print friendly pdf

The Sept. 11 attacks forced US stock markets to shut down for days. When they reopened for business on the following Monday, Sept. 17, many of the nation's corporate stocks immediately experienced dramatic plunges.

Many, but not all.

Take, for example, Northrop Grumman. Its stock closed on Sept. 10 at about $82. On Sept. 17 it closed at nearly $95, a whopping 16 percent gain on a day when the overall Dow Jones Industrial Average fell by more than seven percent.

Meanwhile, Lockheed Martin's share price in that one day rose 15 percent. Even Raytheon, whose management woes have caused it some difficulties on Wall Street, had a banner day. Its share price skyrocketed by some 27 percent. Other examples, large and small, abound.

The trend was obvious: With war talk in the air, and the general economy roiled by worry, pure defense firms suddenly seemed to be a safe bet. In effect, hardened investors were signaling their view that the US defense industry was back, big time. (Boeing, a major defense player, slumped because of problems in civil aviation.)

"Defense," wrote a group of Credit Suisse First Boston analysts, was "a 'no-brainer' investment."

Many officials in Washington agree. Even before terrorists unleashed the attack that brought national security back to the top of the nation's agenda, defense firms had been on a roll. The expectation that President Bush would boost defense spending combined with the relative stability of defense contractors pushed defense stocks up.

Open Spigot?

Now, with the United States embroiled in "a new kind of war," as Bush put it, Congress is waving through major increases in defense funding, with virtually no dissent. Not surprisingly, this turn of events has turbocharged the defense industry.

What will the industry be called upon to do?

The first big batch of post-attack funding went to "intelligence," broadly defined. The question of exactly what it will buy won't be answered until the Bush Administration presents its Fiscal 2003 budget in February. However, the Quadrennial Defense Review, hastily reworked after the attacks and delivered to Congress on Sept. 30, provides some clues.

For instance, it called for more spending on unmanned Intelligence, Surveillance, and Reconnaissance platforms. Counterterrorism efforts would also get more funding under the QDR strategy.

The document highlighted other priorities that have long been cited by Defense Secretary Donald Rumsfeld: missile defense, cyber-warfare weapons and defenses, space operations equipment, and covert strike platforms such as huge submarines bristling with accurate cruise missiles.

Since the QDR was unveiled, a hot war has commenced, and experts note that it will aggravate many pre-existing problems in defense hardware accounts. Two weeks into the conflict, a senior USAF officer warned that wartime operations are "burning up" aircraft, many of which are old and in need of replacement. At the same time, he said, critical new types of munitions are in short supply.

The munitions problem appears certain to generate procurement on a substantial scale.

"We don't know what munitions we are going to expend," said Undersecretary of Defense Dov Zakheim, the Pentagon comptroller. "What I am concerned about is that I not be the stumbling block, that people don't come to me and say, 'My God! We've run out of munition X and munition Y.' My job is to ensure that they have what they need, when they need it, and that the process supports that to the fullest extent possible."

Overall, analysts expect that there will be enough new spending to give a lift to the whole industry. But some companies will benefit more than others.

One contractor in a strong position is Northrop Grumman, which as much as any other firm, has transformed itself from a manufacturer of flashy, high-profile platforms to a diversified supplier of the kinds of electronics, avionics, and ISR systems that many experts expect to be the backbone of America's future military.

In 1990, the B-2 bomber accounted for half of Northrop's sales. Since then, the company has diversified its programs such that no one system accounts for more than five percent of the company's revenues.

The evolution has occurred partly by necessity. Congress, for instance, cut the B-2 procurement from 132 to 75 and finally to 21. In 1991, Northrop lost out in the competition to become the prime contractor for the USAF F-22 fighter. The story was the same with the Joint Strike Fighter in 1996.

Diversifying

Northrop's response? Since 1994, it has purchased a dozen other contractors, including several with expertise in the fields of radar, jammer equipment, and software. Among them were big names such as Grumman, Westinghouse, and Litton Industries, including electronics and shipbuilding.

Today, the closest thing Northrop Grumman has to a showcase weapon is the DDG-51 destroyer, which recently acquired Litton (Ingalls Shipbuilding) has been building for years. However, the company has a portfolio that looks tailor-made for the kinds of reforms Rumsfeld has in mind for America's new war. The biggest line item on the company's income statement, for example, is electronics, which includes the key components for intelligence systems and other weapons. That accounts for slightly more than one-third of the company's projected earnings for 2001, according to Merrill Lynch.

Northrop builds the Global Hawk unmanned spyplane, which could end up an unlikely hero of a war in which intensive ISR is likely to back the bombs and bullets that will be expended.

The $12 million-per-copy Global Hawk is designed to loiter at altitudes up to 65,000 feet. That makes it much harder to shoot down than the Predator Unmanned Aerial Vehicle, which flies at about 25,000 feet. Global Hawk can stay airborne about 36 hours. It can be outfitted with a variety of sensors able to see through clouds and camouflage and track moving targets. The UAV isn't due to be fielded until 2003, but accelerating the Global Hawk program--and buying more of them--are widely considered to be among the Pentagon's new priorities.

"Clearly, there is tremendous visibility right now to the UAV," said Zakheim. "And the possibilities that these systems offer are limitless. You can hang all kinds of equipment on them. They will go places that manned aircraft would only go at exceedingly high risk. They can get you information that, again, could only be acquired at high risk by manned systems. They get it to you in real time. They allow you to completely restructure the way you operate on the battlefield, and so those are very high priorities. ... These UAVs, we are doing our best to accelerate."

Whether new technology will ultimately make a difference in the war against terrorism remains to be seen. There certainly are skeptics who believe that more spending on intelligence hardware will leave gaping holes, such as a lack of human intelligence and an outdated intelligence structure.

The QDR proposed to "expand procurement of the same data collections systems that failed to find tactical targets, such as armored vehicles, in Kosovo," says one critical defense staffer on Capitol Hill. "Now we are being told they will find terrorists in Afghanistan. We shall see."

The Pentagon is seizing the moment to accelerate projects that senior military leaders have had in mind for some time. The QDR makes the case plainly: "The loss of life and damage to our economy from the attack of Sept. 11, 2001, should give us a new perspective on the question of what this country can afford for its defense," wrote Defense Secretary Rumsfeld in the foreword. "This nation can afford to spend what is needed to deter the adversaries of tomorrow and to underpin our prosperity. Those costs do not begin to compare with the cost in human lives and resources if we fail to do so."

If Congress goes along, as it seems inclined to do, the Administration's high-priority missile defense program will be a major winner, along with the companies that build the systems.

Cold Storage

Opposition to missile defense has evaporated or at least gone into cold storage. In the aftermath of the terror attacks, Congressional amendments designed to delay or kill spending for missile defense were dropped. Congress approved $7.5 billion for the program this year. While Carl Levin, Senate Armed Services Committee chairman, vowed that the debate over missile defense "has not gone away," most analysts consider the prospects for missile defense to be brightening rapidly.

The timing couldn't be better for Boeing, which as lead system integrator for the Pentagon's national missile defense program, gets half of every dollar spent on the system. Boeing could use the money. The company's stock fell by about 18 percent on the first trading day after Sept. 11, as struggling airlines rapidly cut back orders for commercial aircraft. It suffered another big hit in October when Lockheed Martin won the dearly sought contract for the Joint Strike Fighter program, worth as much as $200 billion.

Missile defense, by contrast, could be Boeing's salvation. In the week after the September attacks, one analyst rated Boeing stock as a "strong buy" and predicted its price in the next 12 months would rise above its highs for the prior year.

Other contractors will be called on to assist the missile defense effort. Raytheon, which builds the kill vehicle and other components, earns about 30 percent of every dollar spent on the program. Lockheed Martin builds booster rockets and TRW produces the electronics. Even if opposition to a missile umbrella over the United States heats up again, the need to protect overseas bases from missiles should keep spending revved up, since there is broad consensus on the need for it.

Economic Stimulus?

Other spending priorities in the wake of the Sept. 11 attacks are less predictable, except for the general theme that there will be more money for everything. Beyond that, defense spending also counts as a fiscal stimulus that could help bounce the nation out of a sudden recession.

The combination could be irresistible, with some analysts expecting the overall defense budget to soar from $329 billion in 2002 to close to $400 billion in 2003. Much of the increase will go to new defense procurement, they say.

The QDR highlighted capabilities that Rumsfeld believes will be key to fielding the force of the future.

In the Army, for instance, the QDR endorsed the interim armored vehicle the Army has begun to field a boon for General Motors and General Dynamics Land Systems, which build it. But the document was more enthusiastic about the Future Combat System the Army is designing to replace the interim armored vehicle and ultimately the tank.

The Army's plan calls for fielding the Future Combat System throughout the force over the next 30 years. But one top defense official says Rumsfeld would like to speed up the program, with full deployment in 10 to 15 years. There's no contractor yet for the system which in theory would be a set of sensors and vehicles that gather targeting data in one location and relay them to a firing platform someplace else.

Another Rumsfeld priority-power projection. Rumsfeld is seeking a greater capability to rapidly strike distant targets and swiftly move troops to faraway war zones, even when an adversary is working hard to deny access.

An emphasis on moving troops faster would probably be an extra bonus for Boeing, which builds the C-17 transport. It could also mean Lockheed Martin, the biggest defense contractor, would build more of its C-130J transports.

There may also be the beginning of a race to develop a new bomber. The QDR review teams pondered the question of whether the Air Force's plans would lead to a shortage of long-range aircraft not dependent on vulnerable bases close to the combat theater. "There was no movement to kill tacair," says a defense official, "but maybe scale it back." In addition, he says, Rumsfeld has tasked the Air Force with developing plans for new long-range strike platforms.

Lockheed Martin is involved in so many projects that it is destined to benefit from increased defense spending, even if much of it goes to programs on which Lockheed is not the prime contractor. For starters, Lockheed will get a boost from winning the Joint Strike Fighter deal, along with subcontractors Northrop Grumman and BAE Systems. And it gains from the Pentagon's plans to go ahead with the F-22, which was in some doubt during the QDR deliberations. Other Rumsfeld priorities should fall in Lockheed's lap. He has singled out space systems as worthy of attention, not surprising since in 2000 Rumsfeld chaired a Congressionally appointed commission on the subject. Lockheed builds military satellites and launch systems and should do well in that business.

An enhanced emphasis on cyber-warfare and information security will play to Lockheed's systems divisions. And while defense contractors worldwide are eagerly eyeing a rising Pentagon budget, Lockheed also has a vigorous export business going. It has orders for enough F-16s, for example, to keep its lines going for several years.

The war on terrorism could have immediate impact on certain US companies. The Predator UAV, for instance, is likely to be deployed in considerable numbers. General Atomics builds the aircraft, but Lockheed and Northrop provide major components.

And if DOD indeed begins to think more expansively about national defense, the largesse could accrue to other firms that don't routinely sell to the Pentagon.

In the end, officials believe the defense buildup will be long and sustained, like the US war effort now under way.

"The [spending] slope is positive," said Zakheim. "We are clearly pointing upward."