Let Defense Cash Flow Nurture New Business

C. Michael Armstrong, the recently appointed chairman of Hughes Aircraft, is a newcomer to the defense business. But he reckons he doesn’t need to know much about missiles and military procedures to handle the job today: “I know how to lay off and how to abandon facilities. I have no problem downsizing,” says the former IBM executive.

Armstrong, 54, took the reins at Hughes, the aerospace subsidiary of General Motors, six months ago--just in time to announce a restructuring that will cut 12,000 employees and close 92 plants and offices by the end of next year. He is also contemplating cutting Hughes missile division’s work force in half over the next few years.

Like other aerospace companies, Hughes is under pressure from cuts in defense spending that could reduce the Pentagon’s budget by one-third, or almost $100 billion, in five years. Essential U.S. defense capabilities can still be maintained at the lower budget level, says Armstrong.

But he thinks rapid and random downsizing is a colossal waste because it puts engineers and scientists out of work just when their talents are needed to convert the U.S. economy from a specialization in weaponry to a mastery of globally competitive products and processes.

We have the goods, said Armstrong in a speech in Anaheim last week entitled “Defense Technologies to Reignite American Competitiveness.” “We can turn military air defense into civil air traffic control,” he said. “Sensors that warn of chemical warfare can be used to detect pollutants; signal processing can yield digital telephone systems; cruise control radars and infra-red night vision can lead to automotive safety systems . . .”

But an industry developed over half a century can’t be transformed in a few hurried years, he said.

Armstrong, who ran IBM’s massive international operations before coming to Hughes, isn’t speaking to hear himself talk. There is a special Hughes agenda behind his words and a sophisticated understanding of what defense contractors need for the transition to civilian work--and what it means for Southern California.

Cash flow is the key--the stream of income and depreciation that funds all business, plus the weekly and monthly progress payments that characterize defense contracting. At Hughes, for example, $600 million a year in cash flow from defense electronics helps the telecommunications and satellite operation because it pays light and heating bills, and salaries and pensions for more staff than the satellite business alone could afford.

Similarly, defense cash can nurture new industry. Hughes is investing $400 million to launch a direct broadcast satellite to bring 100 channels of television to North America. The venture will “begin to return revenues in 1996, ’97 and so on,” Armstrong explains. So a little extra defense cash could keep things humming until direct broadcast pays its way.

Armstrong suggests that defense cuts be stretched over the rest of this decade to help Hughes build up its $3 billion (sales) commercial operations to balance its $5.5 billion defense electronics business.

Oddly enough, now is a good time to make such a suggestion. Defense conversion is a watchword among advisers to the incoming Clinton Administration. “They talk of trying to integrate work on military and commercial products,” says Loren Thompson, of Georgetown University’s National Security project. And Chairman Les Aspin (D.-Wis.) of the House Armed Services Committee, who may become Secretary of Defense, favors parceling out business to preserve the defense industrial base.

“It would be nice if they had a coherent plan for the 400,000 aerospace engineers and scientists,” analyst Wolfgang Demisch of UBS Securities remarks wryly--not to mention the 4 million people employed directly and indirectly by defense and the military.

Still, cuts will be made in the defense budget; it is not about to become a federal job protection program.

And defense firms, overstaffed now with thousands of Pentagon contract specialists and oversight managers, will have to cut jobs as they convert to other work. Hughes, for example, will eliminate four layers of managers in cutting 20% of its work force. “We’ve become top heavy,” says Armstrong.

Ultimately the solution for Hughes and other defense firms will lie beyond downsizing, in splitting big companies into smaller firms with separate stock to attract capital from the public. Hughes is being reorganized now in separate companies for missiles, for telecommunications and space, and so on. Future sales of stock in those Hughes companies “are a possibility,” says Armstrong.

Also, GM could raise money by selling shares in its Hughes and Delco subsidiaries--now listed as General Motors Hughes Electronics “H” stock on the New York Stock Exchange.

On the investment level, such possibilities make Hughes, and other defense electronics companies such as Raytheon and TRW, “exciting,” says analyst George Shapiro of Salomon Brothers.

On the human level, splitting into smaller firms could be more promising for employees than the current downsizing--which is merely threatening. There could be a blossoming of productivity in these reorganized firms, says Armstrong.

The truth is there will be a lot of planned and unplanned consequences as we convert the defense industry. Layoffs of talented people are inevitable, but that doesn’t mean that aerospace engineers will flip hamburgers. Already in Silicon Valley, computer programmers laid off from working on space satellite photographs at Loral Corp. are looking for jobs at Apple Computer. “I predict that within a few years we’ll have great advances in imaging on our workstations,” says a technology expert.

But rather than have skills and technology developed with taxpayers money dissipate or lie dormant, connections should be made between government support and venture capital to allow companies to adapt defense technologies. That’s what Hughes has done over two decades, going from government to commercial satellites, to providing business networks and ground communications services.

And now it is moving into digital cellular mobile telephones, linked to satellites--an opportunity to bring advanced telecommunications instantly to countries and regions isolated throughout history.

It is both a credit and a caution that those technologies have been developed in Southern California, the area that attracted Howard Hughes, founder of Hughes Aircraft, from Houston, and gave the aerospace industry its beginnings and some of its finest hours.

“Hughes will start its new ventures here because we have the engineers and scientists,” says Armstrong. But for the follow-on production work, Armstrong is concerned about Southern California’s costs; it will have to be competitive.

Like its No. 1 industry, and the country at large, Southern California needs to think about restructuring and change.