The Sweetest Revenge He was passed over for CEO of TRW. Now Ron Sugar is about to run it--and a lot more besides.
(FORTUNE Magazine) – If you can't hit your target straight on, sometimes it pays to launch a flanking attack. That strategy has certainly worked for Ron Sugar. Two years ago Sugar's career hit a wall after he clashed with his boss at TRW over the direction of the defense and auto-parts company. Passed over for the CEO job, Sugar quit. Circuitously, he ended up at defense giant Northrop Grumman in the No. 2 role. There he seized his opportunity. Last February, TRW CEO David Cote--the man who had landed the job Sugar wanted--abruptly stepped down, and in response TRW stock tumbled. Sugar, his current boss, Kent Kresa, and their Northrop cohorts swooped in with a hostile-takeover bid. In July, after four months of hard bargaining, Northrop won TRW for $7.8 billion in stock.
Sugar is expected to step up to CEO of the sprawling enterprise--the combined Northrop and TRW--next March. "I'm the luckiest guy in the world," he says, gazing out the window of his Northrop Grumman office high above west Los Angeles. Sugar, 54, grew up here in L.A. His parents ran a hair salon, and Ron was the first person in his family to finish high school. "I went to school over there," he says, pointing toward UCLA, where he graduated at the top of his class at age 19--and then earned a Ph.D. in electrical engineering at 23. "To come back here as part of the only major defense company still headquartered in L.A., and then have all your friends from TRW join the family--that's a hoot!"
Few top executives these days would describe their job as a hoot, but Sugar's rebound, not to mention Northrop Grumman's remarkable turnaround, shows that opportunities arrive unexpectedly. And that success comes from flexibility and the guts to act. Sugar and Northrop are well positioned thanks in part to a blizzard of savvy acquisitions in recent years (see chart) by CEO Kresa. By snagging Litton Industries and Newport News Shipbuilding, Northrop has become No. 1 in ships. The acquisition of TRW, likely to be completed by year-end, adds missile systems and military satellites. The new Northrop can make all the high-tech stuff that today wins wars: sophisticated defense electronics, surveillance and precision-strike gear, and information technology that the Department of Defense uses variously to manage battles and safeguard its networks against cyberattack. "TRW lifts Northrop to the top echelon," says veteran defense-industry analyst Paul Nisbet of JSA Research. "This creates a very competitive situation where Lockheed, Boeing, and Northrop will all be bidding for pretty much every project that comes up." Combined with TRW, Northrop will have annual sales of about $26 billion, just shy of Lockheed, the Department of Defense's largest contractor.
Meanwhile, war--on terrorism, in Afghanistan, and prospectively in Iraq--has dramatically improved the outlook for the whole defense industry. The Pentagon's budget, $331 billion this year, is expected to be $451 billion in 2007, a 36% rise. That's the largest percentage increase in two decades. After years of shrinking outlays and industry consolidation, the survivors--mainly Lockheed Martin, Raytheon, General Dynamics, and Northrop Grumman--have rising profits (while Boeing's defense unit is doing well, its troubled commercial business is depressing its earnings). The major defense stocks have risen 3% in the past year. That doesn't sound so good until you consider that the S&P 500 is down 28%. While the leading companies used to sell "platforms"--planes or tanks or ships--now they peddle vast arrays of gear and services that connect and coordinate those platforms for efficient, high-tech warfare. "The game is creating smart systems of networked assets," says Sugar. In the past year Northrop's stock has climbed 32%.
To understand how Sugar has prevailed, you need to know something about Northrop's rise from misery. When Kent Kresa became CEO in 1990, the company had revenues of $5.2 billion, was losing money, and was under investigation by the Justice Department and the FBI for falsifying its accounting and test results on weapons programs. Northrop's problems "had some of the same elements" of those of Enron and WorldCom, says Kresa, 64. "It may not have been billions of dollars, but we were dealing with perceptions that we had violated public trust."
The deceptively mild-mannered Kresa, a onetime child actor who holds advanced degrees in aeronautics and astronautics from MIT, revived Northrop by methodically imposing tough new rules and ethical guidelines on management. In 1994 he refocused Northrop according to a prescient vision of how the military would evolve in the post-Cold War world. "It was clear that needs were emerging related to regional conflict and peacekeeping--and in between, periods of terrorism," he says. "More than anyone else in the defense industry," says Loren Thompson of the Lexington Institute, a Washington, D.C., think tank, "Kent saw that Cold War-era weapon systems were going away. He matched to a perfect degree where defense spending was heading."
Northrop, an airplane maker whose largest source of revenue was the long-range B-2 bomber, began a metamorphosis into defense electronics. Kresa made a string of successful acquisitions--Grumman for its surveillance know-how, then the defense-electronics unit of Westinghouse, then Logicon for defense infotech--and by 1997, Northrop stock had climbed to $120 a share.
Then, in July 1998, came a major blow. The Justice Department torpedoed an $8.3 billion buyout of Northrop by Lockheed on antitrust grounds--after the two companies had spent a year working on integration. "When the merger failed, there was a perception internally and externally that we had failed, that we couldn't survive, we were gone," says Kresa. As the stock price sank 50%, he laid off 10,000 workers and sold assets to pare debt. "It was terribly debilitating," he says. "I didn't believe we were gone, but one option was to sell ourselves to someone else."
TRW was already part of the picture. In 1997, shortly before Northrop had begun its ill-fated romance with Lockheed, Kresa had approached TRW CEO Joe Gorman, hoping to merge the two companies. Gorman rebuffed him. Inside TRW, Gorman was wrestling with his own problems. The company had a huge but declining auto-parts business--brake systems, steering systems, airbags--and a jewel of a defense business focused on space, where Northrop longed to be prominent. TRW's hottest executive was Ron Sugar, who had joined in 1981 and first made his mark overseeing the construction of the Milstar communications satellite, one of TRW's most important projects. Says former president Ed Dunford, who hired Sugar: "He was a little slow in exercising authority, but he was technically brilliant and had excellent people skills."
Sugar moved all around the company and rose rapidly. When Gorman asked him to become chief financial officer in 1994, Sugar recalls, "My answer was, 'What did you just say?' I told him that I hadn't taken accounting courses. Joe said, 'You have a good business sense and quantitative skills, and we have lots of people who know accounting.'" As he stretched, Sugar developed a critical executive skill: "I had to surround myself with people who knew more than I did." After being CFO for three years, Sugar gained confidence too. He became a vociferous challenger of the man who had promoted him.
"I developed a concern that TRW could not focus on two very large segments, defense and automotive," Sugar explains. "As I saw it, our competitors were totally engrossed in one or the other, which gave them an advantage." Most observers agreed--including Kresa, who continued to pester Gorman about merging. But Sugar's most influential ally was a legendary character named Si Ramo, who happens to be the "R" in TRW. A half-century ago, Ramo was Howard Hughes's chief operating officer at Hughes Aircraft and then the federal government's chief scientist on the ICBM program. Today, sharp and spry at 89, Ramo says, "I pressed for ten years, writing stiff memos and urging the board to separate the defense and automotive businesses." TRW's auto business "was stinko profundo as seen by the outside world," Ramo adds.
Gorman ignored the critics. He tried instead to revive TRW by expanding the auto business. But by spending $6.8 billion to buy brake manufacturer LucasVarity in 1999, he buried TRW in debt. That year, under pressure from the board of directors, Gorman brought in a certified cost cutter to restructure the automotive unit: David Cote, who had been General Electric's appliance chief.
Cote's arrival included what Sugar calls "a little twist that I had not been expecting." The twist was a clause in Cote's employment contract that stipulated he would be paid a severance fee of $10 million if he didn't get the CEO job at TRW by July 2001. Sugar asked Gorman, "Is this a level playing field for succession?" Gorman, he says, urged him to stay. But that didn't ring true, recalls Sugar, smiling: "I have an IQ slightly above 100--about 103. I said to myself, I guess I'm not the right guy." Gorman, who is now retired, declines to comment. But Cote calls Sugar "a good guy" for the way he took the setback. "He was put in a difficult situation with me coming into TRW," Cote says, "and handled everything with equanimity."
Still, Sugar wasn't about to work for Dave Cote. In March 2000, when a headhunter called and asked if Sugar would consider moving to Litton Industries as president and COO, he jumped. He had learned a lesson from Cote: Sugar secured a clause in his Litton contract ensuring a $5 million "breakup fee" if he was not named CEO by the end of 2001. "It was a strange thing for me to do," Sugar says apologetically. "It's really a litmus test for the board. I said to them, 'I hope to God I'll never have to use this clause.'"
He didn't. Northrop Grumman, which had recovered from the failure of its Lockheed merger and was back on the acquisition trail, had long been interested in Litton. "It was big in electronics, very good in IT--and, oh, by the way, also had ships," says Kresa. Armed with Litton's electronics expertise, Kresa figured, Northrop could build highly sophisticated destroyers and other warships to restock the Navy's diminished fleet. "In a world of regional conflict," explains Kresa, "people often don't allow you to put aircraft in their country. Ships are one way to get close." A few months after Sugar's arrival at Litton, Kresa called CEO Mike Brown and cut a deal to buy Litton for $3.8 billion.
When that happened, Sugar says, "I thought, Oh shit, I wonder if I can find another job." Even if Northrop wanted him, he wasn't sure he wanted Northrop. "I, like others, had thought that Northrop Grumman might not be a survivor," Sugar admits.
Kresa changed Sugar's mind by laying out the vision he had talked about in 1994. So Sugar joined Northrop Grumman in April 2001. But his path to the top job was hardly assured. Kresa, approaching the mandatory retirement age of 65, already had two internal candidates for succession and was thinking about looking outside as well. But shortly after Kresa put Sugar in charge of integrating the Litton acquisition, he realized he had his man. "Ron had all the right moves," Kresa says. "He was very open, a very broadband thinker, very good technically. And people were comfortable with him."
Kresa promoted Sugar to president and chief operating officer last September, and also put him on the board. Meanwhile, Kresa was thinking about how to recast Northrop Grumman. Once he had Litton, he needed to expand in shipbuilding to ensure premier status in that industry. When General Dynamics made a bid for Newport News Shipbuilding, the Navy's sole supplier of aircraft carriers, Kresa pounced. Tirelessly working Washington, Wall Street, and the media, Kresa convinced the Justice Department that the merger would dangerously consolidate nuclear shipbuilding and R&D talent. Then, in November, Northrop nabbed Newport News for $2.1 billion, the same price that General Dynamics had agreed to pay.
No sooner did Northrop close the Newport News deal than a fortuitous change came at TRW: Dave Cote quit as CEO in February. His departure was unexpected but logical. After trustbusters blocked General Electric's buyout of Honeywell, Honeywell needed a CEO, and Cote was a good fit; for Cote, Honeywell, with a market value over four times TRW's, was an irresistible opportunity. On the news that Cote was leaving, TRW stock dropped 14% in two days.
"Okay, what do we do?" Kresa asked his executives. They had two options: negotiate with TRW's board or launch an unsolicited tender offer. Hostile deals are a rarity in the defense industry. (Sugar explains: "None of us have an appetite for hostile takeovers because we work together on projects. We have to live together.") Says Kresa: "I thought, They don't have a CEO. Let's just buy 'em." Sugar and the rest of the board concurred--and they launched a tender offer.
In fact, the deal was not as hostile as it may have seemed. For one thing, the TRW folks respected Kresa and liked and trusted Sugar. Phil Odeen, a retired TRW executive who returned as interim CEO after Cote quit, was both impressed and amused by Northrop's maneuvers. The day before Northrop made its hostile offer, Odeen says, "Ron called to congratulate me on coming back as CEO. I said to him, 'Gee, we're looking for a CEO. Do you want to come back here?' I was serious, but I knew he wanted to stay in California." Sugar remembers the conversation: "I did tell Phil that I was happy working here with Kent." Smiling, he adds, "I didn't share our plans with Phil."
For such a chummy combatant, Odeen fought hard to get a better deal. He drew in rival bidders--General Dynamics, Raytheon, and Britain's BAE Systems--forcing Northrop to raise its initial $47-per-share offer twice. The four-month face-off ended in July, when Northrop agreed to pay TRW $7.8 billion in stock, the equivalent of $60 per TRW share. Though Lockheed has protested the deal on antitrust grounds, analysts expect regulators to approve the deal by year-end.
With Kresa due to step down as CEO next March, Sugar inherits the job of making the new Northrop Grumman work. One concern is the stock price, down 10% since Northrop and TRW made their deal; if it stays low, completing the acquisition will dilute Northrop's earnings per share significantly. A bigger risk, near term, is debt. TRW adds $4 billion to Northrop's existing $5 billion of debt. Moody's recently warned that it may downgrade Northrop's debt a notch, to Ba--below investment grade. The company's plan is to raise cash by doing the very thing Sugar aimed to do inside TRW: sell or spin off the automotive business. But that will be no easy task. While the unit's revenues total $10 billion, its narrow 2% profit margins suggest to analysts that it will fetch only about $5 billion. Potential buyers such as Visteon, Delphi, and Lear lack financial might, so the business may go to a financial buyer such as the Carlyle Group, Blackstone, or Bain Capital.
The longer-term challenge is managing the highly diversified and enormously complex new Northrop. By adding Litton, Newport News, and TRW, the company is four times the size it was just two years ago. "The thing that's beautiful here is that this is already a company of immigrants," Sugar says. "We're used to acquiring people." True--TRW is Northrop's 16th acquisition since 1994. General Motors vice chairman Bob Lutz, a Northrop director until last fall, says, "Northrop has two areas of expertise. One is aerospace products. The other is integrating and managing acquisitions. They're better at it than anyone I've seen in the world." The key: well-trained integration teams, guidelines, and processes that are "laid out like a battle plan," Lutz says. Sugar is also counting on Northrop's pay structure to help. Senior executive bonuses are based on how the entire company, rather than a particular sector, performs.
Making Northrop Grumman the top gun in defense will be the challenge of Ron Sugar's career. Skeptics love to point out that Lockheed Martin struggled after an acquisition binge in the mid-1990s. In 1997, CEO Norm Augustine retired, and profits collapsed; the stock dropped 65% before recently climbing back. While Augustine bets that Northrop will do fine, he says: "Managing acquisitions is one of the hardest jobs a CEO has--and I'm talking about friendly deals. It's amazing how fast things can fall apart." Fair warning for Ron Sugar, who knows firsthand that you can never predict exactly what the future holds.