'A Bridge Too Far'? Pending Defense Industry Merger Raises Serious National Security, Competitiveness Concerns

(Washington, D.C.): In 1993,
then-Secretary of Defense William Perry
made it clear that the Clinton
Administration believed that
consolidation in the defense industry was
not only positive, but necessary in light
of declining defense spending. Since that
time, over 20 major mergers and
acquisitions have occurred in the defense
industrial sector. By and large, these
market adjustments have brought together
companies with complementary — not
duplicative — products and skills. In
addition, some of the leading Fortune 500
companies sold off their defense
businesses, in most cases to firms
already supporting the Pentagon’s
research, development, procurement and
other needs.

As a result of these changes,
America’s defense industry today is
dominated by a handful of giants, leading
to questions of whether that industry
will continue to be characterized by
robust competition. In particular, there
are mounting concerns about whether this
dramatic contraction of the defense
sector will be able cost-effectively to
provide the qualitatively superior
equipment upon which the U.S. armed
forces rely to prevail in combat.

Enter Raytheon, Hughes and
T.I.

Such concerns have become even more
pronounced with the announcement that
three leading defense companies —
Raytheon, Hughes and Texas Instruments
(TI) — intend to merge in two separate
transactions to form a combined entity
under the banner of Raytheon. A recent
article⁽¹⁾
by the Washington Post‘s John
Mintz observes that this proposed merger
appears contrary to antitrust statutes
and/or to the public interest in robust
competition in the defense industry.
According to Mintz, “the new
Raytheon would have a near-monopoly in
air-to-air missiles, night vision
equipment, sensors on spy satellites and
military radar components….”

The proposed Raytheon-Hughes-TI merger
is worrisome for, among others, the
following specific reasons:

Hughes, Raytheon and Texas
Instruments now control — and
compete against each other in —
the manufacture of virtually
all air-to-air missiles used by
the U.S. military. Were
the merger to be approved, it
would be nearly impossible for
another company to enter this
arena and compete realistically
with the new giant.

The Raytheon merger would also
give rise to a monopoly in the
production of counter-
air fire control radars.
Such an undesirable development
would be the practical result of
the concentration of the ability
to manufacture the key
ingredients in advanced fire
control radars (e.g., actively
scanned array radars) —
Monolithic Microwave Integrated
Circuits (MMICs) and
Transmit/Receive (TR) Modules —
in the hands of a single company.
Currently, Texas Instruments and
Raytheon are the primary
suppliers of these advanced
electronic components; their
primary customers as producers of
counter-air fire control radars
are Northrop Grumman, Hughes and
Raytheon.

It is important to note that,
over the past decade, the
government has spent hundreds of
millions of tax dollars to ensure
that Texas Instruments and
Raytheon remained separate and
competing suppliers of these
advanced MMICs and T/R Modules.
The rationale: to spur both
cost-effectiveness and innovation
in this area. Allowing these two
suppliers to join forces, with
the effect of driving competition
out of both the production of
these components and the
production of a critical end-item
like fire control radars, would
squander the positive results of
that enormous investment.

Hughes and Raytheon have
historically been competitors in
the production of the
AMRAAM, the U.S. military’s most
modern and deadly air-to-air
missile. In fact, in the
mid 1980s, after Hughes had won a
competition to build this
missile, the Pentagon spent,
according to Mintz, “tens of
millions of dollars” to
ensure that Raytheon would also
be able to produce the AMRAAM.
According to Under Secretary of
Defense for Acquisition Paul
Kaminski, the competition that
has existed between Hughes and
Raytheon on this project has
saved taxpayers hundreds of
millions of dollars and has
reduced the price of the AMRAAM
by 70 percent. It stands to
reason that the absence of such
competition would foreclose the
possibility of such savings in
the future.

This new company will be able to capture
and exploit for competitive
advantage some of the most
proprietary knowledge of its
competitors. In military
electronics, firms must share
detailed information about the
design of their systems with
their suppliers in order to
obtain correctly-configured
components. It will not be
possible to guarantee to a radar
producer competing with what
formerly was Hughes that
information it provides to the
Texas Instruments division of
this new company will not be
leaked to Raytheon’s Hughes
division.

Some have suggested that
so-called “Chinese
walls” or
“firewalls” could be
put up between the divisions of
the new company to ensure that no
such transfers of information
occur. Such arrangements can
secure information that must be
compartmentalized under certain
circumstances — notably, for
short periods of time and for a
finite purpose. It is entirely
unreasonable, however, to suggest
that these “firewalls”
can be expected to work in
situations where information is
shared over decades with
engineers working for a single
company.

The Bottom Line

The Justice Department last week extended the
review period on the proposed
Raytheon-Texas Instruments merger for
thirty days. The Department should take a
similar action with respect to the
Raytheon-Hughes merger when the first
review period expires next week. It is to
be sincerely hoped, moreover, that such
actions would be taken out of an
appreciation on the part of the Clinton
Administration that these transactions
have potentially serious antitrust and
national security implications. If so,
the Department will presumably decide
ultimately to enjoin the parties from
proceeding with the planned merger.

Against the possibility, however, that
the Administration will regard this
anti-competitive Raytheon-Hughes-TI
merger with the same equanimity that it
has viewed previous defense
consolidations (consolidations that
arguably strengthened the
Pentagon’s industrial base), it
behooves those in Congress who share the
Center’s concerns to subject this
proposal to close scrutiny over the next
few weeks.

While it is at it, Congress should
take a hard look at the tax treatment of
the Raytheon-Hughes transaction described
in a Washington Post business
column by Allan Sloan entitled “GM
[currently Hughes’ parent company] Finds
a Hole in the Tax Code Big Enough to
Drive Billions Through” that
accompanied the Mintz article referenced
above. As Mr. Sloan put it:

“What is clear is that the
stakes go far beyond the $3
billion [in a taxable
transaction] at risk here. If the
Loophole passes its road test,
any company could use it to
dispose of businesses tax-free.
All the seller would need is a
buyer like Raytheon willing to
jump through hoops to let the
acquired business claim to be the
acquirer.”

The taxpayer and the national interest
will be poorly served if further defense
sector consolidation results in the
elimination of needed productive capacity
and competition essential to providing
the highest quality bang for the least
bucks.

– 30 –

1. See “
Raytheon Deals Raise Antitrust Concerns:
U.S. Could Block or Alter Some Merger
Terms” which appeared in the Post‘s
29 January 1997 editions.