Politics matter.

The WSJ reports that Northrop Grumman will withdraw from competition for the Air Force's $40B contract to build a new KC-X fuel tanker.

It's been a long and twisted battle to this point. Boeing originally won the contract in 2002, but Sen John McCain then complained that the Air Force would get a better deal buying the planes versus leasing. By 2003 two senior executives at Boeing (including a former Air Force acquisitions official) headed to prison on charges of illegal job negotiations. The acquisition restarted in 2006 and resulted in a win for Northrop Grumman and partner EADS. Boeing quickly protested. The latest solicitation has been out since Feb 2008, and Northrop has complained that the new scope greatly favors Boeing.

From WSJ:

"We are disappointed by Northrop's decision not to submit a bid for the...program," Deputy Defense Secretary William Lynn said. "We strongly believe that the current competition is structured fairly and that both companies could compete effectively."

The decision also dismayed many lawmakers from regions that stood to benefit from a Northrop win. "I am deeply disappointed that Northrop Grumman was unable to submit a bid for the KC-X tanker program. Frankly, I am outraged at the Defense Department's bungling of this contract for what is now the third time," Rep. Jo Bonner (R., Ala.) said in a statement. Northrop had planned to build an assembly plant in Alabama.

Normally the reader comments on an article like this are unbearably moronic, but in this case there is some decent & substantial discussion if you click over to that. A couple operators that seem to know what they are talking about and some comments on what this bungled acquisition means in terms of larger strategic priorities. Good stuff.

The Feb issue of the SPADE Investor newsletter has a good general analysis of the new U.S. defense budget. Overall the budget looks as strong as ever and should be received by the sector as highly positive for increased competition and generally increased spending.

• Core defense budget (which excludes overseas CONOPS) will grow around $15B annually for the next 5 years
• 2010 supplemental is $33B and 2011 has $159B for overseas operations
• Time & materials and labor hour contracts will decrease 17% through 2011
• SOCOM gets a 6% increase in spending (plus 2800 new personnel)
• DA will add a 12th active duty brigade (a combat aviation brigade) in 2010 and another in 2015
• M&A firm Houlihan Lokey says the 60 transactions completed in 2009 is likely to rise. 50 of those deals were sub-$100M. A confirmed shift from large "exquisite weapons programs" will surely fuel continued M&A as big firms continue to diversify into growth areas like cyberwarfare, UAV, and overall more technical services.

Much more coverage in the full issue, including mention of Sikorsky developing an unmanned Blackhawk, as well as earnings report coverage of all the majors and more.