Reports from Military Vehicles Expo

In preparation for its Military Vehicles Exhibition & Conference on 10 - 13 July in Detroit, event organizer IDGA has published a number of reports & free resources related to the global land systems market. Included are the following one-pagers:

• Official: Marines Need $3B In OCO Funds For Ground Vehicle Reset 
• Stackley: JLTV Contract Award Expected In Fourth Quarter Of FY-12 
• Army Might Replace One Third Of Medium TWV Fleet With Contractors

Good stuff. Again, go here to download.

M&A Consolidation Creating Unexpected Opportunities

A contrarian view on two clear trends emerging in the defense industry that will create unexpected opportunities:

1) Top-tier prime contractors will spend on M&A that diversifies them (further) into UAV, cyber, and intelligence/data.

The most widely accepted trend, this one has the critical fault that the top tier primes do not necessarily have a place in those market verticals. Simply put, why does DoD need the very biggest primes to procure fast-moving technology like cyber and big data? What value do they add for the substantial cost premium? UAV alone is just not a huge market, and both cyber and intel could arguably be served more effectively and efficiently by smaller firms with more exposure to commercial markets. The difference between now and the last big consolidation in the 90's was the nature of the integrations. Back then Lockheed and its Big-5 peers were consolidating other industrial verticals -- other planes and tanks and major programs. From a business perspective that makes clear sense. But this time, the same big companies are attempting to acquire very different types of businesses, and in many cases not the type of companies & technologies that benefit from narrow, long-cycle defense-type development.

These same assets being acquired might be better leveraged in smaller firms with diversified technology business lines.

2) The same top-tier contractors are selling their non-core "mission support" divisions.

The logic seems clear. As the commitments wind down in Iraq and Afghansitan, logistics and engineering support business units -- already single digit operating margins -- become less attractive, especially while chasing new acquisitions in high-margin cyber. So Northrop sold TASC. ITT is currently selling Mission Systems. Also in May PE firm Leonard Green & Partners announced the planned sale of defense consulting services firm Scitor, which it purchased 5 years ago.

In this case I'm not sure it's the market size really shrinking, but the nature of the business risk to the current holders. Surely, these are growing, profitable divisions when the US is deployed somewhere, and that type of support will clearly decrease in coming years. But at the same time, the requirement around the world for vehicle & equipment maintenance and supply chain is set to explode, with no clear leader in a complex global logistics network.

Some argue that the drawdowns will actually increase the need for logistics & supply chain as the DoD organic capability redeploys. During the next 10 years of budget austerity, the fact is existing platforms will obviously need to last longer and will require robust programs for recap/reset, modifications, and upgrades. Especially for the Army's land systems.

Apart from the US based requirements, the need for general maintenance as well as MRO will intensify in emerging foreign markets, when one considers the substantial Leave-Behind-Equipment (LBE) sets and increased Asian, Indian, and Middle Eastern imports, which are frankly growing much faster than the logistics & supply chain infrastructure for those fleets. 

So the issue is likely that large, public companies do not want to compete globally in that verticle due to perceived risk. They rightfully would rather concentrate resources in increasing exports to new foreign markets. However, the same "low-margin" support services business could be a strong match for a foreign company with a different risk profile, looking for a sustainable link to the US DoD & defense base. Likely the right type of strategic buyer could deliver those services a lot more efficiently (i.e. minus Big 5 overheads) and greatly enhance the margins. 

Top Area for Growth in Defense & Government Services

In research, in the trade press, even in polls held on this site, what is the clear #1 area of growth for the defense and government services sector?

"...one of the few areas in which we actually increased our investments, including in both defensive and offensive capabilities.”

M&A volume in this sector up 40% in 2010 and 70% in 2011...

The problem: how can our monolithic, bureaucratic DoD procurement system ever keep up with “hyper-empowered” private individuals grabbing technology right out of an open network? 

Find out more here.

The Pacific Century

I wrote recently on my main site/blog about the strategic shift toward Asia and Oceania. This will be the Pacific Century one way or another.

More Content at a New Site plus Social Media

I've started to write more at my main site http://patrickmalcor.com

I'll still be writing there about broader trends in Government Services and some general topics related to leadership and strategy. I'm planning a lot of new content and a couple of other interesting projects. I hope if you have been reading Defense Ventures you will join me at my main site.

You can also follow my posts on Twitter @pmalcor and connect with me on LinkedIn.

Thanks.

Obama Announces New Military "Strategy"

President Obama visited the Pentagon yesterday to announce the nation's new, leaner military strategy. The WP has a summary here, and the full Defense Strategic Guidance document can be downloaded here.

A very short summary:

Special Ops, drones, and cybersecurity. Out of Iraq, but not the Middle East. No more "prolonged" stability operations. Instead, “tailored capabilities appropriate for counter-terrorism and irregular warfare.”  One war at a time. Expect veterans -- especially Soldiers and Marines -- to get shafted on pay & benefits.

Meanwhile, oil could jump to $210 as the "Great Prophet" moves into the Straight of Hormuz.

Save Money by Reducing Regulatory Burden

I wholeheartedly agree with Daniel Goure of the Lexington Institute, who proposes that the US Government could save up to $80B annually by reducing or eliminating needless, ineffective, innovation-crushing acquisitions bureaucracy. 

If this overhead burden prevents $80 billion worth of waste, fraud or abuse annually, it would at a minimum be a wash. But there is no evidence of this. In fact, there appears to be an inverse relationship between the growth in regulations and oversight and problems with acquisition programs and DoD contracting. There has been no reduction in cost overruns, performance snafus, Nunn-McCurdy breaches and procurement/contracting scandals over the past 20 years. Acquisition programs now take two, three and even four times as long to reach fruition as they did in the era before all the regulations were imposed. What are the costs associated with stretching out programs? I bet it is a lot more than any savings that might have been realized through tighter controls over the acquisition process. It is fair to conclude that DoD is suffering from both a surfeit of regulations and continuing problems of waste, fraud and abuse.

Cheer! Too bad no one will listen.

Looking for cuts?

Ouch. This report says:

"Every year since 1996, the Army has spent more than $1 billion annually on programs that were ultimately cancelled. Since 2004, including FCS, $3.3B to $3.8B, or 35% to 42%, per year of Army DT&E funding has been lost to cancelled programs. The Army cannot afford to continue losing funds in this manner."

(via Battleland)

End of an Era in Defense or More of the Same?

Is it the end of an era for defense contractors, or a cleverly masked status quo? There are two articles worth reading at MSNBC: the first talks about a "golden decade" for defense spending coming to a halting end. The day before a related article describes how the twelve senators from the deficit cutting super-committee come from states with large defense contracts.

The six Republicans and six Democrats represent states where the biggest military contractors — Lockheed Martin, General Dynamics Corp., Raytheon Co. and Boeing Co. — build missiles, aircraft, jet fighters and tanks while employing tens of thousands of workers.

but still:

The wars in Iraq and Afghanistan are winding down, Osama bin Laden is dead, and the federal government is deeply in debt. This spells the end of what was a golden decade for the defense industry.

What's the truth? Frankly, the defense market is likely overreacting just as much as the rest of the market. The initial announced cuts of $350B will almost entirely come from planned, gradual troop reductions in Iraq and Afghanistan. More cuts could happen without destroying the cash-rich defense giants at the top of the league tables. Cut the (still highly notional) Ground Combat Vehicle ($1.3B). The JLTV. Sell the deployed MRAP fleets. Cut one tactical platform each from the Navy and Air Force. Overhaul the military's broken retirement pay system. Make Lockheed and Boeing pay for overruns on the F35 and KC-X (I think this is a done deal, actually). Billions. Very little of that will cut deeply into the multi-year backlogs of major defense contractors -- and there will still be plenty of funding for counterterrorism, unmanned systems, cybersecurity, improved soldier systems, TTL, biodefense... and other new technologies that can be fielded fast and can make a real difference in DoD's mission.

Panetta Tells Congress No Further Cuts

Defense Secretary Leon Panetta, along with Adm Mike Mullen, appeared before Congress yesterday and said further cuts to the defense budget -- beyond the $350B already planned -- would be "disasterous" and "unacceptable." More from NY Times here.