, besides existing shareholders could have an ownership interest in New Ships, Inc.?  Private equity underwriters (Carlyle Group, Bain Capital, KKR, TPG and slightly less mysterious Cleveland Ships) have kicked the hull of Northrop's shipbuilding, which includes nuclear powered submarines and aircraft carriers.  From Northrop Grumman's SEC filing:

99 percent of revenues during 2009 were derived from products and services ultimately sold to the U.S. Government. In addition, more than 99 percent of future orders/backlog was U.S. Government-related.

The Gulf Coast, responsible for roughly 40% of revenues, had an operating loss in 2009.  Shipbuilding was a cash drain on Northrop Grumman last year.

Northrop Grumman was approved by HHS as a participant in the Early Retiree Reinsurance Program (ERRP).  

New Ships, Inc. could receive $40 to $55 million in federal reimbursement over a four year period via ERRP.  That expense savings adds frosting to any PEU deal.

Northrop CEO Wes Bush noted the impact of the Gulf Coast consolidation.

"The consolidation will reduce future costs, increase efficiency, and address shipbuilding overcapacity. This difficult, but necessary decision will ensure long-term improvement in Gulf Coast program performance, cost competitiveness and quality.” 

Who will pay the consolidation costs?  The government.

In connection with winding down the Avondale, Louisiana facility, the company recorded $51 million of liabilities as of June 30, 2010 related to the co-operative agreement with the state of Louisiana and asset retirement obligations on this facility. In addition, the company anticipates that it will incur substantial restructuring and facilities shutdown-related costs, including, but not limited to, severance, relocation expense, and asset write-downs related to the Avondale facility decision. These costs are expected to be allowable expenses under government accounting standards and thus will be recoverable in future years’ overhead costs.

Northrop Grumman stated it would keep no equity in New Ships, Inc.

Northrop Grumman is not planning to have any ownership interest in the company subsequent to the spin-off. 
Who will take on shipbuilding's $537 million debt?

As for quality, supposedly boosted by the consolidation, consider:

"leaks discovered in the USS San Antonio’s (LPD 17) lube oil system, the company became aware of quality issues relating to certain pipe welds on ships under production as well as those that had previously been delivered."

"certain bearing wear and debris were found in the lubrication system of the main propulsion diesel engines (MPDE) installed on LPD 21"

"investigation of the failure of MPDE bearings on LPD 17 subsequent to the Navy’s Planned Maintenance Availability (PMA), which was completed in October 2009. During sea trials following the completion of the Navy conducted PMA, one of the ship’s MPDEs suffered a casualty as the result of a bearing failure."

"The company has also encountered various quality issues on its Aircraft Carrier construction and overhaul programs and its Virginia Class Submarine construction program at its Newport News location. These include matters related to filler metal used in pipe welds identified in 2007, and in 2009, issues associated with non-nuclear weld inspection and the installation of weapons handling equipment on certain submarines."

Might this information have a bearing on potential investors?  For new owners to grow the business, they'll need supreme government connections.

Update 11-5-10:  Northrop Grumman will spin off New Ships and not sell it to a private equity underwriter, mystery or legendary.

Update 10-23-12:  The shipbuilding division was spun off as Huntington Ingalls Industries, Inc.