'Old Economy' Newport News Is Seen Anew

By JAMES FLANIGAN

Feb. 27, 2000 12 AM PT

Why has Bill Gates’ personal investment company bought a stake in Newport News Shipbuilding Inc., a major contractor to the U.S. Navy? Who knows?

Gates may not even know what the managers of Cascade Investments, who invest some of his personal fortune, are buying. But in Newport News those managers probably see a solid company in a business set for improvement in the next decade as the Navy renews its shrunken fleet.

Newport News, a $1.8-billion company that builds nuclear submarines and aircraft carriers, will benefit from expanding Navy budgets in this decade, as will General Dynamics--the other nuclear-sub builder--and Litton Industries, which owns two yards that build conventional vessels.

Newport News’ order backlog will swell this year to roughly $7 billion from just over $3 billion because of work on new classes of submarines and aircraft carriers. The company’s per-share earnings rose 25% last year, thanks to growth in fleet repair and services.

But the 114-year-old company is not a hot stock. Since being spun off in late 1996 from Tenneco--which acquired Newport News in 1968--the shipbuilder’s stock has risen from $17 a share to a high of $34.25 last May, before falling back to its present price of about $26.50 a share. News of Cascade Investments’ acquisition of 8% of the stock did not send Newport News soaring like an Internet play.

Nor should it. Newport News and other defense contractors, though they hold enormous technological resources within their companies, have been ignored by investors in recent years. Fashion has swung to information technology stocks in anticipation of dramatic changes in industry.

But changes in defense are more historic than dramatic. The Navy in the 1990s, after the end of the Cold War, saw its budgets decline and its fleet shrink from 600 ships to just more than 300 at present. With fewer new ships built, the vessels of the fleet are older.

So it’s time for renewal. The federal budget being prepared now for fiscal year 2001, which begins Oct. 1, will contain more than $12 billion for Navy shipbuilding. That’s a decided increase from expenditures of $6 billion a year that prevailed in the 1990s.

Navy budgets these days contain funding for a new Virginia class of submarines on which Newport News and General Dynamics will share the work.

The Defense Department and the White House are committed to a multi-decade replacement of 50 to 60 nuclear submarines. And the Navy is having the vessels, which cost $1 billion apiece, built cooperatively--thus maintaining full-time work at both Newport News in Virginia and General Dynamics’ Electric Boat division in Groton, Conn.

For aircraft carriers, Newport News is taking on additional responsibility for new vessel projects that typically run seven to eight years.

As a result, contracting to the Navy promises to be a more stable business than in the past. That’s why investment analysts and defense experts are drawn to Newport News and the other shipbuilders.

“The Pentagon now is doing a better job of sharing risk with its contractors,” says Jon Kutler, head of Quarterdeck Investment Partners, a Los Angeles and Washington investment banking firm specializing in defense issues.

Kutler adds that defense stocks constitute a “hedge” against a bear market--because defense budgets are trending up and prices of defense stocks remain relatively low.

That doesn’t mean defense stocks will take off soon, just that military shipbuilders are likely to have better earnings in the next few years--and the stock market eventually will take notice of that fact.

In the parlance of today, Newport News and other defense firms are “old economy”--relying on earnings to support their stock price and enduring stretches when the market is unwilling to pay a premium for those earnings.

But companies in that old economy can build up value when nobody is looking. Newport News today is an efficient company, doing better on its own than as a subsidiary of the Tenneco conglomerate. It has prepared for increased business by acquiring Continental Maritime of San Diego, a fleet-repair yard from which Newport can service carriers in the Pacific Fleet.

Newport News, founded by Collis P. Huntington in 1886 as a builder of commercial vessels, is the only firm able to refuel nuclear carriers--a steady business for the decade ahead as ships commissioned in the ‘70s and ‘80s require fuel replacement, a process that takes three years and costs $1 billion.

And military business is not going away. The need for aircraft carriers and a renewed fleet become all the more evident as events in Asia, the Middle East and even southern Europe appear to require a continuing U.S. military presence to preserve the peace.

“We have no land bases across vast stretches of the Pacific,” notes Loren Thompson, a defense analyst with Lexington Institute, a research firm in Arlington, Va. In the Persian Gulf, the situation is similar.

That’s why the “Navy plans to eventually use the Virginia class submarines for stealthy land attack, with cruise missiles. And it will rely on aircraft carriers, which are very useful if you have no land bases,” Thompson points out.

So the “new” economy, of instant and Internet communication and extraordinary trade in goods and services, depends for its unhindered operation on the U.S. fleet and the “old” economy shipyards that build it. Maybe Gates’ investment managers understand that more than most.

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Return to Sea

The Navy’s budget for building ships declined by more than 40% after the end of the Cold War, in 1989, and expenditures satyed down through most of the 1990s. The U.S. fleet shrank from about 600 ships to 316 as a result. But renewed expansion will get underway with the federal budget now being prepared for fiscal year 2001. Statistics show Navy’s annual expenditure for “construction, acquisition or conversion of vessels,” as the budget phrases it.

U.S. Navy Shipbuilding Expenditures

(in millions of dollars)

2005 (estimated): $9.33 billion

Navy ship construction:

*--*

Year Number of vessels 1989 20 1990 20 1991 10 1992 10 1993 8 1994 6 1995 4 1996 5 1997 5 1998 5 1999 6 2999 6 2001 8 2002 8 2003 8 2004 8 2005 7

*--*

Newport News Shipbuilding at a Glance

* Headquarters: Newport News, Va.

* Business: Building, repairing, servicing nuclear submarines and aircraft carriers for U.S. Navy

* 1999 revenue: $1.8 billion

* 1999 earnings per share: $2.31