The biggest players in the defense industry are looking hard at ways to diversify their businesses to rely less on Uncle Pentagon and more on private sector markets -- and no wonder, defense commentator Loren Thompson wrote Tuesday.
[D]efense executives need a new paradigm for how they deploy capital. They’ve already implemented the standard playbook of tactics for defense downturns, such as cutting costs and divesting underperforming units, but those palliatives will only work for so long before softening demand takes a toll on results. Some of their favorite moves, liking “mining” backlogs for improved terms, are unlikely to work at all with the current crew at the Pentagon. Policymakers are more interested in getting bargains than helping industry make profits.
Investors don't want companies to sit on their cash and they don't believe the long-term prospects are healthy for the defense game, Thompson writes. So although it may not happen tomorrow, don't be surprised if the big brand names start to try to edge out into areas that are "adjacent to their core markets," he says.
For instance, General Dynamics and Lockheed Martin are both focusing business development in their information services units on healthcare support and cyber-security, markets that are strongly influenced by federal policies but where there is extensive sales potential beyond traditional military customers. GD bought healthcare IT provider Vangent from Veritas Capital for $960 million in September, and Lockheed has established a fast-growing cyber-security business with companies that operate power grids.The recent United Technologies move to acquire Goodrich is a very different kind of transaction following the same basic logic. UTX’s aerospace units were already broadly diversified across military, civil and commercial markets, and Goodrich will continue the pattern of leveraging skills that have allowed the company to dominate military rotorcraft and engines markets into non-military areas. Unlike rival Connecticut conglomerate General Electric, United Technologies maintained an extensive presence in the military marketplace after the Cold War ended, and is continuing on that path by purchasing Goodrich even as it grows civil and commercial aerospace revenues.
Even Big B, for which defense work is already a smaller part of its business than its commercial side, is starting to make internal shifts, Thompson writes:
Chicago-based Boeing will maintain a major presence in military markets, but it has been repeatedly disappointed by its defense customer in recent years, losing hundreds of billions of dollars in potential business. It is no surprise that most of its future investment will be in commercial-transport development, and that a string of top defense executives have been shifted to the commercial side of the house.
It's too soon to tell what all of this could mean -- or whether it'll actually happen. A narrative gathering steam in some corners of Washington says that Congress should just exempt DoD from the threat of sequestration, whether or not the super committee gets a deal. That would take away part of the long-term business threat for the defense industry and it could take off pressure for companies to start walking away from the arms game.
If the super committee fails, as a lot of people believe, and sequestration does happen, the defense companies will have no choice but to do something -- anything -- else, given the big new holes in their order books. Lockheed will sell you a pencil case made out of the leftover titanium from F-22s; GD Land Systems will offer a wastebasket with a V-shaped hull that can withstand an IED. And so on.
What would be interesting is whether the big defense firms try to remain at roughly their present size as they diversify or whether they try to shrink. This is the scenario that industry advocates warn could turn into a nightmare, as Lockheed closes the Skunk Works and Northrop shrugs and decides it'll just never build another manned aircraft. Then, when the U.S. emerges from its tunnel of austerity and wants to commission work from these or other firms, they just can't accept it.
Unless, that is, the U.S. produces an "industrial strategy," as the industry wants, to keep the nightmare from coming true.
