HRS 0.42% HRS 0.42% Harris Corp. and L3 Technologies Inc. said Sunday they will combine in the largest-ever defense industry merger, as the Pentagon expands budgets with an eye toward increased investment by contractors and quicker weapons development.
The deal, first reported by The Wall Street Journal on Saturday, would unite two companies with a combined market value of about $33.5 billion. With a transaction value of more than $15 billion, the merger would eclipse the 1997 combination of Boeing Co. and McDonnell Douglas Corp.
The combined company would have a product range stretching from military radios and top-secret space hardware to air-traffic-control systems. The amount of overlap between their products is limited, which should help the new entity cash in on a bump in Pentagon spending, spurred by President Trump, that comes after five years of cuts.
The prospect of increased defense budgets and a boom in commercial-jetliner sales have fueled a surge in deal-making in the aerospace and defense industries in the past few years. Aerospace and defense contractors are also seeking to bring more production in house to give them better control of their supply chain and an ability to capture extra profit from repair work.
The merged company would have annual sales of around $16 billion this year and 48,000 staff, ranking it sixth among U.S. defense contractors by revenue.
Pentagon leaders in recent years have become irritated at what they view as a lack of investment by defense contractors to keep the U.S. from falling behind adversaries such as China and Russia in technologies like hypersonic weapons and artificial intelligence.
The Harris/L3 deal would marry two of the industry’s biggest research and development spenders, which earmark more than 4% of their annual sales each year for such work, twice the level of most rivals.
“There’s definitely a need for greater investment, which requires scale,” Harris Chairman and Chief Executive Bill Brown said in an interview Sunday. He would retain those roles for a period at the enlarged business, to be called L3 HarrisTechnologies Inc. Mr. Brown moved the company into the top tier of contractors in 2015 with its $4.6 billion purchase of Exelis Inc.
L3 Chief Executive Chris Kubasik had previously pledged to create a sixth major U.S. defense contractor alongside Lockheed Martin Corp. , Boeing, Raytheon Co. , Northrop Grumman Corp. and General Dynamics Corp. , but until now had been expanding through a series of small acquisitions.
Mr. Kubasik said in an interview that the enlarged company would aim to remain nimble amid rapid change in the industry. “The customer is looking for rapid solutions,” he said.
Assuming the all-stock deal is approved by regulators and shareholders, Mr. Kubasik would assume the CEO role after two years, and become executive chairman a year later. Each company would contribute six directors to the new board.
The terms call for L3 shareholders to receive 1.3 Harris shares for each share they own, equal to $201.33 based on Friday’s closing price, a small premium to L3’s closing price of $195.78. That would give Harris shareholders 54% of the combined company.
The companies have been in talks for months, with the discussions accelerating over the summer, executives said.
The companies said the enlarged entity would generate $3 billion in free cash flow within three years and $500 million in cost savings, of which $200 million would be returned to customers in the form of lower prices. They also earmarked as much as $2 billion for stock buybacks in the year after closing.
Based in Melbourne, Fla.—which would also be home to the combined company—Harris is a provider of communications systems and electronics for military and civilian use. Its systems are used for battlefield communications, global-positioning systems, air-traffic control and weather tracking, as well as by first responders.
Harris, founded more than 100 years ago as a printing-press company, has annual revenue exceeding $6 billion and a market value of $18.2 billion. Its shares dropped sharply over the past week, as did those of L3, as a result of market turmoil sparked by concerns over rising interest rates. Both stocks had risen steadily in recent years.
New York-based L3, with a market value of $15.3 billion and annual sales of about $10 billion, also provides communications and electronics gear for the military, homeland security and civil aviation. The company makes aerospace and communications systems, sensors and other electronics for the U.S. Army, Navy and other clients. Its systems are used in pilot training, aviation security and for applications like night vision.
The latest merger would follow a string of aerospace and defense-industry combinations.
Last week, TransDigm Group Inc. agreed to buy jet component maker Esterline Technologies Corp. for $4 billion, including debt, at a significant premium to where the company’s stock was trading.
In April, General Dynamics, the maker of Abrams tanks and Gulfstream business jets, bought CSRA Inc. for nearly $7 billion after winning a takeover battle for the federal information-technology provider.
Last year, United Technologies Corp. agreed to buy Rockwell Collins Inc. for $23 billion in a deal that would create one of the world’s biggest aircraft-equipment makers. The acquisition awaits approval from regulators.
A year earlier, Rockwell agreed to buy B/E Aerospace Inc. for about $6 billion.
This year, Northrop Grumman closed a deal to buy defense contractor Orbital ATK Inc. for nearly $8 billion.
Morgan Stanley is advising Harris, while Sullivan & Cromwell LLP is principal legal counsel. Paul, Weiss, Rifkind, Wharton & Garrison LLP is special counsel to the board. Goldman Sachs Group Inc. is advising L3, while Simpson Thacher & Bartlett LLP is its legal counsel.