Defense Industry Poised for Period of Steady Gains
Only a few years after the end of the Cold War, arguments over U.S. defense policy are heating up and cuts in defense budgets may be history.
At the same time, the outlook for the defense industry, and its resilient companies, is improving.
That was underlined last week when Northrop Grumman Corp. agreed to pay $3 billion for the defense electronics operations of Westinghouse. Already debt laden, Northrop borrowed more to make the acquisition, confident of a secure future for military business.
And Northrop is right. What is happening in defense reflects a long-term pattern that was established at the Cold War’s end by, among others, Gen. Colin Powell, then chairman of the Joint Chiefs. Powell wanted to avoid a hasty dismantling of the U.S. military. He succeeded, and the defense posture he helped devise at that time accounts for much that has happened since.
That’s the perspective we should keep in mind as we watch day-to-day events, like the fancy prices being paid in defense acquisitions.
Raytheon last year paid $2.3 billion for E-Systems, a Dallas-based electronics company, and General Dynamics acquired Bath Iron Works, a military shipbuilder. General Dynamics’ move was significant because only four years ago it led the industry in shedding defense operations, as reductions in Pentagon budgets accelerated.
Now signs point in another direction. The deal prices say that defense business will be good in the years ahead, not rapidly growing or boom and bust as in the old days but steady.
“It will be a business of upgrading older planes and weaponry, retrofitting with newer technologies,” says analyst Nicholas Heymann of NatWest Securities. It will be a business of building ships and cargo planes for global military missions and of working with foreign customers for U.S. military hardware and expertise.
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Above all, the business will be supported by stable and even rising defense budgets. The political consensus favors defense spending. President Clinton last year added $25 billion over six years to his long-range defense plan and the Republicans in Congress added another $25 billion.
From $265 billion in defense spending for fiscal 1996--down from $294 billion in 1991--Pentagon budgets are scheduled to decline slightly and turn up after fiscal 1998. But with public sentiment favoring defense, an upturn may well come sooner, says analyst George Shapiro of Salomon Bros. investment firm.
That’s especially true if work gets going on the National Missile Defense system--the focus of a dispute between President Clinton and Congress. The proposed missile defense--a kind of Star Wars, the Next Generation--would site anti-missile missiles all over the United States as a defense against rockets launched from so-called rogue states, such as Iraq, Iran, North Korea.
It would cost a lot of money--$40 billion to $50 billion. Even so the latest defense authorization bill set a time table for building such a defense. Clinton vetoed the bill and his veto was upheld last week.
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However, the veto was not on grounds of cost but because such a missile defense might violate the 1972 Antiballistic Missile Treaty with Russia. And that means some kind of system--described in different language--may well be built, say Washington defense experts. The effort in turn will spur industrial development of sensor and surveillance technology.
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But, you may ask, how did we get to this point seeing that only a few years ago all the talk was about peace dividends?
The answer is we got here by calm assessments of the U.S. role in the world.
The current defense posture grows out of thinking in the Bush administration--prominently by Gen. Powell--as the Berlin Wall came down in 1989. Powell wanted to prevent the chaos that occurred after World War II when U.S. military forces were first reduced by 90% and then hurriedly built back up again.
As he relates in his book “My American Journey,” Powell wanted a “capability-based” force. “We still needed the capability to move huge stores to unpredictable trouble spots around the world,” Powell writes. “We still needed the capability to project power elsewhere.”
He proposed that the United States, while reducing military personnel by 25%, retain forces capable of fighting across the Atlantic and Pacific, plus a home-based force ready for deployment to trouble spots and a nuclear deterrent force.
And that description is remarkably close to the U.S. military today, with armed forces personnel down about 25% from the peak but capable of standing guard in frozen Bosnia--as it also stands guard in the Persian Gulf and elsewhere around the world.
The weapons procurement budget at about $40 billion is down 66% from its 1980s peak but it is unlikely to be slashed further. “In fact, Congress has added money to make it $46 billion,” says Richard Bitzinger, an analyst at Washington’s Center for Strategic Budgetary Assessments.
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The truth of the matter is that United States is willing to pay heavily to lead the world militarily. It now spends three times what any other nation spends on defense, accounting for 37% of the world’s military expenditure, according to Lawrence Korb, who was assistant secretary of defense in the Reagan administration and is now a scholar at Brookings Institution.
And that expenditure is the base of a permanent military industry that has adapted to changed circumstances--through mergers, consolidations and roughly 400,000 job cuts--and is now poised for better times.
Curiously enough, investors saw early that the defense industry would adapt and grow following the Cold War. Aerospace-defense stocks, which tumbled along with the Berlin Wall, have been gainers every year since 1991. “And if the military chiefs get even some of their budget requests this year,” says Loren Thompson, of Georgetown University, a long time Pentagon watcher, “this could be a standout industry in a slow economy.”
