A Temporary Sigh of Relief

Many Space and Missile Systems are Well-Positioned
for 2009.  The U.S. Fiscal Crisis May
Deflate Other Program Expectations.

by Marty Kauchak
 

While much of the nation fretted about the downturn in the U.S. economy, the U.S. defense industry was able to breathe a sigh of relief—at least for one more year. On September 30, President George W. Bush signed into law the fiscal year (FY) 2009 Defense Authorization Act that provides $531.4 billion in budget authority for DoD and the national security programs of the Department of Energy. Space and missile programs fared well overall in the authorization bill. But budget dynamics including the health of the economy in 2009 and a new administration’s unknown funding priorities may put pressures on the nation’s discretionary spending, including those for defense.

SOME SILVER LININGS ON THE HORIZON

Defense companies are ending 2008 with diminished stock values. The closing prices of stocks (against a 52-week high) at press time of several representative businesses with space and missile products, and services in their portfolios included Northrop Grumman ($45.91 ($85.21)), Raytheon ($44.15 ($67.49)) and Boeing ($42.91 ($98.97)).

Scott Sacknoff, manager, Spade Defense Index, told MSMF that while the overall defense sector has declined nearly 40 percent in value from its highs, the fundamentals of the sector remain strong and the valuations of many firms are now at levels that are consistent with the sector being severely oversold. “With the market operating on fear rather than fundamentals, predictions for 2009 need to assume a return to ‘normalcy,’” he said.

Sacknoff pointed out that with the approval into law of the FY 2009 authorization budget, overall spending on military space and defense should remain consistent with prior forecasts. Similarly, Marion Blakey, president and CEO, Aerospace Industries Association (AIA) explained that generally, the U.S. military space and missile industry is fairly insulated from economic volatility because the budgeting process secures funds well in advance.

Sacknoff added, “An additional spending package of roughly $50 billion is anticipated during 2009 to meet additional spending needs for military operations in Iraq and Afghanistan and will likely include some reset capability depending on the speed of our reductions in force in the Iraqi region.”

The change in administrations will likely see a shift in defense spending as resources move from operations winding down in Iraq to supporting increased operations in Afghanistan and the anticipated military reset to replenish military capabilities. Sacknoff expects “limited changes for 2009, with a new administration arriving in late January and FY 2010 budgets due in February, along with work beginning on a new Quadrennial Defense Review that will provide greater clarity to defense spending priorities.”

Second- and third-tier vendors may be heartened with Sacknoff’s downstream perspective. “Small and midcap suppliers should find the environment over the next several years beneficial as spending shifts from war efforts to research and development of next generation systems, and the reset of existing equipment.”

EXPECTATIONS FOR MISSILE SYSTEMS

The FY 2009 defense authorization bill provides stable funding for core ballistic missile defense (BMD) programs—a high visibility part of the DoD missile systems portfolio— with decrements to some BMD programs that remain in the embryonic stage.

In part, the authorized budget adds more than $175 million for near-term missile defense; $70 million for Aegis Ballistic Defense and the Standard Missile-3; $50 million for THAAD; $28 million for short-range ballistic missile defense; $30 million for an upper-tier follow-on to the Arrow missile; and $20 million for Army BMD technology development programs.

Conversely, a number of offsets were authorized: $29 million from Airborne Laser funds not supporting the 2009 test schedule; $35 million from the Space and Tracking Surveillance System; $50 million from Multiple Kill Vehicles program; $125 million from Missile Defense Agency (MDA) special programs; $45 million from Kinetic Energy Interceptor program; $30 million from the BMD System Core and $10 million for the proposed Space Test Bed.

Accordingly, industry representatives have an upbeat forecast for the missile segment of their product offerings.

AIA’s Blakey told MSMF that her association anticipates that missile sales, which include ballistic missile defense research, development, test and evaluation (RDT&E), will realize an even larger increase in 2009 as missile stocks continue to be replaced from the wars in Iraq and Afghanistan. “Based on DoD budget estimates, we forecast a 20 percent increase in total missile sales in 2009, pushing sales over $19 billion next year,” she elaborated.

Lockheed Martin is one company riding a bow wave of missile defense successes. “Lockheed Martin programs continue to provide exceptional performance and value for the United States and the Missile Defense Agency and are expected to continue to do so for the foreseeable future,” Cheryl Amerline, company spokesperson, told MSMF.

Beyond Lockheed Martin’s string of successes in 2007 and the first half of 2008 in THAAD and Aegis testing—culminating in the Aegis system shooting down the failed satellite threatening to spread a dangerous chemical upon its uncontrolled re-entry— the company continues to explore new opportunities for improved missile defense for the United States, deployed forces, and friends and allies.

“We are supporting MDA efforts to provide the European site for the defense of Europe and enhanced protection for the continental United States. Lockheed Martin will provide the command, control, battle management and communications (C2BMC) functions for the effort,” remarked Amerline.

Approximately 10 percent of Lockheed Martin’s 2007 revenue was related to missile defense programs.

EARLY TURBULENCE FOR SPACE SECTOR

AIA’s Blakey also forecasted that military space sector sales are expected to increase modestly in coming years, perhaps accelerating later as more policymakers see space as another line of defense to be maintained. “We expect military space sales to approach $4 billion in 2009, and a strong backlog ensures continued solid performance for the near future,” she said.

But DoD and Congress appear uncertain to provide the sustained support that AIA and its industry members envision for national security space programs. One program of note is the Transformational Satellite Communications System (TSAT), which is being competed for by Lockheed Martin- and Boeing-led teams.

TSAT is expected to allow DoD to integrate wideband and protected communications satellite architecture into a single network comprising multiple satellite, ground and user segment components. The system ultimately will replace the Milstar and Advanced Extremely High Frequency programs and provide the Global Information Grid network extension to mobile warfighters, sensors, weapons, and command, control and communications nodes located on unmanned and manned aircraft, on the ground, in the air, at sea or in space.

“Our team has worked closely with the Air Force for more than five years to mature the key TSAT technologies and define a program that is adaptive and executable. We are currently working under a $664 million contract for the risk reduction and system definition phase,” said Lockheed Martin’s Amerline. At press time, the Pentagon announced that the next phase of the multibillion-dollar program would not be awarded late in 2008, but rather the award date is undetermined.

INDUSTRY RESTRUCTURING

Companies typically focus on acquisitions and other restructuring actions to enhance shareholder value as a result of strategic, operational and financial benefits to the corporation. Tightening credit and other macro- and micro-economic factors aside, industry expects to push forward with continued restructuring actions in 2009.

Lockheed Martin’s Amerline provided one insight: “We will consider acquisitions of various sizes in each of our business areas. Whenever we are considering new business opportunities, we evaluate whether we have the necessary capabilities or whether we should build, buy or team in order to develop the necessary capabilities.”

Lockheed Martin continues to remain focused on acquisition strategy, which is to acquire smaller companies that offer new market opportunities, customer access or unique technology.

Indeed, in 2008 Lockheed Martin announced four acquisitions through early autumn:

• Eagle Group International—pro vides logistics, information tech nology, training and health care services to the U.S. Department of Defense.
  
• Nantero Government—develops nanotechnology-enabled devices for use in a variety of military and intelligence applications.
  
• Aculight—provides laser-based solutions for national defense and aerospace customers.
  
• RLM Holdings—provides support to a wide-area surveillance radar network for the Australian Department of Defense.
  

In October, another restructuring action came to a close, as Finmeccanica S.p.A. announced that it successfully completed its acquisition of DRS Technologies Inc.

INTERNATIONAL EXPECTATIONS

Globally, defense spending is on the rise with the total market passing $1.3 trillion, with U.S. defense companies sharply focused on international opportunities for 2009.

“An increase in the willingness by the DoD to allow exports of military hardware should benefit firms seeking this market,” said Sacknoff. Within days of these comments, U.S. Secretary of Defense Gates and Italian Minister of Defense Ignazio La Russa signed an updated Reciprocal Defense Procurement Memorandum of Understanding, which allows effective defense cooperation by establishing principles and procedures recognized by both governments for the conduct of defense procurements. “Under this agreement each government provides access to its defense market to the industry of the other country,” stated a U.S. DoD press release.

Amerline said that Lockheed Martin’s “current international business represents about 15 percent of our annual sales.” Looking forward, Lockheed Martin expects to see continued increases in this segment of its business, with a longer term goal to expand the international percentage of its total revenue. “In the missile defense area, we expect to see growth on key programs such as PAC [Patriot Advanced Capability]-3, Aegis, THAAD and MEADS,” she accurately forecasted.

Soon after those remarks, the Defense Security Cooperation Agency notified Congress of a possible Foreign Military Sale to Taiwan of 330 PAC-3 missiles, associated equipment and services. The total value if all options are exercised is $3.1 billion. ♦