Northrop’s Spinoff of Huntington Ingalls – Unlocking Value?
?Northrop Grumman (NOC) announced it was pursuing a strategic separation for its shipbuilding unit in July 2010, a business which Northrop Grumman entered aggressively in the early 2000s with its acquisitions of Litton Industries and Newport News Shipbuilding. However, times (and budgets) change. Northrop Grumman’s rationale for the shipbuilding separation was to refocus on its core business and shed a business unit facing funding and operational headwinds. Northrop Grumman initially pursued a sale of the business but when that effort did not bear fruit, the company opted to pursue a spin-off.
Given the issues specific to HII and the historical pricing performance of public pure-play shipbuilders, many industry observers anticipated that an independent HII would trade at a discount to Northrop Grumman. For the three years prior to its acquisition by Litton in 1999, Avondale Industries traded at an average 21% discount to an index of defense primes, while Newport News traded at a average 13% discount for the five years prior to its acquisition by Northrop Grumman in 2001.
What is ironic, then, is the reception HII has received in the public markets to date. HII has traded up slightly from its initial “when issued” spin-off price of $37.49, reaching a level of $40.00 as of April 29, 2011. On both an EBITDA and P/E multiple basis, HII is trading in line or at a premium not only to Northrop Grumman but to an index of defense primes. HII is trading at 6.0x consensus 2011 estimated EBITDA, compared with 5.5x for Northrop Grumman and 6.2x for a composite defense prime index. On a P/E basis, HII is trading at 10.4x, compared with 9.5x for Northrop Grumman and 9.9x for the defense primes. With this type of pricing, investors must be expecting the newly-independent HII to tackle the operational issues that have plagued its Gulf Coast shipyards in recent years.
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