DELAY OF LOCKHEED MERGER DROPS NORTHROP SHARES.

Byline: Anne Marie Squeo Bloomberg News

Northrop Grumman Corp. shares fell after the U.S. Justice Department rejected Lockheed Martin Corp.'s latest divestiture proposal, raising doubts about whether Lockheed Martin will be able to complete its proposed $12 billion takeover of Northrop.

After an erratic day of trading, shares of Los Angeles-based Northrop fell 2-1/2 to 107-1/2.

Northrop shares have lost more than $2 billion in value since March 6 when the Justice and Defense departments informed the companies they have serious competitive concerns about their proposed combination.

Analysts and shareholders said the decline in Northrop's stock reflects concerns about the company's long-term viability in an industry where its fiercest competitors are much larger.

``If you prevent this deal from happening, Boeing won't be able to buy Northrop and neither would Raytheon,'' said Credit Suisse analyst Peter Aseritis. ``Northrop would be far and away the smallest of these, and being No. 4 makes it difficult to compete in the long term.''

Earlier this week, the Justice Department told Lockheed Martin that its latest proposal - to divest missile countermeasure units with about $1 billion in annual sales - doesn't go far enough toward resolving antitrust concerns about the transaction, according to people familiar with the talks.

The government has suggested that Lockheed Martin sell all of Northrop's electronics businesses. With annual sales between $3 billion and $4 billion, that would be the largest divestiture ever required to win antitrust clearance for an acquisition, senior government officials have conceded.

``It's clear Lockheed was dead right in labeling the government `fundamentally opposed,' '' said Robert Chapman of Los Angeles-based Chapman Capital LLC, whose firm has a hedged position in Northrop stock options and has been following the negotiations closely. ``It's going to take an act of God to bring the two sides close enough on a divestiture plan to save this one.''

This is reflected in the transaction's spread, or the difference between Northrop's stock price and the amount Lockheed Martin offered for each share. It has widened to more than $30 - the largest it's been since Lockheed Martin offered 1.1923 shares for each Northrop share last July. Lockheed Martin shares fell 13/16 to 115 9/16 today.

A combined Lockheed Martin-Northrop would leave just three major defense contractors - Lockheed Martin, Raytheon Co. and Boeing Co. - and two military aircraft makers - Lockheed Martin and Boeing.

The combined company would have $37 billion in annual revenue, second in the defense industry only to Boeing Co., after last year's acquisition of McDonnell Douglas Corp.

Both sides say talks are continuing and no final decision has been reached.

``Negotiations are still under way,'' said Defense Secretary William Cohen at a Capitol Hill press conference. ``I'm aware that a counter offer was made yesterday that is not fully acceptable, and that they are going back to the drawing board in the next week to see what can be resolved.''

The threat of a court battle looms, given how far apart they are on an agreement, analysts said. Without some resolution, the Justice Department likely will seek a preliminary injunction barring the companies from completing the merger.

That would mark the first time since the defense industry began consolidating in 1989 that federal regulators sought to stop a major defense combination.

The companies are considering, at this point, whether to extend the terms of their merger agreement, set to expire March 31, to allow time for a court fight.

Northrop's board met Wednesday to discuss whether to extend this date, said a person familiar with the negotiations. A spokesman for Los Angeles-based Northrop confirmed that a regularly scheduled board meeting took place, but declined to comment on topics discussed.

In the meantime, Wall Street analysts and shareholders expressed frustration with the lack of information about the negotiations.

``It's kind of like this guerrilla war is being waged, and there's very few people willing to come out in the open and say what's going on,'' said Merrill Lynch analyst Byron Callan.

At recent meetings, the companies were informed by the Justice Department and the Pentagon that a combined Lockheed Martin-Northrop would hurt competition in several areas, including airborne early warning radars, missile countermeasures, and airborne fire control.

As defense consolidation nears an end, the Pentagon has become increasingly concerned about vertical integration.

While horizontal integration involves the combination of two direct competitors, vertical integration refers to mergers that can close the chain of production by creating a company that is both the main buyer and seller of particular products.

While the companies planned to craft a resolution and get back to antitrust officials by April 8, the Justice Department pressed them for a response early this week.

Lockheed Martin made that proposal Monday, which the company said included an offer to divest operations and sign a consent decree that would resolve the government's concerns.

``We have made every effort to work with the government to resolve the issues raised, and our discussions continue,'' the statement said.

Lockheed Martin offered to divest its missile countermeasure operations, which would include electro-optical, infrared and radio-frequency anti-aircraft missiles, a person familiar with the negotiations said. Federal antitrust authorities had sited these as a major area of antitrust concern.

Buying Northrop would make Lockheed Martin the sole source of electro-optical and infrared missile countermeasures, and allow it to lock up about 72 percent of the market for radio frequency ones, federal officials said.

The companies also offered a number of non-divestiture fixes it argued would eliminate vertical-integration concerns. These included an agreement with Boeing to compete aggressively and assurances that relationships with outside suppliers wouldn't change, a person familiar with the negotiations said.

Federal officials have heard these suggestions before, and expressed doubts about their effectiveness because they go against the grain of a company's self-interest.