A handful of CEOs are playing down the prospect of defense budget cuts in the fall, but it’s clearly something that’s on their minds. Promising discussions between lawmakers foundered late last week on the usual defense-vs.-domestic-spending debate. And if no deal appears — as we recently explained — a budget storm is brewing that could sizably cut defense spending.
“The last couple of years we’ve had these two-year budget deals,” Lockheed Martin CEO Marillyn Hewson said Wednesday at the Bernstein Strategic Decisions Conference in New York. “We hope we’ll get a budget deal over two years and be done with this kind of crazy public policy around sequestration and capping that.”
Hewson, and Northrop Grumman CEO Kathy Warden, speaking at the same venue, sought to quell investors fears that these cuts might actually happen. Both pointed to defense being a “long-cycle” business, meaning it takes years for companies to feel the impact from drastic variations in federal spending.
“[W]e are a long-cycle business, that it’s a multiyear process to turn those budget increases into sales.” Warden said.
Asked about the impact of a continuing resolution, where spending is capped at the current fiscal year spending levels, Hewson brushed it off.
“That hits some companies harder than others,” she said. “We’re a long-cycle business.”
She continued: “Even if we were to go into a CR…we don’t expect that to have much of an impact on our business. We don’t have a lot of short-cycle contracts or anything that would be impacted. But it’s certainly not good for the country to go into a continuing resolution.
“Your spending on defense oughtta line up with the National Security Strategy. It shouldn’t be some…50/50 or something like that,” Hewson said. “What I’m hopeful of is they will get a budget deal down. I feel like there’s a good, positive dialogue going on right now among the administration and the parties on meeting to get a deal done so that we can get beyond the budget caps and actually have funds associated with what we need from a defense spending [perspective].”
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What’s in the ‘Emergency’ Arms Deal
Late on Friday, as most Americans were beginning their three-day Memorial Day weekend, the State Department announced that the Trump administration would bypass Congress to greenlight 22 arms deals worth more than $8 billion to Saudi Arabia, United Arab Emirates, and Jordan.
“Delaying this shipment could cause degraded systems and a lack of necessary parts and maintenance that could create severe airworthiness and interoperability concerns for our key partners, during a time of increasing regional volatility,” Secretary of State Mike Pompeo said in a statement.
Sadly, it’s not unusual for controversial announcements like this — regardless of administration, political party or branch of government — to arrive at times when most people aren’t paying attention.
Below is a recap of seven of the arms deals, totalling $3.9 billion, that were announced on May 24. We still don’t know what weapons account for the remaining $4.2 billion, or which countries will receive them.
- $1.8 billion and $800 million for “aircraft follow-on support and services.” It includes “follow-on logistics support and services for the Royal Saudi Air Force aircraft, engines, and weapons; publications and technical documentation; support equipment; spare and repair parts; repair and return; calibration support and test equipment; personnel equipment.” The types of weapons are not disclosed.
- $136 million for “continued Tactical Air Surveillance System Aircraft support.” “Saudi Arabia has requested to purchase spare and repair parts, U.S. Government and contractor engineering, technical, and logistics support services, and other related elements of program support for their TASS (Tactical Air Surveillance System) aircraft program.” The program is run by L3 Technologies.
- $900 million for more than 20,000 Advanced Precision Kill Weapon Systems (APKWS) II laser-guided rockets, which are made by BAE Systems. “The APKWS will provide the UAE with flexibility in the use of proportional, precision fires when operating in remote and mountainous regions as well as populated areas,” the Pentagon’s Defense Security Cooperation Agency said in a statement. The APKWS will complement the Hellfire II missile as a secondary precision munition with lower collateral damage potential.”
- $102 million for Raytheon-made Javelin anti-tank missiles.
- $100 million for “U.S. Marine Corps training and support to the United Emirates Presidential Guard Command.”
- $80 million for RQ-21 Blackjack drones, made by Boeing’s Insitu.
What Else Defense CEOs Are Thinking About
Beyond the budget, here are some other issues that getting the attention of CEOs and Wall Street analysts at this week’s Bernstein Strategic Choices Conference.
737 Max grounding: Alexandre de Juniac, head of the International Air Transport Association, said on Wednesday he doesn’t expect the jetliner — involved two recent deadly crashes — to resume commercial flights until August at the earliest. On Wednesday, Boeing CEO Dennis Muilenburg said that the company’s top priority is fixing the Max and returning it to flight.
“[It’s] very clear to us that the top priority is the Max. When it comes to resources, talent, people, we’re assigning people to Max to make sure we achieve our return to flight,” Muilenburg said when asked how the 737 grounding is impacting Boeing’s plans to launch a new airliner project, dubbed NMA, which stands for New Middle Marked Aircraft. Last week, Jefferies analysts predicted the Max grounding would delay the NMA launch.
Short-or-long-term storage: Boeing is still building 40-plus Max aircraft each month; it has to store all of these planes since deliveries to airlines are on hold. In addition to facilities near Seattle (Everett, Renton, and Boeing Field) the company is now parking planes in San Antonio, Texas, Muilenburg said. “We’ve got…a couple of other commercially viable options for additional storage capacity that we’re preparing as well, if we need them,” he said.
We’re used to seeing retired airliners, not brand new ones, lined up at airfields like the Max has been in recent months. There have been aerial pictures (taken on March 26) of a 20-plus Southwest 737 Max aircraft parked at the Southern California Logistics Airport in Victorville, California. Until recently, the Victorville airfield was also home to the two 747-8 airlines that will become the next Air Force One presidential transport aircraft. It appears one of those planes is parked behind this Southwest 737s. Boeing flew one of the 747-8 aircraft to its San Antonio factory on March 27 and the second plane on April 26. In San Antonio, the jumbo jets will be transformed into flying White Houses.
Boeing kind-of-bullish on defense: “You’ll see we’re gaining momentum there,” Muilenburg said. “It’s still a modest topline growth business. That market is a strong market, but flatter market than our commercial market. We are winning in the marketplace. I think you’re going to see continued growing momentum both top and bottom line.” Muilenburg said the company’s contract awards for the Air Force’s T-X pilot-training jet and the Navy’s MQ-25 airborne refueling drone “will add momentum.” While he called the development of its often-troubled Air Force tanker “challenging,” Muilenburg predicted that KC-46 sales will take off after it moves into full-rate production. “That will be hundreds of airplanes over decades along with the longer-term support tail,” he said.
Meeting missile demands: Lockheed is boosting production of various missiles. “When you’re increasing capacity, that means you see that as a longer-term need,” CEO Marillyn Hewson said Wednesday. Lockheed is increasing production of Hellfire missiles from 7,000 per year to about 11,000 per year, and doubling its production of Patriot PAC-3 interceptors. “We’re seeing an increase in order for those,” Hewson said. “Plus, the U.S. government wants to continue to buy those interceptors. In fact, we are adding capacity for PAC-3. We have capacity for about 250 interceptors a year. We’re now increasing that capacity to about 500 a year and it may actually be asked to go higher than that.” Last week, Lockheed broke ground on a new 225,000-square-foot factory for JASSM cruise missiles.
More missiles: Northrop CEO Kathy Warden says her company is poised to become a major supplier of powered munitions. “Well, the world isn’t becoming a safer place, so that drives my confidence that there will still be demand for missile suppliers,” she said Wednesday. “When we think about missiles, we’re not just thinking about traditional, we’re also thinking about hypersonics. The weapon systems development plans that we have include both traditional and hypersonic missiles.”
Northrop recently added the Advanced Antiradiation Guided Missile, or AARGM, to its wares through its acquisition of Orbital ATK. The company is now building a long-range version of AARGM. “[W]e’re getting strong signals that indeed there is room for a third prime supplier and there is interest in working with us to accomplish that,” Warden said.
In addition to hypersonic missiles, Northrop is also eyeing counter hypersonic work. “That’s an issue of detection, it’s an issue of being able to track and it’s an issue of being able to intercept,” Warden said. “We play a key role in more traditional missile defense systems in each of those areas and expect to play an equally important role in counter hypersonics.”
How do you quantify Northrop’s classified business? It’s a question of increasing importance as Northrop and other firms receive more classified contracts from the Pentagon. “One of the things that does make Northrop Grumman a challenging company for investors is it has the largest fraction of classified business of any of the major defense companies,” analyst Douglas Harned said during his Q&A session with Warden.
Investors scrutinize defense programs — particularly, acquisition milestones — to track whether an effort is performing well. In most cases, the military does not announce milestones for classified programs. A rare exception is the B-21 bomber program: every so often the Air Force announces it completed a developmental milestone.
“As the nature of the threat has evolved or the understanding of the threat has evolved, the country has pivoted to more of a focus on classified programs to protect the information about the advanced weapons systems that we are developing,” Warden said.
The Northrop CEO predicted more classified awards down the road, because the company’s portfolio is “well-aligned to that national defense strategy focus on the high-end threat.”
Huntington Ingalls Industries
CEO Mike Petters touted cutting of the first piece of steel for the first Columbia-class ballistic missile submarine, the lead boat of a class that is slated to replace the Ohio class. But he also talked about the possible market for submarines that don’t have sailors inside — and likened the situation to the early days of the aerial drone market.
“Everybody’s got the charts of when Predator and Global Hawk came along, and suddenly the UAV business went from a nice kind-of-technology-development sort of thing. Suddenly, there was a hockey stick where the growth went crazy and the operators couldn’t get enough of them,” Petters said. “In the UUV business, there is a view that that could happen here. I think the laws of physics make it a lot harder. But I think what you’re seeing is you’re already starting to see the growth in resources that are being applied by the government to solve these problems.”
But it’s hard to foresee the market’s ultimate potential. “I’m not sure that I can predict when the knee in the curve is going to be,” Petters said. “I am confident that the value of that business five years from now is going to be substantially bigger than it is today.”
Island, installed: HII’s Newport News Shipbuilding has video of lowering the island onto the deck of the future USS John F. Kennedy.
On Wall Street
Two developments on the M&A front this week: First, aircraft parts distributor Wesco could be up for sale, Reuters reports. “We would not be surprised if the company were considering a wide range of options while they prosecute a turnaround driven by their Wesco 2020 efforts to improve sales, margin & cash flow,” Citi analyst Jon Raviv wrote Tuesday in a note to investors. “Those efforts have taken a bit longer to manifest (especially margin), but recent underlying trends have improved.”
Second, cybersecurity firm FireEye has purchased Verodin for $250 million, the company announced Tuesday. “The Verodin Security Instrumentation Platform adds significant new capabilities to the FireEye portfolio by identifying gaps in security effectiveness due to equipment misconfiguration, changes in the IT environment, evolving attacker tactics, and more,” FireEye said in a statement. “Equipped with FireEye frontline intelligence, the Verodin platform will measure and test security environments against both known and newly discovered threats, empowering organizations to identify risks in their security controls before a breach occurs, and rapidly adapt their defenses to the evolving threat landscape.”
Light ’Em Up
Northrop Grumman is scheduled to fire up the first stage of its new OmegA rocket Thursday afternoon in Promontory, Utah. You can watch the test here at 2:45 p.m. EST. “More than 12 feet in diameter and 80 feet long, the OmegA first stage will fire for 122 seconds and produce more than two million pounds of thrust,” the company said in a statement. Northrop is pitching OmegA to the Air Force to carry national security payloads into space.
Bob Daigle, former director of the Pentagon’s Cost Assessment and Program Evaluation (CAPE) office, has joined Pallas Advisors, the consulting firm founded by Sally Donnelly and Tony DeMartino, aides to former Defense Secretary Jim Mattis.
Air Force Maj. Gen. Mary O’Brien, who leads the 25th Air Force, has been nominated for a third star and to become her service’s deputy chief of staff for Intelligence, Surveillance, Reconnaissance, and Cyber Effects Operations.
ManTech has appointed Peter LaMontagne, CEO of Quantum Spatial, to its Board of Directors.