June 1, 2009  

Industry pulse: Hypocrisy and hyperbole

Opposition to budget changes is about jobs, not national security

People and companies don’t like change. Change means uncertainty, and uncertainty disturbs complacency and equilibrium.

Defense Secretary Robert Gates, in advancing his vision for the fiscal 2010 defense budget, proposed changing the way the Pentagon looks at preparing for conflicts, wars, procurements and weapons, and support programs.

While the big defense contractors acknowledged that there will be little if any impact for the remainder of fiscal 2009, ending Sept. 30, howls could be heard from coast to coast as members of Congress and companies on the losing end moved to protect their constituents, local jobs and huge corporate contracts.

Current backlogs of several of the programs targeted for termination through normal contract runs may extend beyond fiscal 2010 and in some cases foreign sales will keep some production lines open, notably on aircraft such as the Boeing C-17, but these clearly see a date certain for the end.

Republicans who criticized the Obama administration’s stimulus jobs program as wasteful suddenly characterized defense contracts in their districts as critical to jobs. Democrats who remained silent while Boeing outsourced overseas jobs and technologies for its commercial aircraft programs (principally the 787) renewed the cry for domesticating the KC-X aerial tanker — one of the holdover procurements to survive the Gates re-visioning — asserting that now more than ever it is necessary to award this $35 billion-plus program to a U.S. company.

The debate over whether Gates’ vision for a new Defense Department based on fighting terrorists and Third World sanctuaries vs. preparing to fight the Russians and Chinese is controversial. The fight over which view is correct will engage as the budget bill is reviewed by Congress.

The stakes are enormous. Boeing was easily the biggest loser in the Gates vision. Boeing CEO Jim McNerney was characteristically restrained about the Gates budget plan but accurately reflected the sentiment of all those offended by it: “It is important to keep in mind that the outlining of these priorities and the submission of the president’s detailed budget to Congress [in May] only begins the lengthy annual authorization and appropriations process. Over the course of the next few months, we expect a healthy and rigorous discussion as Congress evaluates the proposals and determines the funding for each program.”

Translation: There is going to be one heck of a political battle on the Hill as members of Congress jockey to save their pet programs and jobs. The maneuvering will be more contorted than gerrymandering a new congressional district.

Calling Boeing’s Integrated Defense Systems (IDS) the “chief casualty” of the program cuts, aerospace analyst Joe Nadol of JP Morgan predicted Boeing’s earnings and cash flow will faces substantial “headwinds” and “difficulty” over the next few years. Boeing’s C-17 program, which has been on life support as congressional allies have required the Air Force to buy more of these cargo transports than it wants, is slated to end production at 205 in 2010 under the Gates plan. The C-17 accounts for 9 percent of corporate earnings before interest and taxes, Nadol said.

Boeing has launched advertisements touting the need for more C-17 orders, and Sens. Kit Bond of Missouri, where Boeing’s defense unit is headquartered, and Barbara Boxer of California, where the C-17 is built, have ramped up efforts to save the program.

Contract opportunities for the long-delayed CSAR-X — which Boeing won, then lost in a protest to be recompeted only to be placed on Gates’ hit list — and the Armed Reconnaissance Helicopter — another recompete chance after Bell Helicopters saw the program canceled following cost overruns and delays — also hurt Boeing’s potential.

The loss of multiple defense programs to cash flow, revenues and profits is alarming to shareholders (including this writer) in Boeing, whose cash position declined in 2008 from $9 billion to $3 billion because of the strike at its Commercial Airplanes unit; development problems with the KC-767, Wedgetail, 787, 747-8, the Homeland Security Virtual Fence, the Airborne Laser 747-based platform (another Gates casualty) and other IDS programs; and a looming multibillion-dollar pension funding requirement by 2011.

Boeing and Lockheed Martin, contractors on the F-22 fighter program, which will be terminated after acquisition of 187 planes, lost no time to begin lobbying Congress to retain the procurement.

Northrop Grumman, on the other hand, did reasonably well in the Gates vision. CEO Ron Sugar had this to say: “[N]o major prime Northrop Grumman programs were recommended for cancellation. Just as important, there will be greater emphasis on areas where Northrop Grumman has extremely strong positions. We’re well-positioned to support emerging initiatives in cybersecurity, intelligence surveillance and reconnaissance, command, control and communications, and in unmanned air vehicles. We also remain well positioned on F-35 and other key programs, such as the Air Force’s aerial refueling tanker.”

Among the big wins for Northrop: the plan to reactivate procurement of the DDG-51 Arleigh Burke-class destroyer. Chosen by Gates over the enormously expensive DDG-1000 destroyer, the DDG-51s are more nimble, less costly and easier to upgrade.

UAV boost

Another big win is the increasing emphasis on UAV procurement, which fits neatly in Gates’ vision of fighting wars like those currently in progress. Northrop is the prime contractor on the Global Hawk B, a 30,000-pound UAV with a 130-foot wingspan. The electronics are supplied by Raytheon, and in dollar value, the cost is about 50-50 between the airframe and electronics. The Air Force plans to buy 55 and the Navy 66.

Northrop is also the prime contractor on the X-47, a stealthy unmanned plane for use by Navy aircraft carriers. This procurement is in the tens of billions of dollars.

The MQ-9 Reaper UAV, also known as the Predator B and Sky Warrior, depending on the service or agency buying them, survived the Gates cuts and will see increased procurement. This is a 10,000-pound UAV with a turboprop engine made by Honeywell. Unlike the Global Hawk, which is strictly a reconnaissance platform, the MQ-9 is used by the military and the CIA to bomb targets. The prime contractor is privately held General Atomics of San Diego.

Lockheed Martin also sees some key gains in the Gates vision: the F-35 Joint Strike Fighter, the Aegis Combat System, the Theater High Altitude Area Defense anti-ballistic missile system, the Littoral Combat Ship and satellites. On the downside, Lockheed (with partner Boeing) stands to lose on the F-22 and the VH-71 presidential helicopter, the latter becoming a target of Sen. John McCain, R-Ariz., and President Barack Obama.

Lockheed also believes it is positioned to benefit from Gates’ increased emphasis on cybersecurity and intelligence.

BAE Systems, the fifth-largest defense contractor in 2008 (up from sixth in 2007), also stands to benefit. BAE is a contractor on the F-35 and major electronics, intelligence and support systems.

The irony of all the controversy is that there is broad agreement that defense procurement is broken. The rising number of defense protests may or may not be indicative of a broken system — after all, with fewer defense companies competing for fewer, larger defense contracts, perhaps protesting an award may come with the territory. The increasing number of sustained protests is probably more indicative of a broken system.

The other aspect of the broad agreement on a broken system is that politics all too often permeates defense contracting. There are far too many examples of members of Congress forcing defense procurements onto the armed services. Prime examples: Back in 1989, then-Defense Secretary Dick Cheney tried to kill the Bell-Boeing V-22 tilt-rotor aircraft, only to be thwarted by Congress; the Air Force wanted to stop acquiring the C-17 after 180 orders, with Congress forcing more onto the service; and the current effort to require procurement of the Boeing KC-767 and the Northrop/Airbus KC-30 despite Gates’ firm opposition to a split buy for the KC-X. (A split buy makes sense for a number strategic of reasons, provided procurement is doubled, but not for the reasons — however politically realistic — suggested by members of Congress urging this solution.)

The hypocrisy, of course, is that the procurement meddling by Congress is only a bad thing when the other guy does it. Reps. Norm Dicks, D-Wash., Todd Tiahrt, R-Kan., and Jo Bonner, R-Ala.; and Sens. Patty Murray, D-Wash., Sam Brownback, R-Kan., Jim Sessons, R-Ala., and Richard Shelby, R-Ala., not only don’t shy away from advocating either Boeing or Northrop for the KC-X program — in some cases, their advocacy and pressure on the Pentagon, the Air Force and the Government Accountability Office reached embarrassing hyperbole and heights that may have done more harm than good to their causes. Many Boeing supporters blame McCain for meddling in the KC-X process and costing Boeing the contract. In reality, McCain observers say he doesn’t care who wins; it was the flawed Air Force procurement process that became McCain’s mission to fix.

Scott Hamilton is a consultant with Leeham Co. (www.leeham.net.)