Finc 312 - Calpers Vs. Lockheed Corporation

December 7th, 2017

FINC312

CalPERS vs. Lockheed Corporation

Founded in 1912, Lockheed Corporation, an American aerospace company, played a major role in the growth of the United States aerospace industry. Over the next 83 years, Lockheed developed numerous models of aircrafts that revolutionized the industry. Over these eighty years, the majority of Lockheed’s revenues were generated from government funded contract programs for the development of aerospace and defense products.

In 1989, Harold C. Simmons, an expert active investor and corporate raider, began investing in Lockheed. Over the course of three years Simmons actively protested management and initiated two proxy contests. His investments started at the beginning of a period of corporate restructuring at Lockheed. Lockheed had a new CEO, Daniel M. Tellep, who was focused on adapting the company to a changing marketplace in addition to handling new problems occurring due to decisions made under previous management.

It is vital to understand the circumstances surrounding the initiation of Simmons investments. These circumstances bring light to the motives he may have had for investing in Lockheed. Lockheed was an attractive target for a takeover, they were listed on the CalPERS focus list. They were dealing with extreme changes in their industry and falling profits, leaving Simmons with a lot of aspects of the organization to criticize.

Lockheed also had an estimated surplus of $1.4 billion stored in their pension plan held by the CalPERS as well as numerous assets that could be easily sold off. The CalPERS holdings in Lockheed had increased from 17% to 62% in the years surrounding Simmons’s active investment program. The New York Times said, "Much of Mr. Simmons's interest in Lockheed is believed to stem from its pension plan. Analysts said he might want to liquidate the plan and pay out the excess funds to shareholders, including himself."

Circumstances at Lockheed before Simmons initial investment

Prior to CEO Mr.Tellep, Larry Kitchen served a three-year term as chief operating officer. Kitchen began his term during a time of success, 1985 was the 4th consecutive year Lockheed had reported record earnings, with net earnings up 17%. Kitchen used this period of success to grow the space sector of Lockheed with over 250+ space related contracts and programs. “All of these programs were characterized by uncertainty, long lead times, and high development costs” (Beyond the Horizons 448). The majority of these contracts were funded by the Department of Defense. Forecasts of government budget cuts and predictions of changes to government contracts put Lockheed in a vulnerable state. The Department began to require contractors to cost-share contracts. Which resulted in major additional risks for Lockheed, these new contracts meant that the government would no longer fund the research and development costs for a Lockheed project if they decided not end up choosing Lockheed’s product. The hundreds projects initiated during Kitchen’s time as CEO now had a much greater risk; the increased possibility of sunk expenses if they were unable to deliver on the contract.

There was no way to predict the new cost-share contracts, which resulted in Kitchen leaving Lockheed as a greatly expanded organization with a very complicated contract problem on their hand.

Daniel M. Tellep

In 1989, Daniel M. Tellep became CEO of Lockheed Corporation. Tellep worked in the missile systems division, where he eventually became President of this division. During his first year as President of this division he increased sales by $700 million, 41% of Lockheed’s total sales (Beyond The Horizons). Tellep recognized the need to bring new business to the division to adapt to a changing market. His success as president of the missile systems divisions ultimately led to his position as CEO. Tellep stepped up as CEO right before this period of turmoil was going to hit Lockheed. Major expenses occurred during his first year as CEO due to the new share-cost contracts. The predictions of cuts in the national defense budget finally surfaced, when the “Omnibus Budget Reduction Act of 1990 (OBRA) mandated that 36% ($180 billion) of the reduction in the federal deficit planed for 1991-1995 come from defense” (The 1990s Defense Build-down in California and the United Sates).

With Lockheed facing expenses of failed contracts, national budget cuts and the costs of restructuring, Tellep had several problems to tackle. All of these new issues were emerging as Harold C. Simmons began his active investment program.

Chronology of Events related to Simmons active investment program

Income before extraordinary items

Period Change in Income Before Extraordinary Items

[1988-1989] -440

[1988-1990] -107

[1988-1991] -134

[1988-1992] -94

The massive decrease in income from $442 million to $6 million is due to several write-offs Tellep made during his first year as CEO. These write-offs were made to cover the costs of fixed-priced program expenses which occurred due to the defense contractor cost-share development contracts made during Kitchen’s time as CEO. Simmons leveraged these large income losses by publicizing these write-offs as consequences of poor decisions made my Tellep. However, it is vital to note Tellep had no control over these write-offs.

***Note first proxy fight occurred in 1990, however 1991 is also an event year where the final proxy fight and end of Harold C. Simmons active investment program.

Changes in Stock Price Performance

From the beginning of Simmons attempted acquisition of Lockheed the market did not respond well with Lockheed stock prices falling 8.23%. It is difficult to know the real affect Simmons had on the company because of many underlying factors affecting the stock price during this time. The few years prior to Simmons involvement, Lockheed’s economic performance was at an all-time low, trading for almost half as much as other firm’s industry. ($36/share compared to $70/share at Boeing). From 1989 to 1991, Lockheed’s stock was extremely volatile as one would expect it to be after Lockheed’s $300 billion write off.

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