By Calvin Biesecker
Major weapons program recommendations released by the Pentagon this week were basically in line with expectations and the contractor hit the hardest is Boeing [BA], according to Wall Street analysts.
The recommendations, unveiled by Defense Secretary Gates on Monday, also spell trouble for pure service contractors, such as CACI International [CAI], ManTech International [MANT], and SAIC [SAI], the analysts say.
However, Gates’ recommendations are just proposals, with “Congress to take center stage” in determining the final outcomes, Credit Suisse aerospace and defense analyst Robert Spingarn says in a note to clients. Following Gates’ announcement, various congressmen and senators began raising their objections to specific cuts (Defense Daily, April 7).
Among the recommended cuts that affect Boeing are ending production of C-17 airlifters at 205, a strong contributor to operating earnings and a program the company would like to see extended beyond next year. Gates also indicated his dislike for the contract structure of the Army’s Future Combat System (FCS), for which Boeing and SAIC are teamed as lead system integrators (LSI), likely another key contributor to Boeing’s defense earnings, says JP Morgan analyst Joseph Nadol.
“Boeing takes it on the chin,” was one of Nadol’s takeaways from the Gates announcement.
Other program decisions where Boeing is impacted include ceasing production of F-22 fighters at 187 aircraft, a program where Boeing is a key subcontractor to Lockheed Martin [LMT], not increasing the number of Ground-based Missile Defense interceptors in Alaska and canceling the second prototype aircraft under the Airborne Laser program, which the company shares with Lockheed Martin and Northrop Grumman [NOC].
In addition, several future business opportunities that Boeing was working toward, including the Combat Search and Rescue-X aircraft and Transformational Communications Satellite, were canceled while a development decision on the Next Generation Bomber was postponed.
On the other hand, Gates said the Pentagon will buy 31 Boeing-built F/A-18E/F aircraft in FY ’10, which appears to be a continuation of the program, according to some analysts, and will stick to the schedule for soliciting bids this summer on the tanker replacement program, or KC-X. Boeing originally lost the tanker competition to Northrop Grumman but successfully protested that decision, leading to a renewed competition.
More details regarding the big ticket defense programs, as well as the remainder of the FY ’10 defense budget request, are expected to be released next month. Collins Stewart analyst James McIlree said that restructuring FCS–Gates has recommended canceling the $87 billion vehicle component of the program–and terminating TSAT will put pressure on the Joint Tactical Radio System program, which could hurt Boeing’s Ground Mobile Radio portion of the program.
Boeing’s defense business has grown slightly in the past five years, up 5 percent in sales volume from 2004 to $32 billion last year. Operating earnings in that business climbed 10 percent during that period.
How some of Boeing’s programs will fare in the FY ’10 budget and beyond will depend on congressional support for its programs, and in the case of the C-17, potential international orders.
As for service contractors, Gates said his budget proposes converting 11,000 contractors to full-time government employees by 2015. He said that overall during the next five years his goal is to reduce the number of support-service contractors from the current 39 percent of the Pentagon workforce to 26 percent, which is what existed prior to 2001.
“Our goal is to hire as many as 13,000 new civil servants in FY ’10 to replace contractors and up to 30,000 new civil servants in place of contractors over the next five years,” Gates said.
The move to in-source work that has been being outsourced to defense contractors, including large companies such as General Dynamics [GD], Lockheed Martin, Northrop Grumman and Raytheon [RTN], is in line with what the Obama administration has been saying since coming to the White House in January.
JP Morgan’s Nadol says the administration may not quite achieve its in-sourcing goals but the initiative still goes beyond just slowing outsourcing.
“We view this initiative as a clear negative for pure play service providers such as SAIC, which also took a hit on FCS, since it is partnered with Boeing as LSI, and CACI, and it reinforces our views that these companies will be impacted just like the defense manufacturers and that their premium valuations are excessive,” Nadol says.