NEWS ANALYSIS : War May Yield Mixed Results for U.S. Arms Firms : Defense: The conflict indicates that high-tech weapons work. But the industry fears that the U.S. will deplete its inventory and have no budget for replacements.

The fog of the Persian Gulf War has descended on the defense industry itself, obscuring whether the conflict will ultimately prove to be a benefit or detriment to weapons manufacturers.

Early reports from the field suggest that the central strategy of the defense establishment, which has long espoused the merit of lavish spending on the very highest-technology weapons, has paid off.

Stealth fighters, advanced cruise missiles and sophisticated command systems appear to have performed competently in the war so far, winning endorsements from military and

political leaders. More importantly, American soldiers have been spared by systems that reduce their vulnerability to enemy fire.

Even if those

performance reports hold up as the war proceeds, however, there is a growing concern in the industry that they will not translate into increased production of current weapons. Nor is greater support for controversial high-technology systems now under development--such as the B-2 bomber or advanced tactical fighter--guaranteed.

Indeed, the cost of the Persian Gulf War is so great that it threatens to deplete the defense budget of money that would otherwise pay for future procurement. That would mean that the industry will have even harder times than originally foreseen, some industry executives say.

And if today’s high-technology weapons continue to perform well, financial analysts worry that Congress may see less need in the immediate future to move on to the next generation of advanced weapons, especially if tensions with the Soviet Union continue to ease.

“I am very worried that there will be a very adverse impact on the procurement accounts and eventually the research and development accounts, unless the country decides to have some kind of a supplemental budget authorization for Operation Desert Storm,” said General Dynamics Executive Vice President Ralph Hawes. “Procurement is going to get dinged pretty hard.”

The Bush Administration has adeptly avoided disclosing its cost estimates for the Persian Gulf War. The General Accounting Office, a branch of Congress, estimated before the war started last week that the crisis would cost the U.S. Treasury an additional $37 billion this year, wiping out the $36 billion that was carved out of total government spending last year.

Now that the shooting has started, those costs are certain to escalate sharply. And once the war ends, the United States could well face an expensive long-term troop deployment in the region.

It remains unclear exactly how much of the cost of the Persian Gulf War will be contributed by U.S. allies. But so far, the limited early contributions are going into the Treasury’s general fund, rather than the defense budget.

Even a quick victory would not erase the savings and loan crisis, the economic recession or the other financial burdens weighing so heavily on the nation. When the euphoria of victory wore off, the grim reality of the nation’s financial condition and the burden of the enlarged budget deficit would sink in.

In a declining defense budget, the wartime performance of American weapons might not do much good for the industry, said Prudential-Bache Securities aerospace analyst Paul Nisbet. But he does not believe that the industry’s outlook has necessarily worsened.

“I don’t think Congress will be in a position this year to deny the extra money,” Nisbet said, estimating that there will be a supplemental appropriation of $25 billion to $30 billion for the war. “If we have a successful four- to six-week war with few negative surprises, the outlook will be somewhat better than before all this started, but there still will be a long-term downturn.”

Hawes, though, worries that the government already has failed to reconcile the cost of the war with its ongoing plans to reduce defense spending.

“Here we are in a hot war, and if we use these weapon systems, there is no plan for replacing them,” Hawes said. “We are going to end up with a very depleted inventory and no budget for replacement. It is a grim scenario for the industry, but it is an even grimmer scenario as far as I am concerned about what that means for our ability to sustain another engagement if we have to.”

The ability of the services to fund the B-2 bomber and the advanced tactical fighter is even less clear, though the Persian Gulf War appears to have vindicated the idea of buying ultra-sophisticated--albeit expensive--weapons.

Ben Rich, who retired just two weeks ago as chief of Lockheed’s famed “Skunk Works”--its secret aircraft unit in Burbank that built the F-117A--said the nation should hold back its euphoria. But he acknowledged that the good performance “is going to help the technology people. If we can come back with minimum losses, that shows technology pays.”

Stealth technology, Rich said, enables U.S. pilots to enter combat with a much better chance of survival--something he figures that the American public is willing to pay for. “The leverage of stealth is survivability. That’s the whole idea behind it,” Rich said.

Wall Street investors were so enamored of the U.S. military’s performance this week that stock prices--including those of major defense firms--shot up.

“The implication is that these guys in the defense industry saved our boys,” said Paine Webber analyst Jack Modzelewski. “People will say, ‘We’ll pay anything for this equipment.’ The American people embrace winners, and right now the defense industry is a winner.”

A senior scientist at Hughes Aircraft said Thursday that many technical experts are gratified that their weapons finally are getting the benefit of good military planning, training and execution.

“It is premature to make judgments, but everybody is impressed by what they have seen so far,” he said. “We are amazed at the planning. In so many exercises in the past, there were planning problems, and the technology never had a chance to succeed.”

Perhaps the industry’s fondest wish is that it will enjoy a fundamental change in its tarnished reputation.

“We as an industry have gotten an awful lot of criticism about our ability to put out quality products,” Hawes said. “We are going to see numerous success stories--that, by God, we really put out things that are very sophisticated and work very well.

“That would imply that maybe we really have solved some of our problems. Maybe we haven’t solved all of the cost problems that people would like us to solve, but we have in the reliability and operability of our products.”

But will that matter? Others agree with Hawes that it may not matter much.

“The F-117A went in and knocked out a lot of Iraq’s radars and air defense systems--and the F-117 is old stealth technology,” said Donald Hicks, a former undersecretary of defense who also was a Northrop executive. “It isn’t nearly as good as the stealth in the B-2 bomber. Weapons like the B-2 bomber can be terribly important to our defense capability.”

Although Hicks says the performance in the Persian Gulf has “has been a real vindication” for the industry, he adds: “When all of this is done, and it comes time to look at what we should do in the future, I am not sure this is going to have much effect. A lot of time the technology gets blamed, when it is the acquisition system that is at fault.”

Defense critics have not had their say yet in whether the Persian Gulf War should launch the nation on a continued path of weapons development. And it is not clear how well the high-technology weapons would perform against a tougher adversary.

“When historians write the events of this war, it may appear that the Iraqis completely underestimated the American threat,” Lawrence Harris of Kemper Securities Group said Thursday. “It is probably not a fair test of these weapons versus what they would get from the Soviets.”

If the judgment remains that the weapons did well, some critics will seize that as the rationale for not producing even more capable weapons.

Byron K. Callan, an analyst for Prudential-Bache Research, said the effect of a quick war might be a “bittersweet” victory for the industry. If the existing technology works better than expected in the Persian Gulf War, he added, weapons under development may not be needed in the foreseeable future.

“There will probably be a replenishment of munitions stock,” he said. “But early victory is a two-edged sword for the industry. You’ve shown that existing hardware is effective, but there’s less reason to upgrade the systems.”

The best hope the industry has is for future increases in foreign arms sales. And nowhere is the market looking better than in the Middle East. A pending $15-billion sale of aircraft and tanks to Saudi Arabia has the industry spinning.

Hughes Aircraft is so eager for the sale to move forward that it asked its employees to engage in a letter-writing campaign to members of Congress, asking for their support and specifically mentioning the sale’s importance to defense job prospects. The campaign, however, left a bad taste in the mouths of some managers, and it was substantially toned down.

“A lot of people feel that if you put sophisticated weapons in the Middle East, some day they may be shooting at us,” one Hughes manager said. “Saudi Arabia is no more stable than Iran was.”

Foreign arms sales may ultimately prove to be a minor factor in the industry’s future. Although high-technology weapons seem to have proven themselves in battle, the defense industry has yet to show that they are affordable.

A number of industry experts, including Hawes and Hicks, believe that the imperative facing the industry is to bring down weapons costs and permit the Pentagon to buy in larger quantities.

“If we had the same type of system for commercial industry in this country, we couldn’t sell anything,” Hicks said. “Nobody could afford a washing machine.”

DEFENSE STOCKS AT WAR A number of aerospace and defense company stocks, many of which had been weak in recent months, were revitalized by the outbreak of war. How key stocks moved between Jan. 15, the United Nations’ deadline for Iraqi withdrawal from Kuwait, and the close Friday, versus the broad market index of the S&P; 500.

NYSE close NYSE close Stock Tues. Jan. 15 Fri. Jan. 18 % Change GeneralDynamics 213/8 251/4 +18.1% General Motors-H* 16 3/4 18 3/4 +11.9% McDonnell Douglas 28 3/4 31 7/8 +10.9% Rockwell International 24 1/4 26 1/2 +9.3% Northrop 18 1/8 19 3/8 +6.9% Lockheed 33 7/8 35 7/8 +5.9% Loral 35 1/4 35 3/4 +1.4% Raytheon 69 3/4 70 1/8 +0.5% S&P; 500 index 313.73 332.23 +5.9%

* Represents former Hughes Aircraft Co., now part of GM Hughes Electronics