ITT was almost unrecognizable at the Army’s annual conference in Washington earlier this month. Sure, the defense contractor had its usual array of electronics equipment on display and its executives circulating. ¶But it also had a new name (Exelis), a new color scheme (orange) and even a new tag line (“The power of ingenuity”) as part of its separation from parent company ITT, a move first announced early this year. ¶ That parent split itself into three parts, with the defense business becoming ITT Exelis. The breakup is just the latest reconfiguration for a company with a long history of bulking up and slimming down. ITT’s decision is part of a larger story going on as the defense industry remakes itself. ¶
In the 1990s, contractors tended to merge with one another in an effort to survive shrinking defense spending. This time around, Pentagon acquisition chief Ashton Carter has made it clear that the Defense Department doesn’t want to see consolidation among the big contractors, as competition helps the department get the best price.
Investors now are pressing companies to slim down and break into pieces.
“Frankly, I think what investors want for these companies will ultimately be detrimental to their survivability,” said Loren Thompson, a defense industry consultant with the Lexington Institute. “What you see in a Northrop Grumman or a Lockheed Martin is an entity that is so big ... that it can roll with whatever punch the customer throws.”
Contractors and industry advocates continue to warn of tougher times ahead. Just last week, the Aerospace Industries Association cautioned that defense cuts of $1 trillion over 10 years could jeopardize more than 1 million jobs, while Lockheed officials said their future forecasts remain hard to predict as the government wrestles with debt reduction plans.
In reponse to the uncertain times, many defense firms are taking a look at their organizations. New York-based defense contractor L-3 Communications earlier this year spun off its locally-based government services business into a new public company called Engility. At the time, Michael T. Strianese, L-3’s chairman, president and chief executive, said the services business had become a lower-margin business where price wins a contract — a model inconsistent with L-3’s focus on high-tech sectors.
Other companies also have removed lower-performing businesses; Falls Church-based Northrop Grumman, for instance, cleaved off its shipbuilding unit earlier this year.
ITT started in 1920 as International Telephone & Telegraph. The company made some early acquisitions but hit a turning point in 1960, when it embarked on a 17-year buying binge.
ITT picked up more than 350 companies, including Hartford Insurance, Avis Rent-a-Car, Wonder Bread maker Continental Baking and Sheraton Hotel, and in one month it acquired 20 companies. Harold Geneen, ITT’s chief at the time, believed strongly in growth and created a multinational conglomerate that at one point had 2,000 working units.
In 1995, ITT split into three companies: ITT Corp., a hotel and gaming business; ITT Hartford, an insurance company; and ITT Industries, a group of manufacturing companies.
ITT Corp. was acquired in 1998, and ITT Industries reclaimed the corporate moniker in 2006 (ITT Hartford changed its name to Hartford Financial Services Group).
Early this year, the surviving ITT announced it would split into three pieces — a manufacturing business that produces a range of products, from industrial pumps to highly engineered aerospace valves and brake pads, and which recorded sales of $1.9 billion in 2010; a water technology unit with 2010 revenue of $3.2 billion; and a defense unit whose sales totaled $5.9 billion last year.
The defense group’s staff, headed by David F. Melcher, who already led the defense group and now serves as president and chief executive of Exelis, started working on a name, hiring a consulting firm to help brainstorm and then sift through 900 suggestions. Company officials picked the color orange in an effort to stand out in a sea of contractors using black, blue and red.
ITT Exelis, which specializes in electronics and communications equipment such as radios as well as technical services such as cybersecurity and intelligence offerings, then embarked on a road show, meeting with investors in New York to make its case. Melcher and his team argue that ITT is well positioned to succeed and that the break up will help the defense business focus on defense, without distraction.
The company, which is headquartered in Tysons Corner, added high-profile members to its board, including John J. Hamre, president and chief executive of the Center for Strategic and International Studies and retired Army Gen. Paul J. Kern of the Cohen Group.
Earlier this month, Melcher and Exelis finalized his employment agreement, setting his salary at $930,000 with a 2012 target annual bonus worth up to the same amount and a 2012 target long-term bonus worth up to $3.8 million.
Despite the company’s efforts to stake out a new spot, analyst Thompson argues that ITT Exelis faces a difficult road.
The conglomerate company may have appeared to be “a collection of disconnected pieces, but they gave them financial mass that will be missing for their spun-off entities,” said Thompson, who was invited by Melcher to speak with ITT Exelis management. “Wall Street wants defense companies to slim down to their core franchises; the problem with that approach is that they have very little resilience if the core franchises run into problems.”
ITT Exelis disagreed with Thompson’s concern, noting that nearly 30 percent of the company’s revenue comes from non-defense sources.
“Agile companies with diverse, well-positioned portfolios and a history of performance and competing very favorably in their chosen markets will be the ones that prosper in this challenging market environment,” Melcher said in a statement. “We also have increased autonomy over investment choices and a leaner corporate structure.”
The company’s stock has been trading in a trial period since mid-October; it opened at $12.50 a share, but has settled in the mid-$10 range. The transaction that will separate the three ITT companies formally is set to close today, and regular trading is planned for tomorrow.
Still, it’s not unusual for tougher economic times to push companies to rethink their organization. Arpad Krizsan, managing director and co-founder of ERG Partners, a Westport, Conn.-based advisory firm that specializes in mergers and acquisitions, said that booming economies don’t raise as many questions for investors.
“If you have prolonged periods [in which] a market goes up and then down ... investors are looking more closely,” he said. “Usually it comes back to, ‘OK, let’s focus on what we’re really good at.’ ”
But backers may not always have the long-term health of a company in mind, argued Thompson: “They are less concerned with how resilient or successful the resulting enterprises will be over the long haul.”