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

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(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.

Center for Security Policy

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