Defense execs bullish on foreign and domestic sales; Classified contracts rise; Report forecasts rise in global arms spending

The short month between Thanksgiving and Christmas is my favorite time of year in Washington — so many parties, so many story leads. But the stakes are higher this year as everyone looks to find out how President-elect Donald Trump will shape his Pentagon team and its priorities. Putting aside the parlour gaming over who will sit in what seat inside The Building, this week we heard from the leaders of America’s largest defense firms, who gathered in Palm Beach, Florida, for Credit Suisse’s Annual Industrials Conference.

One by one, they professed to have no inside line on the next administration’s priorities, even though some have already met with Trump’s transition team — and yet most expressed optimism, even bullishness, that defense spending is about to rise. That’s good news for their firms’ bottom lines.

“We’re in a period now where we hope the negative years are behind us and we’ll be entering a period of budget growth,” said Michael Strianese, chairman and CEO of L-3 Communications.

The CEOs seem in agreement that Trump’s Pentagon will spend more money on readiness. We saw this already this week as lawmakers ironed out a 2017 National Defense Authorization Act that added $3.2 billion for more soldiers, airmen and Marines.

“Both [presidential] candidates had expressed a need to focus on putting more defense spending toward national security for military readiness,” said Marillyn Hewson, Lockheed Martin’s chairman, president and CEO. “Now we’re seeing with President-elect Trump certainly a focus on that.”

Hewson also noted that Lockheed is “working with the transition team.”

The executives also expect even more money to be spent on technology development, already an area of focus by the Obama administration. Thomas Kennedy, Raytheon’s chairman and CEO, predicted that the Trump administration would hew to the Third Offset strategy, the Pentagon’s quest to find new technologies.

“I know they’re going to call it something different, but it’s something that’s going to have to get done in order to allow us to be a dominant player in terms of military,” he said.

While all the speakers said higher defense spending is expected, exactly how much is still unclear, particularly with budget caps on the books until 2021.

Strianese was a bit more measured than some other speakers about defense spending, noting Congress still needed to repeal those defense budget caps and that more specifics were needed about priority areas.

“There’s not a budget and there’s not a lot of detail yet, which is hard to model,” Strianese said.

Richard Cody, a retired Army general who is now the senior vice president of Washington Operations for L-3, said he expects little more money in 2017, but anticipated a 2 to 3 percent increase in the Pentagon’s 2018 budget plan.

“Over a five-year [period], we expect to see a much larger — not double digit, but 3 or 4 percent — increase,” Cody said, noting he expects the initial funding bumps to come through the Pentagon’s uncapped war budget.

Cody predicted that Gen. Joseph Dunford, chairman of the Joint Chiefs of Staff, and the rest of the Joint Chiefs would remain in place. Their top priority is readiness.

“They’re going to have to buy it back and buy it back quick if they have to go [to war] some place,” Cody said. “Vertex and some of our other companies are well postured to get moving on that.”

The CEOs brushed off some analysts’ suggestions that Trump’s comments about Muslims and urging allies pay more for their defense could prompt them to shop from European firms instead of American ones.

“We’re going to see, we believe, even more uptick in Europe … South Korea and the Asia-Pacific region, especially Japan and to a certain degree even Taiwan,” Kennedy said.

“We think that we’re going to get a double bounce,” Kennedy said. “One bounce is coming in and refreshing our domestic elements and pouring money into that and the second bounce is the fact that all our coalition partners are kind of being put on notice that we need them to pick up their end of the game here.

“We’re positioning ourselves to take advantage of that in terms of slight alterations of our strategy and our focus in the marketplace,” he said.

Kennedy said in his meetings with allied leaders, he’s not seeing a wavering when it comes to defense.

“The bottom line is, even despite the economics, despite the politics, we still believe these nations need the systems that we have provided them in the past and we continue to provide them for the future to be able to protect their sovereignty,” he said.

Companies Are Winning More Classified Business

Speaking of the Third Offset, it’s apparently spurring classified contracts with defense firms.

“Across the company, we are seeing an uptick in classified domestic and it ties back to … the Third Offset strategy,” said Kennedy, Raytheon’s chairman and CEO.

Earlier this year, Defense Secretary Ash Carter revealed — much to the surprise of Pentagon officials and industry executives — that the Navy has secretly modified Raytheon’s SM-6 to sink ships, in addition to being able to shoot down planes and missiles. And it sounds like more is happening in that secret arena.

An Aviation Week analysis earlier this year projected about $68 billion in the Pentagon’s “black” classified budget in 2017.

“Classified budgets have been expanding in terms of the number of programs included in that space and also growing in terms of dollar amount of those programs,” said Strianese, L-3’s chairman and CEO. “There’s a lot going on in that space.

“I guess if it’s hard to see, it’s hard to cut, which is a good reason why we’re there,” he said.

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Global Defense Spending ‘Upturn’

That’s the prediction in a new Fitch Ratings report. “Global defense spending has stabilized, and should rise in 2017, with the global threat environment serving as a tailwind.” Outside of the U.S., the market is expected to grow between 3 percent and 5 percent, the report states. Note the projections include only markets accessible to US firms and defense companies within the borders of America’s allies. Basically that means the projections don’t include spending in Russia, China, North Korea or Iran. As for U.S. defense spending, the ratings agency assumes budget caps will be raised or lifted in coming years. “[T]his assumption is stronger as a result of the recent U.S. elections,” the report said.

Plane, Ships Don’t Make NDAA Cut

But that doesn’t mean they won’t find their way into the defense appropriations bill at some point. The key is when that point will come. House Armed Services Committee Chairman Mac Thornberry, R-Texas, suggested that the president-elect could request a supplemental spending measure for the $18 billion for fighter jets and ships that didn’t end up in the NDAA. We have the highlights of the NDAA agreed to by the Senate and House here.

Coming Up: Reagan National Defense Forum

Lots of big names on tap this weekend at the Reagan National Defense Forum, aka the “Davos of Defense” after the annual World Economic Forum in Switzerland. It’s become a must-attend event in recent years. I’ll be there and will have a lot more to say in next week’s Global Business Brief. Here’s who else will attend:

From the Pentagon: Defense Secretary Ash Carter, Deputy Defense Secretary Bob Work, Air Force Secretary Deborah Lee James, Gen. Joseph Dunford, chairman of the Joint Chiefs of Staff, all of the Joint Chiefs, Adm. Harry Harris, head of Pacific Command and Adm. Mike Rogers, head of Cyber Command and the NSA.

Business executives: Thomas Kennedy, chairman and CEO of Raytheon, Jerry DeMuro, president and CEO, BAE Systems, Michael Strianese, chairman and CEO of L-3 Communications, Marillyn Hewson, chairman, president and CEO of Lockheed Martin, and Leanne Caret, president and CEO of Boeing Defense, Space & Security.

Other speakers: Defense ministers from the U.K., Norway and Singapore and a number of senators and congressmen. We’ll also be on the lookout for any members of the Trump’s Pentagon transition team.