Savvy dealmaking by Northrop not reflected in falling shares. (Corporate Focus).

NORTHROP Grumman Corp.'s stock price may be falling, but days before the scheduled completion of its acquisition of TRW Inc., the Los Angeles-based defense contractor's dealmaking prowess has been validated again.

Since July, when months of negotiations ended in an agreement to acquire Cleveland- based TRW, Northrop shares have fallen 22 percent, lowering the value of the all-stock transaction to $7 billion from $7.8 billion, not counting $4 billion in TRW debt.

The deal gives TRW shareholders 38 percent of Northrop's stock, and Northrop is calculating that the increased number of shares to be issued will lower its earnings per share in 2003 by 42 cents. But the damage will be limited by some astute deal-making.

A "collar" placed on the share exchange limits the amount of shares Northrop will have to issue. While the aerospace company still will issue more stock than planned, TRW holders will get less than the $60 per share announced value of the deal. Based on the highest exchange rate allowed by the collar, TRW holders will receive about $52.

Meanwhile, Northrop executives succeeded in orchestrating the pre-merger sale of TRW's automotive parts business at a time when the auto industry faces major challenges and lower interest from private equity buyers. The sale of the parts business to Blackstone Group, announced Nov. 19, removed the last major risk factor in the TRW deal, and positions Northrop to complete the acquisition with lower debt ratios than it would have had as a standalone.

(After Blackstone's bidding partner, Carlyle Group, backed out of the deal, Northrop stepped in to retain a 20 percent equity interest, likely to continue for several years.)

So the new Northrop will be a stronger company than the old one, even if its chairman, Kent Kresa, had to give some of it away.

"Our balance sheet also improves dramatically with TRW," said Richard Waugh, Northrop's chief financial officer, in a conference call discussing the transaction. He put net debt to total capital at 26 percent after completion of all the contemplated transactions -- down from 40 percent for Northrop standalone, and well within the company's comfort zone. "This will offer us a great deal of strategic flexibility going forward."

Signs of strain, gain

Northrop has been stumbling recently, as problems with two ongoing programs produced a third quarter earnings miss. Northrop is also likely to log a pension-fund expense next year (although it will be able to pass on much of any pension-fund costs to the federal government due to contract provisions).

Add to that a rebound in other areas of the stock market, drawing attention away from defense, and Northrop's stock, which company officials assumed would be around $130 when the deal closed, is hovering around $98.

Meanwhile, Northrop's merger partner has been on a roll. TRW announced three big contract wins since August: an $868 million cost-plus contract from the Defense Department to begin development of the Space-Based Infrared System Low missile defense element; a $2.9 billion contract to build the National Polar-orbiting Operational Environmental Satellite System, the nation's next-generation meteorological satellite system; and an $825 million NASA contract to build the James Webb Space Telescope, the successor to the Hubble Space Telescope.

These developments spurred TRW Chairman Philip Odeen, who negotiated the transaction, to issue an unprompted defense of the deal in the same road show presentation leading up to the scheduled Dec. 11 vote.

"At today's price, compared to both how the auto and the defense industry stocks have traded, the deal still represents an attractive premium to our shareholders," Odeen said.

Northrop's operational stumbles have occurred on two contracts. An $87 million charge was taken on the Polar Tanker project that Northrop inherited from its acquisition of Litton Industries, due to a shortage of skilled workers in the New Orleans area, where the ships are built.

Northrop also took a $65 million charge due to higher materials costs on the E-16 Block 60 program, selling aircraft to the United Arab Emirates.

Analysts lowered 2003 earnings estimates at that time.

While Northrop has since lowered its "economic" earnings guidance to between $7 and $7.50 for '03, from $7.75 to $8.30, it's been mostly due to adjustments related to the share issuance, the particulars of the TRW auto unit sale, and the unrelated sale of Northrop's component technologies business. The revision includes an upward adjustment of 5 cents a share, driven by contract wins announced since July-many at TRW.

Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224, or at [e-mail].

[GRAPH OMITTED]

Northrop Grumman Corp.

YEAR (Dec. 31)                  2001    2000

Revenue (millions)           $13,558  $7,618
Total Expenses (millions)     12,554   6,520
Operating Income (millions)    1,004   1,098
Net Income (millions)            409     608
Earnings Per Share             $4.80   $8.58

SUMMARY

Business: Defense contractor

Headquarters: Los Angeles

CEO: Kent Kresa

Market Cap: $11.2 billion

Dividend Yield: 1.7%

Total Liabilities: $13.3 billion

P/E Ratio: 19.4

Long-Term Debt: $4.9 billion