Northrop's sale of business unit signals start of a divestiture trend

A law requiring Defense to restrict integrators from both developing and overseeing weapons systems work should force more sales.

Northrop Grumman Corp. announced on Sunday that it has agreed to sell its defense consulting unit TASC Inc. to an investor group led by the private equity firms Kohlberg Kravis Roberts and General Atlantic for $1.65 billion, a move that could signal more sales as other integrators shed potential conflicts of interest.

TASC, based in Chantilly, Va., specializes in providing technical and administrative support to Defense Department agencies. The unit is part of Northrop Grumman's information systems sector and has about 5,000 employees.

The company is selling the business unit to avoid a potential conflict of interest as outlined in the 2009 Weapon Systems Acquisition Reform Act, a Northrop spokesman said. The law requires Defense to tighten regulations regarding the acquisition of major weapons systems by January 2010 to ensure that a company can't develop a weapons system and then oversee the work on that system on behalf of the government.

"This transaction is in the best interest of Northrop Grumman's customers, employees and shareholders," said Ronald Sugar, chairman and chief executive officer, in a prepared statement. "It reflects Northrop Grumman's desire to align quickly with the government's new organizational conflict of interest standards while preserving TASC's unique organizational culture and its status as the advisory services employer of choice."

The defense contractor initiated the sale of the unit in response to officials' anticipated direction the new regulations would take. The Northrop Grumman spokesman declined to specify what project caused the conflict of interest. TASC expects 2009 revenue of about $1.6 billion. The deal is expected to close by the end of the year.

Alan Chovtkin, executive vice president at the industry group Professional Services Council, said he has spoken with other companies that are considering similar sales and they are wary of acting before the new regulations have been finalized.

"Other companies are concerned about the premature ejections of some business units," he said. "Not everyone is following the same path of putting the business unit up for sale when they perceive a potential conflict."

Large weapon systems integrator have found it increasingly difficult in recent months to justify to Defense how they can maintain separate business consulting units without creating a conflict of interest., said Ray Bjorklund, FedSources senior vice president and chief knowledge officer. "Companies I've talked to have done it, but the rules are becoming more stringent," he said. "The Weapon Systems Acquisition Reform Act is driving DoD to be much more explicit in the rules. Northrop Grumman is getting ahead of the problem."

Chvotkin and Bjorklund said other firms considering divestiture might act soon because private equity firms and financial institutions are showing interest in acquisitions for the first time in almost two years.

"I've always felt professional services is a strong market. It's not only a good business, but there's equity available, funding for transactions and mergers," Chvotkin said. "There's been a lot of hesitancy on companies' part to test the market; this deal may well encourage others to come into the market as well."

Bjorklund said he didn't expect a flood of offers, but agreed that further deals by private equity firms were possible. "I don't think there will be some big wave, but there may be a slight period of opportunity for private equity to make these kinds of purchases," he said. "Private equity firms have been sitting on these resources and can hold these companies without creating a conflict of interest."

Chvotkin also mentioned that private equity firms tend to be short-term investors. A spokesman with General Atlantic, however, indicated that the firm intends to hold on to TASC for the long term, and referred to the statement of Wood Parker, TASC's general manager who will become chief executive officer upon closing. "As a fully independent entity, TASC will expand its ability to solve the U.S. government's most pressing technical challenges," the statement read. "Our singular focus, as always, will remain supporting the vital missions of our customers. Moreover, we will now have more flexibility to invest in research and development as well as in retaining and attracting the finest talent in the nation."