Military Chip Maker Is Exploring a Sale --- Shortages crimp weapons production as Pentagon looks to cut reliance on imports

"One of the Pentagon's top manufacturers of microchips is up for sale, just as the defense industry faces a shortage of crucial semiconductors that executives said could stretch for another two years.

Mercury Systems Inc. said its board has launched a strategic review, a move widely viewed by analysts as a precursor to a possible sale after activist investors pushed for change at the Andover, Mass.-based company.

A sale could fetch well over $3.5 billion, said analysts, and provide another test for antitrust regulators. Lockheed Martin Corp., the world's biggest defense company, dropped a bid to buy rocket maker Aerojet Rocketdyne Holdings Inc. last year after the Federal Trade Commission sued to block it on competition grounds, while regulators unsuccessfully tried to stop the sale of a maker of defense software.

Mercury Systems shares soared by as much as 20% Wednesday, lifting its market value to $3.3 billion.

Combat jets, missiles, radars and military radios rely on ever-larger quantities of specialized microprocessors, designed to endure tough environments and be impervious to cyberattack.

Raytheon Technologies Corp. and other defense companies told investors last week that chip shortages continue to hamper efforts to boost production of arms destined for Ukraine.

Companies have redesigned weapons such as the Stinger and Javelin missiles to use different chips. L3Harris Technologies Inc. said it had cannibalized old radios to make new communications equipment shipped to Ukraine.

Supplies of chips for consumer electronics have improved in recent months, but thathasn't been much help for those with more specialized requirements.

Mark Aslett, Mercury's chief executive, told investors this week that chip shortages recently eased a bit, but the company was still waiting as long as 72 weeks for deliveries compared with as much as 99 weeks at the end of 2022. New orders could take as much as two years to fulfill.

"There's a belief that the supply chain has been resolved. That's absolutely not the case," Mr. Aslett said.

The defense industry helped develop the modern microprocessor sector but now accounts for a tiny fraction of global demand as smartphones and consumer electronics have expanded to dominate the sector.

"We need to prioritize the supply chain for national defense," said Mr. Aslett. "That's not happening."

The Chips Act, signed into law last year, is among myriad efforts to boost U.S. semiconductor manufacturing and reduce reliance on suppliers in Asia -- including China. The Pentagon has also toughened rules on the types of chips that can be used and taken strides to boost domestic production.

The military relies on customized chips rather than the mass-produced ones used in cellphones. For instance, while the Lockheed Martin F-35 combat jet contains more than 3,000 advanced chips, production runs for the most sensitive military-grade processors range from a few dozen to 1,000. That compares with tens or even hundreds of millions for consumer-electronics devices.

Mercury Systems creates the high-end chips and electronic systems from supplies drawn mainly from big producers such as Taiwan Semiconductor Manufacturing Co. and others in Asia that dominate the global market. Like most of the manufacturing sector, Mercury has suffered from shortages as overseas plants struggled with demand during the pandemic.

Lockheed, Raytheon, Northrop Grumman Corp. and the U.S. Navy accounted for half of Mercury's sales in its last fiscal first quarter, according to regulatory filings.

The sale to a larger defense company or private-equity group could help give Mercury more scale to buy chips and speed delivery, said analysts. The squeeze on supplies has dented Mercury's profits, and two activist investors have taken ownership stakes in an effort to direct its strategy or pave the way for a potential sale.

Mercury declined to comment on the timeline for any deal and said it was just starting to explore strategic alternatives as part of the review.

"There can be no assurance that any transaction will be approved or consummated," said the company.

Any buyer would be expected to continue supplying all customers. L3Harris has pledged to continue providing rocket engines and other equipment to all companies if its $4.7 billion offer for Aerojet Rocketdyne is cleared by regulators.

Bankers said high defense company valuations -- driven by the prospect of elevated military budgets -- make this one of the strongest environments for deals in years.

"We do believe Mercury is an attractive asset that should generate significant interest," said Ken Herbert, who covers aerospace and defense at RBC Capital Markets LLC." [1]

1. Military Chip Maker Is Exploring a Sale --- Shortages crimp weapons production as Pentagon looks to cut reliance on imports
Cameron, Doug.  Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 02 Feb 2023: B.6.