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Morgan Stanley On Obama's Pentagon

Morgan Stanley’s defense industry analysts, led by sharp veteran Heidi Wood, have written up their initial thoughts on “Obama and Defense,” concluding that no major budget cuts are likely for about 18 months.

The Obama team is unlikely to cut defense before 2010, at the earliest, more likely in 2011. Democratic sensitivity to being labeled soft on defense will prevent big cuts, but, “the days of large year-over-year DoD budget increases may be over,” the analysts write.

The mantra of the Obama team will be cost control, a continuation of the across the board accountability Defense Secretary Robert Gates has brought to the department. They said the “leanings” of players in the Obama administration will be to cut back on defense spending following a “reasonable” time in office, which in their accounting equals around 18 months into his term.

Rather than a repeat of the post-Cold War run at a peace dividend, the Obama team will seek to trim spending at a more deliberate pace, with a big emphasis on spending efficiently. They identify the pork laden and poorly managed O&M accounts, 35% of the base budget, as a likely target for scrutiny. Additional procurement and RDT&E funds could be wrung out of O&M, the analysts said.

The Obama team intends fewer new program starts, less over-reach on technology, a focus on affordability and getting their own defense spending house in order. As for individual programs, Morgan Stanley identified clear winners as: F-35; shipbuilding, with an emphasis on smaller and affordable, which strengthens LCS; space; unmanned systems; cyber-warfare; and greater emphasis on rebuilding the Army’s war-worn battle fleet.

Gloomier outlook: FCS, enough said; F-22, viewed as a “cold war relic” by some Obama defense people; missile defense, which has always been a highly politicized collection of programs, with less emphasis likely on land-based interceptors and more on ship-based; and DDG-1000, which is viewed as too costly.

The Obama team will also decide the futures of the C-17, F-18E/F/Gs and, of course, the seemingly never-ending tanker story.

The Morgan Stanley analysts said leading Democratic defense folks have been “incubating their thoughts” for the past 8 years and will be eager to put them into action. The “can do" early days of an administration present the best opportunity. Some of the major themes they will strike are likely to be a greater focus on transatlantic cooperation, no more of that old-Europe nonsense. That could be bully for transatlantic M&A and programs with potential allied teaming a la F-35.

Gates has been pounding away at the “soft power” idea in many a public forum, and that theme will likely continue with the Obama team (which of course may or may not include Gates). The analysts said there will be much discussion devoted to this notion, but what follows in terms of money flow is tougher to identify.

Many of the likely defense players in an Obama administration were on hand during the Clinton era defense industry consolidation and there is wide agreement that it went too far. How that is remedied and greater competitiveness re-introduced, the analysts said, is unclear.

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