Defense Shift Drives a Boost in Spending

By James Flanigan

Sept. 8, 2002 12 AM PT

A year after the attacks of Sept. 11, the United States has launched a once-in-a-generation increase in defense spending and is taking it in a new direction, even though most of the money spent this year and next will be for paying and supporting troops in the war on terrorism and not for sparkling new weapons.

At least $30 billion in new appropriations since Sept. 11 have been spent on supporting troops in Afghanistan and elsewhere and patrolling U.S. coastlines, air space and military bases. The heavy burden of such operational spending will continue indefinitely because of the higher level of readiness since Sept. 11.

But the Defense Department also is embarking on a long-term effort to transform traditional ships, planes and armaments into networked communications and computing platforms. In military planning and spending terms, this is a historic turning point comparable to the aftermath of World War II, when the modern Defense Department was created, and the early 1980s, when the Reagan administration dramatically increased the military budget.

The defense budget, due to rise 15% to $366 billion in fiscal 2003, which begins Oct. 1, is projected by the Congressional Budget Office to expand more than 8% a year for the rest of this decade. Defense spending would total almost $700 billion in fiscal year 2010, but still would be a smaller percentage of the total U.S. economy than during the big defense buildup in the 1980s.

Pentagon policy is shifting away from traditional plans to fight major wars against other nations. The new emphasis will be on creating “a portfolio of capabilities” aimed at “dissuading potential adversaries from threatening the United States, its interests, or its friends and allies,” in the words of Deputy Defense Secretary Paul D. Wolfowitz in a recent guidance for military departments planning budgets for 2004 through 2009.

The aim is to develop flexible armed forces capable of combating terrorist groups and chemical, biological and technological warfare. The Pentagon has begun awarding contracts for design of new kinds of ships and aircraft.

It is ordering satellite surveillance systems and advanced communications and computer systems that would allow U.S. forces to hit enemy targets from afar. Planners cite the fighting in Afghanistan, in which global positioning satellites in space and U.S. special forces on the ground identified targets then hit by traditional bombers, as an example of information aiding weaponry.

The new defense policies could bring many jobs to major defense contractors over this decade, but also could curtail or cancel other programs for fighter planes, helicopters, tanks and other vehicles. For example, Secretary of Defense Donald H. Rumsfeld recently canceled the Army’s Crusader artillery program, which would have cost $11 billion, to free up funds for the high-tech weapons his policies favor.

Smaller companies stand to benefit most from the Pentagon’s new emphasis. Companies such as L-3 Communications Holdings Inc. and Alliant Techsystems Inc. are thriving by supplying communications and smart-weapons components to major defense contractors--Lockheed Martin Corp., Northrop Grumman Corp. and others.

But analysts caution that growing defense budgets don’t automatically make defense stocks a successful investment. “Despite large increases in spending, there are still too many programs to be funded,” says analyst Pierre Chao of Credit Suisse First Boston.

Investors can watch for argu- ments over program cuts between Rumsfeld and Defense Department officials and committees of Congress, where views of the military services and defense contractors often hold sway.

For example, Rumsfeld wants to cut back the F-22 fighter program to eventual production of 180 planes, down from the 331 planes that the Air Force and contractor Lockheed Martin are counting on producing and the 750 planes envisioned a decade ago when the F-22 was conceived as a replace- ment for the F-15 fighter. Billions of dollars in research and planning have been spent on the F-22 so far.

So why cut back production, which has not even begun? One reason, given by Wolfowitz and others, is that fighter planes, which imply close air combat, will be needed less when warfare is carried on from long distances by surveillance systems and long-range bombers and ships. A bomber version of the F-22 is being considered for development, says a Lockheed Martin spokeswoman.

The new class of destroyer that Northrop Grumman is designing at its Newport News, Va., shipyard exemplifies the new weaponry. In an artist’s rendering, the proposed vessel looks like a metal box on a long raft, recalling the Merrimac and Monitor of the Civil War. But such a ship, packed with elec- tronics, computing and laser gear and communicating constantly with satellites, is supposed to be able to stand offshore and disrupt the workings of whole cities. In concept, it could stand in the Persian Gulf and target Baghdad, say military analysts.

There are several implications of the new policies favoring mobile special forces as opposed to massive forces. In military tactics, they recognize, as Rumsfeld says repeatedly, that U.S. forces can’t be ponderous and slow in a world in which enemies move with speed and stealth. Of course, the Viet Cong taught the United States that lesson long before Al Qaeda.

Shifts in defense policy have given rise to entrepreneurial firms within a long-established industry.

L-3 Communications was created in 1997 by former executives of Loral Corp. when Loral was acquired by Lockheed Martin. L-3 has grown to more than $3 billon in annual sales by concentrating on sophisticated communications such as new systems it is developing to allow Army helicopters to share information in combat.

Alliant Techsystems, a specialist in ammunition, was formed in 1990 when Honeywell International spun off defense operations. And United Defense Industries, which did $2 billion in research work on the now-canceled Crusader, is a medium-sized company backed by former Defense Secretary Frank Carlucci’s private equity firm Carlyle Group.

Will that Crusader artillery system research now go to waste? Not really. Whatever principles of physics, aerodynamics and propulsion were discovered will be applied to other weapons systems and perhaps ultimately in the commercial economy.

Global positioning systems now guide commercial trucking and shipping--and automobile drivers too. Integrated circuits, invented in 1958 with support from defense research, have become ubiquitous in devices of modern life. And the Internet, developed in 1969 with Pentagon support, goes on simultaneously shrinking the world and expanding knowledge.

Defense spending, which has been crucial to the development of the U.S. economy--not to mention the economy of Southern California--for at least 60 years, is entering a new expansive period.

James Flanigan can be reached at jim.flanigan@latimes.com.

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How Defense Shares Have Fared

Shares of most defense-related companies are higher today than they were the day before the terrorist attacks, reflecting investors’ increased interest in the sector over the last year. But shares of smaller defense issues generally have fared better than the stocks of the industry’s biggest companies, as investors have hunted for niche players. Here are stock price data and market capitalizations (share price multiplied by number of shares outstanding) for 17 companies.

Major Companies

9/10/01 Friday Pctg. Mkt. cap Company price price change (millions)

Lockheed Martin $38.32 $64.67 +69% $29,418

Northrop Grumman 81.94 123.08 +50 13,903

Raytheon 24.85 36.31 +46 14,628

General Dynamics 75.97 77.00 +1 15,553

Boeing 43.46 37.21 -14 29,741

S&P; 500 index 1,092.54 893.92 -18

Smaller Companies

CACI Intl. $20.68 $35.77 +73% $1,096

L-3 Communications 31.50 52.84 +68 4,965

Herley Industries 11.68 19.02 +63 279