As if the defense industry didn't have enough to worry about, what with the prospect of shrinking DoD budgets and the potential end to a few of America's less fashionable wars, here's another problem, outlined by the defense commentator Loren Thompson: The threat from its own investors.
"Activist investors," Thompson writes in a new Forbes column, could make life difficult for defense firms if they take control and want short-term financial gains but don't care about the long-term prospects for the companies -- which, in turn, could imperil the specialized vendors upon which DoD depends for the kinds of things only it buys. Thompson's news peg for this warning was an announcement by the "corporate raider" Carl Ichan that he now controls a chunk of military truck-builder Oshkosh, a situation which Thompson warns could be bad news for the company:
The stock had fallen 18 percent since the year began when investor Icahn burst onto the scene with his surprise announcement that he owned 9.5 percent of shares and would seek a meeting with management to discuss ways of boosting shareholder value. Other investors predictably piled into the stock, raising the share price markedly but burdening Oshkosh executives with a sizable faction of shareholders bent on realizing substantial near-term gains. That can’t be good news for a company still carrying a heavy debt burden from recent acquisitions and facing soft demand in all its major markets.Thompson goes on to give the examples of L3, ITT and Northrop Grumman, all of which have had to adapt in response to shareholder pressure in the years following the peak of defense spending in the Bush administration. A longtime voice for the defense industry, Thompson wants the big boys to stay big and diversified, citing GE and United Technologies as examples of companies that show it's possible to play well both in the military and commercial sectors. If investor pressure gets out of control, he warns, the industry could be sold, split up or spun off until it's no longer recognizable:
It isn’t so clear what Icahn’s game is with Oshkosh, since the company isn’t likely to fetch a big premium from suitors in its current state and any effort to break it up would impair economies of scale dependent upon integrated manufacture of diverse product lines. But what’s significant for the purposes of this commentary is that Icahn’s move on Oshkosh is just the latest in a series of hostile shareholder actions against military contractors that could significantly reshape the defense sector at a time when companies were already facing major challenges.
Taken too far, the logic of the activists could largely dismember the defense sector during a prolonged downturn. Wouldn’t Boeing perform better if its surging commercial-transport business was separated from its under-performing defense business? Would Gulfstream serve investors better if it were a pure-play builder of high-end business jets rather than being wrapped in a defense contractor? And what exactly is the synergy between Northrop Grumman’s information and aerospace sectors? Once you start posing such questions, there’s no end to the mischief that activist investors might cause under the banner of shareholder value. At some point the government would probably step in to protect what’s left of the defense industrial base, but until that day arrives, the defense sector could be headed for a prolonged period of what economist Joseph Schumpeter called “creative destruction.”