Is it CSAR-X? Is it KC-X? The Next-Generation Bomber? F-22? The Future Combat Systems? Or maybe the Expeditionary Fighting Vehicle? Certainly the DDG-1000, right?
What gets cut, if not killed, and by how much and how fast - that's what is dominating conversations in the aerospace and defense realm from the Potomac to the Hudson. In a seemingly sudden acceleration of events, the new Obama administration is recrafting the fiscal 2010 budget under its own green eye shades wherein most observers thought such scrutiny wouldn't start until the next budget cycle. All the programs above have been listed in news media tea-leaf reading, including our own pages at Aviation Week, and they come while the prospects for major acquisition process reform appear to be climaxing.
As AvWeek's Joe Anselmo reports, it has Wall Street and industry on edge. A&D stock prices are getting hammered by repeated blows brought by headlines purporting the next major defense program to be cut, as well as a slowdown in the commercial sector. Merger and acquisition activity in the U.S. aerospace and defense industry is falling off a cliff. Acquisitions declined 57 percent in 2008 to $14.3 billion, virtually drying up in the fourth quarter as the global economic crisis intensified and companies moved to conserve cash, PricewaterhouseCoopers reports.
Still, the industry is much healthier than it was last decade, when post-Cold War Washington sought to cash out on part of the defense budget. And there is still much to be spent on national security. Indeed, the Defense Department expects to invest more than $357 billion over the next five years on the development and procurement of major defense acquisition programs, congressional auditors said in their latest report on the government's high-risk programs, which the Pentagon dominates.
But these defense programs also continue to take longer, cost more, and deliver fewer quantities and capabilities than originally planned. The U.S. Government Accountability Office (GAO), the investigative arm of Congress, plans to release its latest assessment of the cost overruns and delays afflicting the Defense Dept.’s largest weapons programs. The last such GAO report, last spring, sent shock waves from inside Washington’s Beltway out through the country over the fact that 95 of the Defense Dept.’s largest acquisition programs were, on average, two years behind schedule and have exceeded their original budgets by a combined total of $295 billion.
The end result of it all is a lack of conventional wisdom. Morgan Stanley’s Heidi Wood questions whether the new administration is laying the groundwork to lower the boom on the industry next year as it pushes its fiscal 2011 budget request. “We believe President Obama’s real views about defense are coming to light, and it doesn’t bode well,” Wood wrote in a recent research note. “The economic crisis, atop Obama’s ambitious domestic agenda, says something has to give.”
But not everyone on Wall Street shares Wood’s pessimistic view. Macquarie Research Equities analyst Robert Stallard says defense stocks are priced as if earnings will peak in the coming year. He believes the Pentagon’s core budget will continue to grow at 2 percent above inflation for the next 3-4 years.
“The major driver of U.S. defense spending over the last 50 years has been the global threat environment,” Stallard says. With defense stocks trading at a 25 percent discount to the S&P 500 after recent declines, “we think the valuation case is compelling.”
We won't really know until the administration details its FY '10 budget, which is expected within a month. That's a long, long time in Washington-years, so don't expect relief any time soon.