Cold War Fallout: Cash for Stockholders but Fewer Jobs

Mikhail S. Gorbachev, speaking last week at the Missouri site where Winston Churchill declared that an “Iron Curtain” had descended across Europe, used industrial language to describe the arms race of the now-ended Cold War.

“Defense sufficiency was exceeded,” said the former Soviet leader, dispensing with the rhetoric of global politics. Arms production was overexpanded and so now both Gorbachev’s country and our own face the problem of shutting down defense plants or converting to commercial work.

The U.S. defense industry is burdened by massive overcapacity--with four times more missile production than the Pentagon could conceivably want, and similar excess in just about every other weapon.

That’s why consolidation is gathering steam. General Dynamics revealed last week that it’s negotiating to sell its missile division, a big, $1.4-billion-a-year business that makes the cruise and Tomahawk and other missiles.

The GD negotiations, with Hughes Aircraft, follow last month’s announced sales of LTV Aerospace assets--civilian fuselage work to Northrop Corp. and its missile business to the Thomson-CSF Group of France, which beat out bids by Lockheed and Martin Marietta.

The trend means many things on many levels: Cheers in the stock market, relief in the Pentagon, competitiveness in the industry but a challenge in employment.

Defense firms are becoming attractive on Wall Street because investors see them accumulating cash and increasing payouts to shareholders. As their business outlook declines, the companies have little need for new investment but cash is flowing from old contracts and now from sales of operations.

General Dynamics, for example, now has $1.2 billon in cash and the missile division sale could bring it another $500 million.

And Chairman William Anders says, “We believe the most effective and efficient way to apply our excess cash to the commercial economy is through distribution to shareholders.”

For Anders--the former astronaut who flew around the moon in 1968--it’s a simple matter. Shareholders--including Chicago’s Crown family which owns 20%--are not paying him to buy into other businesses. “The purported benefits of military-to-commercial diversification are largely illusory and such investment would be wasteful,” Anders told GD’s annual meeting.

So the company, which has already hiked its dividend markedly, is contemplating a stock buyback or special distribution to shareholders. GD stock is up 41% in the last two years.

GD has been the most aggressive so far in selling assets, says analyst Lawrence Harris of Kemper Securities, but others will follow as the winnowing process comes to other weapons. There are four makers of helicopters, for example--the Bell division of Textron, Boeing, McDonnell Douglas and the Sikorsky division of United Technologies--but a market for only one or two. There are seven fighter plane makers with work available perhaps for three.

So shakeout time is here and the Pentagon is relieved. With weapons-procurement budgets expected to fall in the next few years from more than $120 billion to less than $75 billion, the Defense Department couldn’t keep a lot of contractors going even if it wanted to.

Chances are the Pentagon won’t object to the sale of LTV’s missile division to France either, says John Harbison, aerospace expert for the Booz Allen consulting firm. Truth is, the U.S. industry is weakened by too many defense firms working at 25% of capacity, says Harbison. In Europe, aerospace firms have consolidated and the survivors are stronger.

When experts talk of survivors in the U.S. industry, Lockheed heads the list because of its strength in four product areas--missiles, space, aircraft and electronics. Rockwell gets a nod for electronics and rocket engines, Martin Marietta for electronics. And Northrop is seen to be securing its future as subcontractor of fuselages to Boeing. The list is short; all defense companies will shrink.

And that means defense employees will lose their jobs. With the Cold War over, the United States can’t and won’t continue to make weapons simply to employ people. And defense firms cannot really switch to commercial work--”the sword maker cannot make a cost-effective plowshare,” as one expert put it.

The answer to new employment, in Russia as in this country, will be in small organizations. Entrepreneurial firms will be set up to hire away defense personnel, perhaps even renting or buying a company’s idle factory space. There will have to be government funds to help workers and communities make the transition, says Lawrence Korb, former assistant secretary of defense for manpower who is now a fellow at Brookings Institution.

And some of the cash building up in defense companies will be part of such transition funds, helping to pay early retirement benefits and the like. Company executives and investor owners should not forget that today’s cash surpluses result from five decades of massive public expenditure--and so have public obligations in this new peaceful decade.

Let us all not forget other truths as well. One, this could be a great national opportunity. From a shortage of scientists and engineers to do commercial work, we now will have an abundance. “There are 60,000 research workers in defense labs alone,” says Korb.

And two, defense workers are losing their jobs not because their business failed but because they succeeded. They won the Cold War. Now let’s hire the veterans.